Is Resource Nationalism on the Rise?

by Alena Mikhan and Andrey Dashkov

According to an Ernst and Young (E&Y) report Business Risks Facing Mining and Metals 2011-2012, resource nationalism is the biggest risk companies currently face. Wikipedia defines resource nationalism thusly:

Resource nationalism is a term used to describe the tendency of people and governments to assert control over natural resources located on their territory.

E&Y argue that during the last three years resource nationalism has been rising. In the 2009 update of the Business Risks report, it was risk number nine. Just a year later it had jumped to fourth, together with the related "social license" risk (difficulties with local communities that may or may not approve of mining operations for environmental, safety, or land ownership reasons). Social license is risk number four in the current edition of the report, while resource nationalism is number one.

Resource nationalism and issues involving the "social license" are parts of a broader notion of political risk. Besides local community support and the danger of out-and-out expropriation, political risk includes the potential to lose income directly and indirectly because of increased taxes, royalties, social unrest, and other uncertainties.

When a certain commodity appreciates and costs associated with production do not rise similarly, windfall profits happen. The E&Y report states:

Because the mining and metals sector rebounded quickly from the global financial crisis, it became an early target to help restore treasury conditions. In a number of producer nations, concerns over "Dutch disease" or two speed economies have led to plans to tax mining more heavily, and provide tax relief to other sectors.

From the outset of 2011 we have seen numerous countries changing their fiscal environment (taxes, royalties), and some have invoked "use it or lose it" clauses. Governments worldwide have also been looking to increase local participation in projects and we think that this trend will only increase.

Mike Elliott of E&Y states that in the past 12-18 months, the company has identified at least 25 countries that have either announced the intention to increase government’s tax take or have done so already. The most recent examples are Ecuador and Peru.

This August Ecuador President Rafael Correa claimed that he wanted mining companies to sign exploitation contracts that will pay 8% in mining royalties instead of the current 5%, thus adding $100-200 million to the national treasury in 2012. The royalty payments, Correa demands, should be paid in advance of production, before a company is "starting to extract the mineral." This virtually guarantees that no new mines will be built.

Peru – a leading producer of copper, silver, and tin – raised taxes after leftist president Humala came to power at the end of July. Mining companies are rumored to have agreed to pay higher royalties under new tax system already. Under this system, companies are going to pay royalties based on their operating profits instead of sales. The new system will be similar to Chile’s. Though the new royalty rates are still undefined, they will definitely be higher than the current rates of 1% to 3% charged on sales. Many African countries – such as Ghana, Namibia, and Tanzania – show signs of the same disease. Moreover, even such jurisdictions as the U.S. and Australia seem inclined to increase mining taxes and royalties.

Governments may consider the mining industry a handy source to cover extra expenditures or deficits, but they also realize that mining companies provide jobs in mining areas, directly and indirectly. It is a global practice of mining companies to support local communities and offer various services to them, often building schools and clinics, etc. And it goes without saying that mining companies pay taxes and royalties to the government anyway. Thus, there should be a fair balance between state or local community claims and a company’s ability to remain competitive. It is economic suicide to eat the goose – or mine – that lays the golden eggs.

One would think that a good, pro-business environment would be where most capital-intensive businesses such as mines get built. Interestingly enough, that is not always the case; you can’t tell Mother Nature where you want to find metals, and politically riskier countries are found in the top gold producers’ ranks.

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Since it’s impossible for gold mining investors to avoid political risk entirely, they are forced to accept some of it, but must be wise and cautious.

News reports state that "economic genius" President Hugo Chavez has announced his intention to take over Venezuela’s gold sector which produces around 400,000 ounces of gold per year. With gold beating nominal records, we expect the decree to come in short order and Venezuelan gold production to shift into decline not long after the developed multimillion-ounce deposits in hand are plundered.

The trend we observe in the making is not a happy one. It makes weird sense, given gold’s performance and the smell of windfall profits gold miners should be enjoying. They often aren’t, as mining costs have been rising as well – particularly in capital expenditures. With the N-word – nationalization – in action, it becomes even more difficult to start a profitable operation in what seems a stable jurisdiction.

["Politics" is just one of Doug Casey’s "8 Ps" that Louis James evaluates on his frequent rock-kicking trips, scouting for the best small-cap precious metals investments around the world. Turn his due diligence into your investment profit by subscribing to Casey International Speculator. It’s risk-free for three months.]