Mining Finance Africa: Great Expectations and Great Challenges

The risk of under- and overestimating difficulties in Africa.

Anita Kruger

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JOHANNESBURG, SOUTH AFRICA – The African extractive sector is back in the global spotlight. With 12% of global oil reserves, 40% of the world’s gold and up to 90% of chromium and platinum group metals (as estimated by the United Nations Economic Commission for Africa), it is not hard to understand why. The continent’s vast wealth in mineral resources coupled with impressive growth figures averaging at 5% annually over the last two years has given rise to great expectations in foreign investment flows. However, each of Africa’s 50 plus economies face challenges, both unique and general, raising the questions about the permanency of its new title of being the world’s second fastest growing economy.

Over the past decade the rise in commodity prices has aided greatly in Africa’s growth trajectory, yet whether this will be enough on its own to launch the continent as an economic powerhouse remains to be seen. Recent strikes, continuing uncertainty surrounding resource nationalization and price decreases in certain commodities have already taken its toll on major mining houses such as Rio Tinto, Barrick and Kinross who have set their sights on mining projects in Africa. $3.7 billion of British-Australian Rio Tinto’s $14 billion loss against its 2012 profits was due to the 80% write-down of its coal project in Mozambique, according to Euromoney. Kinross suffered a similar blow in Mauritania after acquiring a 100% interest in the Tasiast gold mine that was responsible for most of its $3.2 billion impairment charge at the end of 2012. Barrick remains optimistic that it can make its copper operations in Zambia profitable despite taking a $3.8 billion charge in the fourth quarter, mainly due to rising costs of operations.

As it is becoming clear that the industry has underestimated the difficulties of developing mining projects in Africa, investors have become much more conservative with placing their bets in African mining sectors, especially over the last six months.

Following China’s fiscal stimulus in 2008, Chinese companies were eager to buy up assets in Africa in order to diversify its commodities supply and shareholders of big mining houses were eager to compete in these acquisitions. However, China’s decreasing demand for imports of metals since mid-2012 has signaled a change in the voracious investment attitude to one of anxiety. This is also visible in the contraction of 43% in global bank lending to the mining sector as reported by Ernst & Young.

With the major mining companies becoming increasingly hesitant to embark on new large-scale projects, junior miners are also feeling the pinch as they rely heavily on the infrastructure developments that accompany such projects. Junior miners in Africa are struggling to raise the capital they need from major mining companies or the Chinese, leading to a risk of being stuck with undeveloped assets while stock prices decline.

However, all is not lost. While the public market has become more skeptical, many private equity funds are getting wind of distressed assets and looking to take advantage. In sub-Saharan Africa alone investments of $1.3 billion were made by private equity units in 2012 and in February 2013 the African Development Bank announced that it would give $50 million towards a private equity fund held by the US-based Carlyle Group, which plans to invest $500 million in sub-Saharan Africa, according to the UN’s Africa Renewal.

Investment in Africa is never risk free and up to 50% of private equity investments in Africa are placed in these units’ existing portfolio companies in South Africa, as a launchpad for investment into the rest of Africa. Factors such as local empowerment initiatives and indigenization also shape the investment environment in Africa. The limit on foreign ownership in many African countries means that private equity firms must structure their investments through locally-owned entities making investment choices not just about providing capital but also carefully forming the right partnerships to navigate the dynamic regulatory environment that is created by the overlap between the public and private sector in the mining industry.

Despite the challenges and growing pains, the continent is experiencing a higher rate of return on foreign investment than any other developing region. According to the IMF, sub-Saharan Africa’s economy is expected to grow by 6.1% in 2014. If this trend holds to be true, the role Africa plays in the global economy is set to become increasingly important. By 2040, it will be home to a fifth of the world’s young people, causing the size of its labor force to surpass that of China. There is still much to be done to alleviate poverty, and to promote transparency and good governance, but with the African middle class on the rise these measurements are sure to improve. Africa and its vast resources cannot be discounted when it comes to long-term strategic planning. Investors, however, must be wary of two common mistakes: underestimating the ease of developing the mining industry in Africa, and overestimating its challenges.

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