Latham & Watkins partners Glen Ireland, Chair of the firm’s Mining & Metals Industry Group, and Clement Fondufe, Chair of the Africa Practice, look at the challenges facing foreign-owned mining companies and discuss how mining companies and Sub-Saharan African governments can make open-access infrastructure arrangements work while attracting new types of investors to their railway and seaport infrastructure projects.
What are the most significant impediments to extracting Sub-Saharan Africa’s world-class undeveloped mineral deposits?
Fondufe: The majority of Africa’s commodities are meant for export markets, therefore it’s critical that you have the infrastructure in place. But in some cases, the cost of the infrastructure is significantly greater than the cost of developing and operating the mine itself, which is why this is such an important problem for Africa to solve.
Ireland: Political instability or risk, increasingly volatile commodity prices and resource nationalism tendencies are all significant impediments to the development of resource projects in Africa. But during the last several years, the greatest impediment to the development of these world-class mineral deposits is the lack of an existing railway and seaport transportation infrastructure, the increasing cost of building that infrastructure — because the deposits are increasingly inland — and the emerging debate between mining companies and governments about how that infrastructure is to be controlled and used.
African governments have articulated a new vision for mining in Africa, which calls for mining projects to be developed in a way that increases the benefits for local economies. This is supposed to be achieved through greater linkages among the mining projects, their infrastructures and local industries. The government wants the rail and the port assets’ extra capacity to be made available to other industries — such as agribusiness, passenger rail and other smaller mining operations — in addition to the first-mover mining company. The rationale behind this is that none of these other businesses would be viable if they had to build their own rail and port facilities.
Will weakened commodity prices and shareholder demands influence how large-scale infrastructure projects are funded?
Ireland: From the mining companies’ perspective, the weakened outlook for commodity prices could mean that cash flows in the future may struggle to support the massive capital investment that’s needed for these new projects. Additionally, investors in most of the major mining companies are concerned about the amount of value destruction that has occurred with the last series of mine development projects, which experienced large cost overruns and delays that ultimately led to multi-billion dollar asset impairments. And like all shareholders, they are increasingly looking for yield; they want mining companies to pay greater dividends rather than get involved in another series of major capital projects — especially if it is seen as being outside the core function of mineral extraction.
What innovative approach does Latham propose to solve Sub-Saharan Africa’s railway and seaport infrastructure challenge?
Ireland: Historically mining companies have sought to own, control and maintain exclusive use of their rail and port infrastructure projects because it gives them maximum operational flexibility and allows them to achieve operational efficiencies. But faced with increasing pressures from shareholders and demands from governments for an open-access infrastructure model — we believe it’s feasible for mining companies and governments to implement alternative structures that can reduce the financial burden on the mining companies and allow the infrastructure to be developed and financed on an independent basis. Under this new and independent approach, African governments would have a greater degree of confidence that open-access arrangements would actually work.
Our idea is that the infrastructure component would be separately developed, constructed, owned and financed in a Special Purpose Vehicle (SPV) benefitting from the first-mover mining company’s commitment to use it. The SPV would commit to making the infrastructure component available on an open-access basis to other users, with the first-mover mining company having certain pre-agreed founder rights including priority access.
Could this approach make large-scale infrastructure projects more economically viable overall?
Ireland: When mining companies invest their money, they need a relatively high rate of return for investors because they are in a relatively risky business. But if you break the infrastructure piece away from the mine, you can structure it as a utility-type business. An infrastructure utility wouldn’t generate huge profits, but it would have stable, low-risk cash flows because it would benefit from a financially strong, long-term dedicated customer base. Therefore, its cost of capital and, consequently, investment hurdle rates would be much lower.
What types of investors would an SPV-type structure in Africa attract?
Ireland: As we look at the possibility of different models including an SPV-type structure, we are exploring whether this could open up access to new pools of capital, which are desperately needed to fund African infrastructure. There are funds set up to invest in high-yielding, low-risk utility assets but they are not seeing as many public infrastructure opportunities in OECD countries as they would like due to government financial contraints. So the question would be whether a portion of those pools of capital would be interested in well-structured infrastructure opportunities in frontier economies. That’s yet to be established, but needs to be tested.
I think that international development banks, which have been trying to solve Africa’s infrastructure problem for many years, would also support and invest in mining infrastructure projects if they are well structured. They, too, have been promoting the idea of open-access infrastructure in Africa, and the mining sector presents real opportunities to achieve this.
What is the single biggest impediment to successfully realizing this kind of financing structure?
Ireland: In order for this to work and be credible for all the stakeholders, an open-access infrastructure requires strong regulatory oversight. Where we’ve seen successfully functioning open-access infrastructure networks, we find a capable expert regulator that can make sound decisions about access, tariffs and enforcement of regulations. In Sub-Saharan Africa, the government regulators and other institutions that are needed effectively to regulate multi-user scenarios simply don’t have the capacity and, in some cases, do not exist, and even if they were to be created would take years to achieve credibility.
This is an area that requires further thought and a degree of creativity. International arbitration doesn’t strike me as the answer because it’s very expensive and time consuming and doesn’t necessarily bring to bear the expertise required. We are exploring different possible regulatory options that would provide a cost-effective regime for reaching appropriate regulatory outcomes in a timely manner and that would be acceptable to Sub-Saharan African governments.