Mining Projects in Under-Developed Countries are Risky Ventures

Implications: As global demand for mineral commodities like copper, nickle, gold and aluminum continues, major mining companies are venturing into under-developed countries to find and exploit new world-class ore deposits.  Major ore deposits are increasingly difficult to find in stable and/or developed countries.  The risks mining companies assume when investing in under-developed countries include extreme political and social risk, poor safety conditions, government corruption, lack of infrastructure to support world-class mining operations and inadequate supply networks for fuel, consumables, supplies and spare parts.  To the extent major mining companies bank their futures on projects in the under-developed worlk, their risk profiles change dramatically and investors should expect higher returns on their investments. 

Analysis: The Wall Street Journal article appearing today (5/31/07) regarding Phelps Dodge's investment in Tenke Fungurume copper and cobalt mine in  the Congo illustrates very well the significant risks major mining companies are assuming by investing in the developing world.  The world-class ore bodies in stable operating environments in places like Canada, the United States, Australia and Chile are largely tapped out, so finding large projects that provide a mineral reserve stream over many years are increasingly difficult to find in those countries.  Additionally, these stable countries are adopting increasingly more stringent environmental standards that increase the cost of new projects significantly.  Global mining companies who once feigned at assuming the risks in developing countries like the Congo are now increasingly finding it necessary to invest in such places to maintain or grow their future production profile and meet global demand for mineral commodities.

The Tenke Fungurme project illustrates the following risks that major mining companies often must assume by investing in projects in under-developed countries:

1.  Political and social risk:  Under-developed countries often have very unstable governments and social environments due to a proliferation of poverty and disease.  Investment contracts aren't worth much if a country's government might be replaced by another regime in short order.  Terms like environmental requirements, tax stabilization agreements, etc. can be difficult to enforce over time due to the lack of "rule of law."  Furthermore, mining companies are often targets for social protest as can be demonstrated by the periodic suspension of operations at projects like Newmont's Yanacocha project in Peru.  Mining projects even face the threat of nationalization in countries like Venezuela whose current governments have a socialist agenda.
2. Poor safety conditions:  Many under-developed countries are in a virtually state of civil war with destabilizing insurgent groups or factions competing for power.  Mining projects often operate in remote rural areas where help from government militias is not readily available when needed.  It is not uncommon for mining companies to staff their own militias to ward off attacks from insurgents at least long enough for government troops to arrive.  Adequate medical facilities are often not available in the areas mining companies are operating, so they must staff their own medical facilities to handle emergencies.
3. Government corruption:  Under-developed countries are often rife with corruption from the highest level of government down the the local police force.  Mining companies are often faced with demands for bribes to move forward with construction and development of projects or to sustain operations once a project is underway.  This is a particularly difficult scenario for companies that are subject to the Foreign Corrupt Practices Act in the United States.
4.  Under-developed countries often lack the infrastructure to support world-class mining projects such as railroads, paved roads and highways, electricity power grids and generation facilities, etc.  Such conditions often require mining companies to construct this infrastructure as part of the development cost of a project, thus increasing substantially the initial investment in the project.
5.  Under-developed countries often lack sufficient local industry to provide for a mining companies needs for fuel, consumables, supplies and spare parts.  This is particularly evident during the construction and development phase of a project when significant quantities of such items are required.  This requires mining companies to import the vast majority of these items to construct, develop and operate a world-class project.

Major mining companies are currently enjoying a sustained cycle of high mineral commodity prices, fueled primarily by high demand coming from the growing economies of India and China.  However, history has shown that the mining industry is a cyclical one.  World-class mining projects typically have long operating lives 10, 20 or 30 years into the future, and it is highly unlikely the current up cycle in the industry will be sustained for such long periods.  The current environment perhaps justifies investments into under-developed countries like the Congo, but a long-term view of the mining industry suggests that such projects carry a high degree of risk.  Investors should consider the risk profile of mining companies as they shift their focus to the under-developed world and expect signficantly higher returns on investment.