Local content in the extractive sector: What opportunities in a challenging global environment?

What opportunities in a challenging global environment?

Isabelle RAMDOO

West Africa Mining and Power ConferenceAccra, 1 – 3 June 2016

Local content in the extractive sector

Outline1. The current context

i. What do we expect in the short-term?ii. How do we reverse the trend?

2. Local content: Getting the debate rightI. Key featuresII. Where are the opportunities?III. Cost spending scanIV. Critical gaps to be addressed

3. Partnership is key1. What governments and companies can do together2. What Governments can do?3. What companies can do?

4. Conclusions

1. The current contextThe mining industry and resource-rich governments are facing challenging times as a result of the prolonged downswings in commodity prices;

This is a combination of (i) demand, (ii) supply and (iii) financial market conditions: (i) On the demand side: Two main factors:

In the 2000s, demand for raw materials shifted from advanced economies to the East, fuelled by China’s insatiable appetite for base metals and energy, needed for its industrial and construction boom (about 50% of base metal consumption). Since the last few years, Chinese demand has slowed down (triggered by the transition from an investment-driven growth towards a more sustainable growth based on domestic consumption);

slow recovery of the global economy from the crisis;

(ii) On the supply side: High demand and high prices for commodities led to supplies build

up in the metals sector. In the oil sector, supply factor played a bigger role, due to OPEC

countries’ decision to maintain production despite US strong shale production and as a result of earlier investments in new frontiers due to high prices.

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(iii) Tightening of financial markets:

Beyond supply and demand, a third factor has been influencing short-run fluctuations in commodity prices. Weak prices left many with less cash flows as earnings were absorbed by debt repayments and servicing.

It is also probably true that some companies are in difficult financial situation, having ‘gorged’ on cheap debts during the China led-metal boom, now having to pay the price.

For these reasons, banks are more prudent in lending and investors and financial markets move away from what they perceive to be risky bets, including stocks and commodities. This so-called “risk off” behaviour has put downward pressure on prices of both oil and metals.

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(ii) What do we expect in the short-term?The short-term economic prospects do not look very promising:

WB predicts a further 10% decline in metal prices this year; Oil prices have recently gone up due to problems in Canada and

Nigeria, but the supply glut has not been addressed – shale in the US might take off again; Iran may add more to SS etc.

This is certainly a challenge for everyone: For Govts: Less fiscal space, buffers melting like ice, declining

TOT; risk of debt sustainability; pressure on currency reserves. All this affect the scope of key reforms necessary for economic diversification (in particular fiscal reforms) but does not diminish pressure from the population, who is still expecting returns

For companies: Uncertainty and shrinking confidence about quick recovery; less cash flow; less capex investments; tightening financial conditions; increasing pressure from Govts: as fiscal revenues fall, pressure is shifting to local content and value addition

(iii) How do we reduce the pressure?– Little we can do to significantly change the commodity prices, at

least in the short-term – it recurrent and cyclical. Some even say it’s a ‘new normal’.

– But companies and governments can change the mechanics of their interaction to become more resilient to the effects of the future potential downturns

– A more sustainable engagement can spread the benefits of mineral sector to the local economy, beyond rents and taxes and therefore reduce some of the pressures.

– Viewed differently, the current situation can be seen as a chance. A chance to finally engage on the fundamentals of increasing benefits for companies and governments alike.

– But it requires a fundamental change in mind-sets and a new approach to partnerships.

2. Local content: Getting the debate right This current situation can become a good opportunity to make sure

you have a common understanding of what ‘local’ and ‘content’ mean in your specific context.

Currently not the case. No agreed definition of what “local” is or what “content” means.

Mining and oil and gas countries have different approaches to LC. Stricter in O&G than in mining. Frameworks are often general but mandatory (‘blanket’ definitions). Do not always reflect capacity to deliver. Govts play the role of a regulator, but not sufficiently that of a facilitator or of an investor.

Companies approach the issue with a ‘compliance’ mind-set: some do just what is necessary to meet the requirements but without integrating it in their core business operations. This approach assumes LC has a negative impact and does not necessarily look at the business benefit that can be derived from it. If certain conditions are met, LC can shave off costs in a tight situation.

(i) Key features of local contentWhat is ‘local’?

• Spatial dimension : is ‘local’ related only to the geographic proximity of the mine or does it have a national dimension?

• Ownership or indigenization: Share of capital or types of businesses to be owned by nationals of a country;

What is ‘content’?

• Local employment at different stages of the VC and different competencies

• Max. local procurement and preferences• Share of value addition and optimizing linkages

(forward, backward and lateral)

(ii) Where are the opportunities?For the mining industry, essentially upstream We can look at it from a supply chain perspective and in terms of

other key factors of production that are needed to enable production (such as labour)

For the resource sector as a whole:Opportunities can be downstream and sidestream, provided

conditions are met. Not automatic; resource-specific; depends on a host of factors (infrastructure; energy; comparative advantage; level of industry’s integration in GVC, capabilities etc) – beyond the scope of the presentation.

LC opportunities depend on the stage at which the industry is in the mining cycle

Site construction phase is more labour intensive, but short-lived and temporary;Operation phase more capital intensive but with greater and more sustainable potential for the supply of goods and services

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Source: ICMM

(iii) Upstream opportunities during production phase: cost spending scan

Source: McKinsey, 2013

Average cost spending

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Substantial (potential) contributions thro’ employment, skills dev’t & supply chains. Companies spend between 40 - 80% of revenue on procurement of goods & services (in some cases that exceeds tax & royalty payments).

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Oil and gas sector

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(iv) Identifying critical gaps between LC goals and countries’ capabilities

1. Gauging critical competency gaps is important for employees productivity and to design appropriate support (training, skills upgrading etc)

2. Identifying existing local suppliers and their capacity to meet the requirements of the company in terms of quality and standards; delivery lead time; price competitiveness; Stimulating entrepreneurship for future suppliers breeds innovation and creativity.

3. Identify logistics constraints that may add up to costs: energy; infrastructure; administrative red-tapes;

3. Partnership is key!

(i) What governments and companies can define together

The objectives to achieve. These should be specific, measurable and realistic. Targets are necessary but must be flexible and adaptable to contextual circumstances. Incentives are equally important to get the buy-in of companies

The pathways to achieve the set goals, with clear roles for each partner. Effective coordination and communication are critical at that stage.

A mechanism to monitor progress and to adjust to unexpected challenges. This requires flexibility, on both sides

Agree on targets for each partner. Too often governments and companies pass the ball on each other when it comes to demonstrate success

(ii) What governments can do:

1. Success depends on what you want to achieve – policy targeting is key. The first imperative for policy makers is to gain detailed knowledge of their resources supply chains so that they know exactly where the value is, and what benefits they can realistically get, given their economic situations

2. Master the country’s competitive edge Benefits that can be captured locally depends on number of factors: (i) the type of resources; (ii) the level of industrialization; (iii) a country’s unique aspects such as location, language etc. Some factors of production can be easily localised (eg. manual and low-skilled labor and basic materials); others require significant industrial adjustments. Governments must therefore develop those capabilities.

3. Carefully assess the opportunity cost of regulatory intervention

Assess whether regulations would unnecessarily raise costs and damage the competitiveness of extractive companies is critical. They also need to ensure that : Business environment is conducive (remove hidden costs of

doing business) Regulations do not create perverse incentives (picking

winners) Are compatible with trade and investment commitments;

4. Regulation is necessary but enabling is essential. Provide access to finance; provide red carpets, not red-tapes; support SMEs; provide requisite infrastructure; intra-govt coordination to ensure policy coherence

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(iii) What businesses can do

1. Local content is a business case, not just a compliance or a CSR issue: include it in your core business as it can bring cost-savings across your supply chains (lower staffing costs; avoid currency fluctuations, save taxes on imports etc);

2. Participating in economic diversification can provide you with significant negotiating advantages for future licences or projects

3. When well managed, LC can improve the relationship with local governments and reduce risks of social tensions.

4. Most importantly, manage expectations of what businesses can or cannot do. Success can only be achieved if you remain within your economic sphere: “the business of business is to do business”

4. Therefore be clear on your capacity to contribute and what you would need governments to do to allow you to succeed. It takes two to tango and risks must be shared.

5. Measure performance together, including that of Government. Targets must be set both ways, as the success of one depends on the other

4. Conclusions 1. No sustainable development path without industries. LCPs are

key to stimulate entrepreneurship and development of PS. 2. But not an end in themselves. Must be viewed as part of

broader industrial strategy and with a new mind-set. Certain conditions are necessary.

3. Clear definition and objectives of LCPs is fundamental & should be very clear: otherwise difficult to monitor results;

4. Effective LCPs require holistic approach: should be well targeted, flexible and adaptive and need to assume politically difficult trade-offs.

5. Successful policies pointed to the importance of a balance between regulatory measures and the need to safeguard the competitiveness of the industry.

6. Finally collaborative partnerships is paramount: Government is a strong actor, but in the end, the business is conducted by the PS and without their buy-in and support, difficult to have sustainable results.

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