How Russia Decides to Go Nuclear
Deciphering the Way Moscow Handles Its Ultimate Weapon
For the world’s mining industry, the past few years have been turbulent. Politicians, citizens, workers, and stakeholders all want a greater share of the profits, and mining companies have seen national governments raise taxes and demand the renegotiation of contracts on more favorable terms. Some governments, including that of South Africa, have even considered nationalizing mines outright.
One reason for the friction is that mines in rich countries have become increasingly depleted, making miners more reliant on deposits in less developed countries. That entails significantly more risk; poorer countries are precisely the places in which the potential for corruption and resource nationalization is greatest.
Another reason is that commodity prices have soared. Even after a drop this year, prices for many metals, minerals, and gems are still roughly double what they were ten years ago, and profits have risen accordingly. The world’s 40 largest mining firms brought in about $500 billion in 2012, compared to $100 billion in 2002, according to a study by the think tank Chatham House. Yet many host governments never anticipated such a rise in mining revenue when they initially negotiated contracts years or decades ago. They claim that most of the windfall has bypassed them, and that might be true -- there is so little public information available about how much governments really get on average, and therefore it’s often impossible to determine what constitutes a good deal. Further, without good data, all sides are prone to suspicion, frustration, and -- quite often -- disputes that eventually kill investments and thwart development.
But the fog of secrecy might be lifting. Resource-rich countries are increasingly looking to consultants, advocacy groups, and development agencies to help them negotiate with miners from a more informed position. And miners are doing the same in the hope of avoiding the conflicts that have plagued them in the last few years. The upshot is that, over the next few years, the resource-extraction industry, and mining in particular, will become more transparent than ever. Mining firms will probably see less profit, and poor and middle-income resource countries will get more. That can go toward addressing their populations’ basic needs and speeding up development -- or it can be lost to corruption.
Calls for transparency in the mining industry are nothing new. Initiatives such as the Extractive Industries Transparency Initiative (EITI) and Publish What You Pay (PWYP), both of which were established to push for disclosure in mining and energy, are each roughly a decade old. Advocacy groups began by pushing miners and governments to disclose financial flows between them, but that didn’t force a major change. Some of the world’s most corrupt politicians have signed on to voluntary disclosure regimes, accepted praise and additional aid from the developed world as a reward, and then simply carried on with graft and theft. Now, however, advocates are looking to collect more details. They want contract terms disclosed, for example, and instead of detailing the lump sums of financial flows they want the information separated by payment. Eventually, as the details pile up, industry watchers hope that they can monitor specific mines to see if contracts are adhered to, and can spot corruption and other problems much faster.
In this effort, advocates are aided by new laws in several rich countries that aim to promote financial stability and combat corruption and tax sheltering. These include the United Kingdom’s Bribery Act and the Dodd-Frank Wall Street Reform and Consumer Protection Act. If applied as intended, these laws will hold domestic companies responsible for misbehaviors abroad and force them to disclose payments made to foreign companies.
Mongolia is a good case study of the potential impact of transparency. In 2009, the country signed an investment agreement with Rio Tinto, the world’s second-largest mining firm, to extract metals from Oyu Tolgoi, a major deposit of copper and gold. When Mongolia signed the deal, it had few working mines and a turbulent history with foreign investment. The country also lacked the roads, rail lines, and shipping infrastructure needed to reach buyers. In short, Rio Tinto took a big risk and expected a commensurate payoff.
In 2011 -- before the first ounce of copper or gold was extracted from the mine -- Mongolia became the world’s fastest-growing economy, thanks to the work of building the mine and the infrastructure around it. Either suspicious that they had undervalued the deal or thinking that they could squeeze more money out of Rio Tinto, the country’s politicians decided that they wanted to renegotiate the agreement. They spent a year trying to do so, but Rio Tinto refused to budge. The effort scared off many other investors, who feared that any contracts they might sign with the Mongolian government would quickly be broken.
Faced with such a scenario in the past, mining firms have offered up a little more of the profits to host governments or helped politicians find other ways of claiming victory or saving face, such as by increasing social spending and community service. But others believe that showing flexibility could open the floodgates for more handouts and side arrangements in the future. Rio Tinto decided to take its case directly to the Mongolian people. It plastered billboard ads around Ulaanbaatar, the capital, that cited an IMF calculation positing that the Mongolian government would receive between 55 percent and 71 percent of the total take from the mine. But average Mongolians had no way of knowing whether that was a good deal. They had nothing to compare those numbers to.
The Mongolians aren’t alone: there is no rule of thumb or comprehensive database of global profit splits currently available in the public domain. Most mining companies and analysts say that mines can’t accurately be compared to one another because there are too many variables -- the quality of the resource, local costs, transportation costs, and other factors. But with enough time and persistence, a rough measure can, in fact, be determined. In 2010, the Swiss financial-services firm UBS pegged the global average effective tax rate for mining at 40 percent. In other words, after all costs to build and run the mine are taken out, governments get about 40 percent of what is left over, in the form of licensing fees, royalty payments, and various taxes and other charges paid to the state. A 2013 report by Goldman Sachs put the global average at 39 percent. As the Goldman report noted, that is a much better deal for miners than the industry average of 53 percent for oil and gas production. In 2012, the IMF studied the issue and concluded that mining agreements are most likely to be honored by both sides if the government gets between 40 percent and 60 percent of the profits.
So, on paper at least -- and without delving into the question of whether agreements based on such parameters are always faithfully implemented -- it does seem as if Mongolia should have been happy with its 55 percent. But anyone looking at Rio’s billboards that autumn had little chance of understanding that. At any rate, the standoff between Mongolia’s government, its population, and Rio Tinto continued. Although the mine began operating in 2013, Rio Tinto remains undecided about whether it still wants to develop the mine past the initial phase. Mongolia could end up with less money than it was planning for, and has already started to scale back ambitious development plans.
For some Mongolians, that could be deadly. The country already has problems meeting its citizens’ basic needs, and it’s desperate for additional revenue. In winter, Ulaanbaatar is one of the world’s most polluted cities; a housing shortage has forced people to live in felt tents, burn coal to stay warm, and bury their waste close to the town’s main water supply. Foreign investment could have helped Mongolia pay to fix these problems.
FAIR IS FAIR
Within the small group of experts on mining revenues, there is broad agreement that countries should pass laws to establish rules and tax regimes for all resource projects, rather than negotiating each new project as a separate deal. But such experts disagree about other issues. One debate concerns whether tax regimes should be designed to maximize potential revenue (which the IMF favors) or simplified so that countries can effectively enforce contract terms (which the George Soros–funded Revenue Watch Institute advocates).
For those focused on how to find fair value in mining, some agree with the effectiveness of the 40-60 split, whereas others believe it squeezes too many variables into one formula. Still others argue that a profit split is the wrong way to think about the issue. Miners, they say, should be offered only what’s necessary to prevent them from abandoning the project, which could be far less than 60 percent of the profits. But with more countries hiring consultants and comparing notes, that idea could prove moot. If a going rate is established -- in other words, if the market becomes transparent -- then fewer parties on either side are likely to insist on more or settle for less. The risk of pride and ego intervening at the negotiation table would diminish.
Although it is generally assumed that mining companies will take home less profit if transparency does create more accountability, miners can also benefit from disclosure. Publicizing cash flows could insulate them from accusations from corrupt or grandstanding politicians, and could tamp down the conspiracy theories that often flourish when poor countries first jump into the global economy. And that is why miners and energy producers alike are funding transparency efforts themselves. Rio Tinto, for example, posted the investment agreement for Oyu Tolgoi online. And extraction companies are a major source of funding for EITI. According to the group’s Web site, 55 percent of the organization's 2012 budget of $3.7 million came from resource companies and their shareholders. Since the group’s primary task is to compare what miners say they pay to governments with what governments say they get from resource-extraction companies, the participation of businesses is a must. Miners are also increasingly participating in discussions with governments and locals affected by mines. Examples include Canada’s miner-financed Devonshire Initiative, which provides a platform for miners, governments, and communities in developing countries to resolve problems associated with mining projects.
Resource companies’ support for the transparency agenda is not unlimited, however: in 2013, the U.S. Chamber of Commerce, the American Petroleum Institute, and two other groups successfully sued the U.S. Securities and Exchange Commission to nullify a part of Dodd-Frank that would have forced them to disclose payments to foreign governments exceeding $100,000.
COUNT ON ACCOUNTABILITY
Will all this eventually result in smoother relations between miners and host countries and the better use of revenue by host governments? Disclosure is, of course, no guarantee of change -- people in resource-rich countries have to figure out what information is available and how to put it to use. In Mongolia, three years after the Oyu Tolgoi agreement was signed, many (including business executives and public servants) were surprised to learn that the document was available online. And if Mongolia’s experience demonstrates the need for transparency, Nigeria’s suggests that transparency isn’t enough. In 2003, its government pledged to implement EITI rules. By 2009, Nigeria was declared compliant with them, despite remaining one of the world’s most famously corrupt countries and despite most Nigerians remaining ignorant of the EITI data now available. Guinea is a similar case: it is among a handful of countries that has pledged to publish all mining contracts online through a website (www.resourcecontracts.org) recently created by Revenue Watch and several development-sector partners. But corruption has continued, and Guinea remains close to Nigeria on rankings such as Transparency International’s Corruption Perceptions Index. In the 2013 list they placed 144 and 150, respectively, among 177 countries and territories.
In short, transparency hasn’t yet created accountability. The world will have to wait for that next step as the information available becomes more comprehensive. The EITI now encourages reporting on a mine-by-mine basis (rather than for the sector as a whole) but does not mandate it. But when it and others manage to procure enough mine-by-mine data it will be possible to track whether contract terms are being enforced and to spot the common ways in which taxes are dodged. That would help close loopholes, train tax collectors, and address any other problems that prevent the sector from operating smoothly.
It’s clear how transparency can help governments can do a better job holding miners accountable, but what about citizens demanding better from their leaders? Even among the most educated citizens in the richest countries, political debate is not necessarily grounded in truth. The transparency movement is clearly good news, but there will be many more obstacles to overcome before it pays off.