Global Mining Deals 2010: The Rise of Frontier Markets – Five Risks

The expectation of sustained commodity demand has increased investor interest in mining projects in frontier markets. Frontier markets are generally characterized as being less politically stable places that have a relatively recent history of steady mining activity and therefore provide a more uncertain operating environment for mining companies, particularly when compared to more mature emerging markets with longer track records of inbound investments in the mining sector. As such, these countries have a unique set of political risks associated with their mining sectors that companies involved in the space should be aware of. We have profiled five such risks.

1. Security: Often, the lack of mining sector development in a frontier market is due to poor security conditions that threaten the physical safety of mining staff or disrupt mining operations. The security uncertainties in turn often stem from internal conflicts and/or from social and environmental stresses (discussed further below). For example, in Niger, one of the world's poorest countries, the marginalization of nomadic Tuaregs, whose home areas coincide with many uranium-rich regions of the country, has been the catalyst for a low-level insurgency in which uranium mining infrastructure and staff are sometimes targeted. Local security threats in Tanzania have also been a major problem for gold mining operations in the northern Mara region. In particular, uprisings by local villagers against mining operations have led to clashes with government-backed security forces, leaving miners open to attack for alleged complicity in heavy-handed security responses. Elsewhere, in Papua New Guinea, security personnel at mines have been accused of violent attacks against local populations, adding fuel to existing local backlash against mining companies.
2. Social/environmental stresses: While resource nationalism generally originates from central governments, local opposition over social and environmental concerns to mining projects can also pose significant challenges for companies in frontier markets. For instance, the most prominent risk to mining investment in Guatemala stems from local community, religious, and environmental groups, which have attempted to impede projects. Recently, in June 2010, in response to community opposition to operations at the Marlin gold mine over environmental and human rights issues, President Alvaro Colom announced the suspension of Goldcorp's license. Local landowner disputes and environmental challenges are also prevalent in PNG, such as in the case of Lihir Gold's Lihir mine, which has repeatedly faced landowner compensation disputes and repudiation of contracts, occasionally leading to temporary closures. Similarly, the Porgera gold mine, now operated by Barrick Gold, has faced numerous disruptions caused by landowner disputes and complaints about an alleged lack of compensation for environmental damage.
3. Corruption and lack of transparency: Corruption is an "informal" mode of government intervention, but one that mining companies must deal with in all but a handful of markets. One market that has ranked consistently near the top of corruption indices is the minerals-rich Philippines. Local business groups in the Philippines have been pushing into the mining sector since the industry's decline in the 1990s. The groups have considerable connections with national and local politicians, as well as with the judiciary, bureaucracy, and media. For now, considering that they lack technical and market expertise, these groups will largely accommodate foreign partners, but some of them may eventually use their networks and access to build nationalist sentiments or turn regulatory decisions to their favor.
4. Resource nationalism: Resource nationalism involves policy measures designed to shift revenue and/or control of key natural resources assets from international or private hands to domestic, often state-controlled, interests. The Democratic Republic of Congo is a prime case of resource nationalism linked to the recent global copper boom, with the focal point being the government's review of all 60 post-civil war contracts between parastatal mining company Gecamines and foreign mining firms. While almost all mining contracts have been successfully renegotiated following the mining review instituted in 2007, uncertainty persists in the industry, particularly surrounding resolution to the outstanding contract dispute with First Quantum, which is the largest of the contracts that underwent a review.
5. Government instability: Frontier markets also tend to be more vulnerable to general government instability, particularly around elections. For example, ahead of a 7 November 2010 presidential run-off vote, mounting tensions and violent clashes in Guinea cast a large shadow over the future of mining operations in the country. Although the threat of instability and regime change has sharply declined since the Guinean Supreme Court confirmed the victory of Alpha Condé of the Guinean People's Rally party in December, reform of Guinea's mining sector depends in part on Condé's ability to secure a smooth political transition from military to civilian rule, which is far from assured.
   
   In Kyrgyzstan, although the parliament's approval of Almazbek Atambayev as prime minister in December 2010, followed by the establishment of a cabinet, were positive steps toward restoring political order in the country, the majority coalition in parliament is likely to be unstable over time, given the divergent political views of its member parties. It also remains unclear how politicians in the government and parliament will treat foreign investors, and some politicians have voiced support for nationalizing critical industries like mining. Moreover, negative sentiment against ousted president Kurmanbek Bakiyev will remain a potential source of trouble for investors who were considered too close to the previous regime.

Managing frontier market political risk from a deals perspective

There is no easy path for managing these kinds of political risks but three key measures can help mitigate potential downsides. First, companies contemplating M&A in frontier markets should fully explore and leverage government and private political risk insurance options. Second, companies should ensure that both local partner selection and community/social relations programs are used to build a "shield" of local stakeholders, including suppliers, joint venture partners, local employees and regional/ municipal governments, and NGOs to support the project. Finally, companies should ensure that risk assessments are undertaken at the board and senior management levels before entering a new market and on a regular basis from a monitoring perspective. Maintaining awareness among senior corporate decision-makers of local political dynamics will increase the likelihood of a timely and effective response should problems emerge.

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