Sunday, May 17, 2009

China Gains, Congo Loses, In Mine Deal

The recently-announced copper/cobalt mining contract between the Democratic Republic of Congo and China--widely proclaimed as bringing $9 billion in development aid to the DRC--looks like another unfortunate deal for Congo. According to my back-of-the-envelope calculations, it is probably even more one-sided than American multinational Freeport McMoRan’s arrangement for Tenke Fugurume that I examined recently.

Last year, the Congolese Ministry of Mines announced that it had signed an agreement between China's Exim Bank, the Kinshasa government, Congolese state mining company Gecamines, China's Sinohydro Corp, and China Railway Engineering Corp forming a joint venture to develop the Mashamba West and Dikuluwe copper and cobalt deposits, concessions originally scheduled to be developed by Katanga Mining Ltd through a joint venture with Gecamines. The deposits are believed to hold ten million tons of copper and two million tons of cobalt.

While complete details of the contract are yet to be announced, what is known doesn’t look particularly profitable for the Congolese. On the surface, the deal sounds fine, with the Chinese agreeing to build $6 billion worth of roads and railroads and another $3 billion in mining infrastructure in return for rights to operate the mines. Gecamines is to own 32% of the venture, too, or nearly twice as large as the share it has in Tenke.

Using recent prices for copper ($4500/ton) and cobalt ($30,000/ton) and spreading production over the 25 year term of the deal, annual gross revenues of the mine will be $4.2 billion. Using the same operating cost assumptions as at Tenke, profits will be approximately $2.6 billion annually. Gecamines share could be $832 million.

The devil, though, is in the details. First, the $9 billion from the Chinese is not a gift—it’s a loan secured by the mines and to be repaid from the Congolese share of the operation’s profits. Generously assuming that the loan will be for the 25-year life of the project and carry an interest rate of only two percent (much less than I expect it will be), Gecamines will be on the hook for $540 million in annual debt service. That leaves only $292 million as the Congo’s share of the mine’s profits. By comparison, Gecamines’s deal with Freeport annually yields $100 million more.

Additionally, Gecamines has agreed to either give Katanga Mining deposits carrying nearly four million tons of copper and 200,000 tons of cobalt or pay the company $825 million as compensation for giving up the Mashamba West and Dikuluwe concessions. This additional cost, of course, further reduces the DRC’s take from the deal with China.

The IMF has objected to the deal on the basis that Congo is simply trading $11 billion in current debt (which the DRC hopes to have canceled) for $9 billion to the Chinese, and that the state guarantees of those loans are ill-advised at a time when the government can’t fund basic services, much less invest in the country’s growth. The IMF has said it might go along with the deal pending a study to make sure the mine’s reserves cover the cost of the infrastructure and if the terms are renegotiated.

The Chinese stand to gain in several ways from the deal as announced. In addition to their nearly $1.8 billion in annual profit from the mine, they’ll earn perhaps $4.5 billion in interest on the development loans—more if they carry an interest rate higher than two percent. There also looms the very large question of who will get the profits from the contracts to build the promised infrastructure. My assumption is that China's Sinohydro Corp and China Railway Engineering Corp will be awarded those contracts on a no-bid basis, which means they’ll take home another billion or so in profits on the project.

It would seem to me that a better deal for Congo would be a straight-forward mining concession with the Chinese along the lines of those typically negotiated by Zambia and South Africa, where the parastatal companies get 51% of the operation. The infrastructure could be financed from those revenues, open-bid contracts for the roads, railroads, and power facilities let to the lowest bidders (maybe even Congolese companies), and funds would still be left over for the state general revenue coffers.

Dave Donelson, author of Heart of Diamonds a about in the

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