Strategic Review of the Mining and Metallurgy Sector
The present Study of the mining and metallurgical sector has been requested by the government of Kazakhstan and conducted by a Study team composed of staff and consultants of the World Bank. An inter-ministerial working group was established to provide guidance and information to the Study team. The team members wish to express their thanks to the government and various colleagues in Kazakhstan for their assistance in the preparation of this Study. The views expressed in this Study are those of the staff of the Bank, even though they have been thoroughly discussed with the government authorities.
Kazakhstan is fortunate to be exceptionally well endowed with petroleum and mineral resources. But, since independence, the vast majority of new investment in the sector has been devoted to petroleum. New investment in the mining and metallurgical sector has not been commensurate with the country’s geological potential or the importance of a sector which accounts for over 30% of total export earnings, 16% of GDP, and 19% of total industrial employment. Kazakhstan has a long tradition as a mining country. Some oblasts are dominated by the sector and certain municipalities depend on the kombinats for vital social and infrastructure services. The government has adopted the policy of fostering private sector development for mining and metallurgy and has privatized the existing kombinats. However, new exploration investment in the sector is far below the levels required to replace reserves, up-grade technologies, or that registered in other countries with similar geological potential. Thus, the government has requested the present review of the mining and metallurgical to answer three fundamental questions which are at the heart of a strategic vision for the sector. Why is Kazakhstan not attracting new private sector investment in the mining and metallurgical industries? What can the government do to better stimulate new investment in the sector? And, if it does succeed in stimulating new investment, what economic contribution can be anticipated from the sector?
All governments share similar objectives for the mining and metallurgy sector: enhancing contribution to economic development, providing an equitable distribution of benefits, creating jobs and spin-off industries, stimulating new investment, and creating a competitive investment climate. Kazakhstan has partially achieved some of these objectives, but has made little progress towards achieving others, notably improving the investment climate to stimulate new investments. To develop even part of Kazakhstan’s estimated mineral reserves will be expensive. For example, based on the capital costs of recent “greenfields” mining projects in other countries, an average of US$ 5,700 must be invested for every tonne of copper produced; an average of US$ 640 must be invested for every ounce of gold produced. To develop its mineral resources Kazakhstan will have to mobilize international capital resources.
Other countries have faced similar challenges and have successfully mobilized investment by carrying out a comprehensive “mining reform program”. The reform program requires a fundamental re-definition in the role that the State plays in the mining sector. Instead of acting as “owner/operator” of mines the new State role is that of “regulator and referee” for the sector. Investing and operating mines should be the responsibility of the private sector which is better suited to mobilize the funds and take the risks associated with such activities. The reform program generally includes up-dating overall sector policies, adopting internationally competitive laws, regulations and taxes, strengthening government oversight institutions, improving capacity of the civil servants within the institutions, and modernizing the earth science database. A key element of such a program is an open, efficient and transparent mineral title licensing system. Since the late-1980s, several countries which have undertaken such programs have achieved remarkable success in terms of exploration expenditures, new investment, increased production, exports and tax revenues. The present Study argues that if Kazakhstan were to vigorously implement a mining reform program it, too, could achieve similar positive results. Kazakhstan has a world class minerals resource base; carrying out a comprehensive mining reform program would help to develop those world class resources.
Kazakhstan is the ultimate mining and metallurgical country, defined in this study to include coal, ferrous and non-ferrous minerals. Some 233 mining enterprises produce a wide variety of commodities: coal, iron ore, chromite ores and ferro-alloys, alumina, copper, lead, zinc, manganese, steel, titanium sponge, uranium, barites, and others. The total value of mineral commodities produced in 1999 is evaluated by the National Statistical Agency as the equivalent of approximately US$2.7 billion. The majority of this production is exported to the countries of the former Soviet Union and to international markets, over US$ 2.1 billion in 1999. Mining and metallurgy account for 3-4 percent of government tax revenues and employ directly nearly 200,000 persons nationwide. The economies of certain oblasts – Karaganda, East Kazakhstan, Pavlodar, and Kostanai – are dominated by mining and metallurgy. Moreover, the structure of the existing kombinats is such that they provide essential infrastructure and social services to the communities in which they operate.
During the years following independence, the dislocation of traditional markets in the former Soviet Union and the increases in relative factor costs caused Kazakshtan’s mineral production to decline by over one-third. Much of this production decline has now been redressed, though adjustments to the conditions of the market economy have not been easy. During the mid-1990s the government embarked on an ambitious program to privatize or put under trust management many of the mining and metallurgical kombinats. This has been reasonably successful in terms of maintaining social tranquility and providing employment and services to the workers at some of the largest and most important of the kombinats. It has been somewhat less successful in terms of increasing productivity and efficiency due to lack of transparency and poor governance of the enterprises. In some cases the government has rescinded the trust management contracts or declared the privatization invalid. Following independence, with the plentiful availability of risk capital for mining ventures in the international equity markets, numerous foreign companies in conjunction with local interests began exploration or development programs in Kazakhstan. With one or two exceptions, these companies have withdrawn or reduced their operations. On the one hand, foreign companies have complained that government policies, laws, and taxes discourage new investment in exploration. On the other hand, the government has been disappointed in the performance of some foreign companies which seem to promise much but deliver little. In certain instances disagreements between the government and the companies have caused international litigation. Indeed, due in part to the damage to the country’s reputation caused by these previous bad experiences, Kazakhstan is viewed by the international mining investment community as something of a “no-go” country. The country attracted only US$ 9 - 10 million in new exploration in 1999, an amount vastly insufficient to replace reserves currently being exploited.1 Part of the reason for this failure to attract sustained investment in exploration is the reduced availability of funding in the international capital markets and low commodity prices. But other countries, with less geological potential than Kazakhstan, continue to attract new investment. This Study concludes that the principal reasons are: a) the lack of a clear government strategy and policy for the sector; b) deficiencies in the legal, taxation, and institutional arrangements; c) a tendering system for mineral properties which is not in accordance with international practice; d) a reserve classification system which is incompatible with international standards; and e) the stigma, rightly or wrongly deserved, of unfair and arbitrary dealings between the government and the private sector, mostly due to questionable governance practices.
The corner stone of development of the mining and metallurgy sector is the body of laws and regulations that govern access by the private sector to mineral rights. The Kazakhstan constitution, in fact, provides a basis for such private access, and other legislative acts governing mining and subsurface usage further define the role of the State to facilitate access to mineral rights. A fundamental problem in Kazakhstan is the confusion of the mining and metallurgy sector with the oil and gas sector. The economics of the two sectors are entirely different and what works for one does not necessarily work for the other. The case in point is the tendering system for blocks of geologically prospective ground that is contemplated in the legislation. This practice, while extensively used in the oil and gas industry, is very uncommon in mining and metallurgy and, in the countries where it has been tried, relatively unsuccessful. Because of the cumbersome tendering system and long delays in negotiation of contracts, gaining exploration rights in Kazakhstan is more complicated and time consuming than in other countries. The legislation also does not strictly adhere to the doctrine of the “same rules for all investors” by giving preferential treatment to obtain mining rights to “National Companies”. This appears to leave open the possibility of direct State intervention to own and operate mines which would seem to be inconsistent with the policies of private sector led development in mining and metallurgy. Security of tenure – that is the right to exploit a deposit in the event of a discovery – is a key concern for an investor. This actually is a concept which encompasses a number of issues such as the nature of the mining right (property or contract), exclusivity, continuity from exploration to exploitation, term lengths, maintenance requirements and work obligations, among others. On each of these issues (with the possible exception of term lengths), the legislation not only could be clearer and more precise but also more in line with international practice. It is important that investors have liquidity of their investments – that is the ability to transfer the mining right. In fact, the amendments to the sub-surface law introduced in 1999 added provisions in this respect, though these could be strengthened by conforming more closely to the provisions governing pledges. Investors also will be concerned about the centralized and bureaucratic environmental permitting and monitoring procedures outlined in the legislation. In fact, comments such as “?arbitrary and little flexibility?” and “?command and control mentality?” were used by investors when asked about this particular issue. Finally, in a number of domains such as the certification of reserves, obligation to produce at volumes designated by the State, and the requirements to use local goods and services, the legislation provides for government interference in what, in most other countries, are matters for the private operator to decide.
The taxation regime applied to mining and metallurgical enterprises in Kazakhstan is fundamentally unattractive to new investment and not competitive internationally. This is due, in part, to several taxes which confuse the mining and metallurgy sector with the oil and gas sector. In particular, “discovery” and “signature” bonuses as well as reimbursement of “historical costs” are highly unusual in the international mining industry and increase the costs and risks to new investors. Royalties on minerals produced – if any (and the international tendency is to eliminate minerals royalties) – should not exceed 2% net smelter return. The royalty should be determined in the law or regulations and not negotiated on a case-by-case basis. Concession fees and surface rents should be based on a set amount per hectare of the surface area of the land held under exploration or exploitation permit; for the exploration permit, these amounts may be increased each year during the life of the permit to discourage holding the land for purely speculative purposes. In order to encourage exploration, import and customs duties should be eliminated during the exploration phase of the investment; import duties of around 5% are generally acceptable during exploitation operations. The value added tax should be “zero-rated” for mining projects which export their products. Since value added taxes are reimbursed for exports anyway “zero-rating” will eliminate accumulation of reimbursements which the government must subsequently make to exporting companies.
The basic rate of taxation of corporate profits (30%) and dividend withholding taxes (15%) are competitive internationally. The Kazakhstan mining taxation legislation, correctly, does not provide for exemptions from profits taxes or “tax holidays”. However, the government may wish to consider removing the “excess profits tax.” In other countries, this taxation instrument has proven ineffective in terms of increasing government revenue and is sometimes perceived negatively by investors in the mining sector. Also, for the calculation of taxable profits internationally competitive dispositions relative to depletion allowances and accelerated depreciation could be put into place. Government guarantees that the tax rates and methods of calculation will not change for a certain period – “tax stabilization” – have been effective in other countries to reduce the risks perceived by investors. Though not directly in the control of the central government, many oblasts have local taxes and levies which investors find confusing and often complain about. Finally, regulations should be prepared to determine the tax treatment for funds and other allowances which companies make for mine closure.
Public institutions to fairly and adequately administer the legislation are essential for the development of mining and metallurgy. At independence, Kazakhstan inherited the old Soviet institutional structure. This structure has been substantially modified since independence, most recently in December, 2000, in an attempt to make it more responsive to the needs of a market economy. Specifically, the vesting in the new Ministry of Energy and Mineral Resources of primary responsibility for oil and gas as well as mining and metallurgy creates a single focal point for the sector which has proven to be successful in other countries. However, while the new institutional set-up could do much to remove the present overlapping responsibilities and cumbersome jurisdictions of several national and oblast agencies and ministries, the government will have to guard against allowing mining to be confused with oil and gas and to pay due attention to the specifics of the mining and metallurgical sector. Government policy is clearly to promote private sector development of mining and metallurgy. However, there remains in several agencies and ministries a “command and control” mentality, specifically with reference to reserve certification and usage, that is inconsistent with this policy or international practice. Finally, there is, as is common in all countries, the question of sustainability of public institutions. The present level of funding, logistical support, recruitment and training of professionals for the public institutions responsible for mining and metallurgy is insufficient for long term sustainability and requires close government attention.
Many investors have cited lack of good governance and transparency in public and private sector decision making as significant obstacles to investment in mining and metallurgy in Kazakhstan. As noted previously, the privatization program has stabilized production and maintained employment and social tranquility. But, if the existing kombinats are to be able to attract investment on an international level, directly or as a listing on a major stock exchange outside of Kazakhstan, internationally accepted standards for transparency, disclosure, accountability, and auditing must be adopted as well as other basic measures to protect shareholder rights. These reforms are also necessary to attract new investment. No domestic or foreign investor will risk substantial new investment in the “ad hoc” atmosphere that prevails currently on many of these critical governance issues. Finally, there are significant shortcomings with the remaining trust management arrangements and with the residual shares still held by the government in many of the privatized enterprises. These shareholdings have not produced any significant dividend streams for the government, do not give rise to any substantial government influence on corporate decision making, and consume scare government management resources. It is recommended that the government proceed with a responsible program of divestiture as, for example, the re-activation of the “blue chips” program.
Kazakhstan has inherited a legacy of significant environmental problems at many of its mining and metallurgical kombinats. The standards and practices used previously are not in conformance with international standards. The government has, however, made progress to develop internationally competitive environmental legislation and regulations. Nonetheless, greater emphasis needs to be placed on the concept of “sustainable development” and the three key principles thereof: partnerships, revenue sharing, and transparency. A number of specific issues need to be addressed including implementing Environmental Impact Statements, providing for mine closure, improving health and safety, disclosure by companies of environmental performance, and adopting international norms for monitoring, in particular of the ambient environment and not just effluent discharges.
Efficient and adequate supply of infrastructure – especially rail transportation – is vital to Kazakhstan’s mining and metallurgical industry. Indeed, mining and metallurgical products account for over 85% of the total freight traffic on Kazakhstan railways. Following independence, the rail system implicitly subsidized the industry by supplying commercial and social services in spite of a dramatic fall in rail traffic and revenues. Freight rates in Kazakhstan as calculated on a per kilometer/tonne basis, are very low by international standards which implies a continued subsidy to the mining and metallurgical industry. This has been made possible by drawing down on reserves of material, tracks, locomotives, wagons and other infrastructure. However, little new investment has been made and it is anticipated that the next fourteen years will require an investment of US$ 14 billion in new infrastructure and rolling stock. Mobilizing this funding will require a reduction in operating costs, an increase in tariffs, and access to private investment. To facilitate this the government has just passed a new railways law which will re-structure the State railway company, Kazakhstan Temir Zholy (KZT). Many KZT services will be divested and/or privatized and the creation of “own account” operations will be authorized. The restructuring is a promising step towards improving efficiency and exploiting new market opportunities for Kazakhstan mining enterprises.
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