Fewer in Number, but Better in Quality! How to Diversify the Metal Mining Sector?
The metal mining sector is a factor that could enable Kazakhstan to take a serious economic leap and become a competitive producer of goods. However, it should be noted that the privatisation process in the metal mining sector has not turned into a process of diversifying the sector. The policy of focusing on goods of a low value added, i.e. raw materials, which is being pursued by the owners of mining enterprises, significantly increases the risk of the domestic economy’s dependence on foreign markets and poses a threat to its stable development.
The stabilisation and growth of output in the mining sector prove the feasibility of steps taken by the government in the mid-1990s on adopting market relations in the sector. The ferrous and nonferrous metal sectors currently account for 20.3% of Kazakhstan’s industrial output. The output of metal ores has grown by 250% since the mid-1990s. However, now that the privatisation campaign in Kazakhstan has created major monopolist companies with foreign involvement, the government is forced not only to enjoy the advantages, but also to accept the disadvantages of this policy. Among the disadvantages are undeveloped production assets, a technological lag, the low level of value added and a narrow range of metal products. Aiming for innovations, the state has to take into account the views adopted by the owners of mining enterprises, which do not always correspond to official Astana’s vision of reforms. As such, in February 2007, Kazakh President Nursultan Nazarbayev said, “We should insist that our foreign partners, who are developing Kazakhstan’s rich natural resources, realistically and seriously turn to the needs of the country and take an active part in diversifying our economy and social development on a market basis”.
As a result, the owners of metal companies were asked to change their status – from that of dear guests who were offered all of the finest advantages to that of equal business partners. The adoption of the Law On Investment had an indirect impact on this situation by equating the rights of foreign and local investors, as did the Kazakh president’s demand that contracts be revised after tax conditions changed. At the same time, the managers of mining enterprises, who have been declaring their adherence to the principles of diversification, have found an original counteraction, offering the state three scenarios for its involvement in this process. The first scenario demands that the state cover 50% of the expenses incurred in switching mining enterprises to new rails. The second scenario says that the state should improve taxation by extending a list of costs included in the production costs, and introduce common tax incentives for money spent modernising and reconstructing production lines in the real sector of the economy. The third scenario suggests that in order to attract investment, dividends received by residents of Kazakhstan from local sources should be exempt from taxes for three to five years.
Of course, this approach could not but bring the situation to an impasse. The chair of the Kazyna Sustainable Development Fund, Kayrat Kelimbetov, said that this had resulted in “achieving no common consensus on the problems of diversification” in the mining and oil sectors.
This inability to reach agreement has led to a situation in which the diversification of the domestic economy is very low, despite the impressive dynamics of its growth. In terms of growth rates, the mining sector (63.2% in real terms in 2001-2006) is outperforming the processing sector (55.1% in the given period), and the threat of the country turning into a raw materials exporter is more than realistic.
It should be noted that back in 1999-2003 the mining sector had been tasked to conduct research and development by setting up small and medium-sized enterprises and to adopt technology to produce competitive products of high value added. Nevertheless, the industrial production of materials and metal products based on new technology (powder metallurgy, electric metallurgy, plating, new casting, chemical technology, etc.) and the efficient use of secondary resources are still minimal. The situation is complicated by the fact that resuming idle and expanding existing enterprises, and improving the quality of products has not boosted productivity. Analysts say that the output of certain nonferrous metal ores has fallen significantly over the past 12 years, for example lead-zinc ores have fallen by over 67%. The reason for this is a lack of investment in restoring and maintaining production capacities.
Experts from the Investment Fund of Kazakhstan believe that the ageing technology, its low environmental security and distortions in the structure of production (the low level of ore reserves available to mining enterprises and the low value of products) have a negative impact on the state of the domestic nonferrous metal sector. However, the main issue is the factor of depreciation of the main production facilities, which stands at about 50%. Experts also state that many types of precious metal products have been lost. They back up their arguments with the example of the former Shymkent Lead Plant, which used to produce 25 types of products and extracted 14 chemical elements from the ore, whereas its successor, the Yuzhpolimetall company, is currently producing only about 15 types of products and extracting nine elements.
The yield of the main metal from the ore has also fallen. It used to stand at 94-95% for lead, 92% for gold and 95% for silver, whereas these numbers now stand at 80-85%, 90% and 92%. Moreover, rare metals are not being extracted at all. Without the discovery of new fields and the expansion of the reserves, producing nonferrous metals in Kazakhstan will be competitive for no more than 25-30 years. Experts always raise the issue of the need to develop profitable zinc and copper mines. According to the Kazakh Geology and Mining Committee, the current investment share in prospecting metals out of the total investment in geological prospecting fell by 90% compared to 1996 – from 22% then to 2% in 2003. Even though this figure has grown in recent years, it is still premature to talk about the final solution to this problem.
The situation is no better in the ferrous metals sector. According to the Investment Fund of Kazakhstan, the country does not produce the necessary range of rolled iron and metal products for the machine-building, oil and gas, mining, light, food, construction, heavy machine-building and ship-building sectors. The country does not have lines to produce materials and metal products based on new technology either. The use of scrap metal is also inefficient – its reserves have not yet been finalised and its exports have not been put in order.
Meanwhile, analysts say, the country’s mining and energy sectors are capable of employing modern steel-making technology, using the existing resource base. This is, above all, the technology of extracting iron directly from the ore and concentrates through receiving sponge iron (a high-quality raw material that replaces cast iron and scrap metal in making steel in arc furnaces) and the technology of making bar iron of increased strength and elasticity from carbonic low alloy, alloy, stainless and other types of steel. This would enable Kazakhstan to cut imports of bar iron and even export it in the future.
However, so far investors are not rushing to employ new technologies, despite the fact that world metal prices make it possible to do so without even thinking. Perhaps, in order to produce high value-added goods, they need additional incentives that are not available. Individual examples (such as the state’s involvement in building an electrolysis plant in Pavlodar or the establishment of the Institute of High Technology by the Kazatomprom national nuclear company) cannot, unfortunately, serve as a point of reference for diversifying the mining sector.
Investors’ orientations, formed when the sector was in crisis, to boost the output of raw materials at any price in order to receive quick returns from investment are the very obstacle that is preventing the mining sector from stepping into the future. Obviously, the main reason for “failures” in diversifying the sector is hidden in the steadily high world prices of the main raw materials.
For example, the price of copper on the London Metal Exchange was $1,784 a tonne on 1 January 2001, whereas it exceeded $5,680 a tonne in January 2007. The price of zinc has jumped from $900 to $3,500 a tonne over the past six years. As a result, 90% of the Kazakh mining sector’s output is exported, and selling concentrates and metal remains the most profitable and unproblematic way of receiving revenue.
Still, we should remember that nothing lasts forever. For example, analysts from the Beijing Antaike Information Development consultancy predicted that the sharp growth of prices of nonferrous metals over the past five years will cease by the end of 2007 because of the high growth rates of reserves. Thus, the diversification process will become the only possible scenario for the stable growth of the sector, given the direct dependence of the Kazakh mining sector on world metal prices.
There is also an opinion that Kazakh mining companies’ initial public offerings (IPOs) will move this issue beyond deadlock. The Eurasian Natural Resources Corporation seems to follow the Kazakhmys Corporation, which attracted £661m for 26.2% of its shares on the London Stock Exchange. However, it is premature to talk about mining companies’ readiness to conduct international auditing and enter the international stock market. The greatest risks companies face while placing IPOs are the threat of losing control over their companies and the threat of disclosing information. By placing an IPO, a company not only acquires many shareholders, but also becomes public. Bearing in mind that many extracting companies have not yet joined the initiative of making their mining contracts transparent, there will be no large-scale placement of IPOs in the near future.
As a result, it is highly likely that the diversification process will be postponed indefinitely. Moreover, in light of the steady demand for metals on the world market and its knock-on effect, Kazakhstan can finally entrench itself in a group of countries with extractive economies. The Kazakh mining sector, which seems to be developing dynamically, has actually been stagnating, and the “recovery” linked to some companies’ IPOs on the international stock market can signal a temporary remission. A real change in the situation should be expected only when there is consensus between the state and investors, as discussed by the head of Kazyna.
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