Africa must learn to cope with commodity volatility – expert

By:KENNETH AGUTAMBA , 29  June 2015, The New Times (Rwanda)

The drop in commodity prices such as minerals and oil on the international market means investors are reluctant to sink their money deep in the ground to extract resources; what should commodity-dependant African countries do? First, avoid another ‘race to the bottom’ where governments give investors overly generous incentives to invest; they should also diversify their economies to cut dependency on commodities, according toAntonio Pedro, the United Nations Economic Commission for Africa director for Eastern African region. In an exclusive interview with The New Times’ Kenneth Agutamba, Pedro discusses how economies can adapt and change with the tunes on the global market. Excerpts

First, give us an overview to put this discussion in context; we are experiencing low commodity prices internationally, but it’s not a novel experience, what’s the background?

Africa is at crossroads because of its dependence on commodities for export. 2000 to 2008 was a period of historically high commodity prices for the continent, the so-called ‘super cycle.’

Now we are experiencing a down-turn in prices. This might lead to some policy reversals. What’s the point? In the period where we have high commodity prices, we have what we call the ‘sellers’ market’ where those that have the commodities dictate the terms and conditions of the transactions. This is what the super cycle of 2000-2008 was about.

Now we are in the period of ‘buyers’ market’ because commodity prices are low and buyers have the muscle to dictate the terms and conditions. The low commodity prices may push governments into offering more and more incentives to attract investors.

Such a thing happened in the 1980s and 90s, causing what was termed as a ‘race to the bottom.’ It was a beauty contest of sorts among countries, each offering more and more incentives to attract suitors (investors) by reviewing and relaxing their legal and regulatory policies.

The results were bad. These countries’ overall tax base was eroded. So I am afraid that with the current low commodity prices, if we are not vigilant enough, we could witness another race to the bottom.

Petroleum commodities present a paradox of sorts in a sense that although most countries in the region are majorly net importers, some such as Uganda and Kenya were in high gear preparing to become producers when prices of crude started plummeting. Is the turbulence over?

No, not at all. I think we always need to remember that commodity price volatility is a feature of instrument and that we will always have it no matter what.

The issue for countries, therefore, is to understand what to do during times of volatility. So the short answer is that, we will see more volatility because it’s part of the industry.

There’s a bet out there, that the price of crude will never be the same again at more than $100 a barrel. If so, there would be more winners in Africa than losers. Rwanda, for example, is a net importing country of petroleum products…

Of course, if you are an oil import-dependant country such as Rwanda, a reduction in price is a good thing for the balance of payments because the share of dollars paid for oil imports will go down On the other hand, for oil producing countries low prices are not beneficial, especially if a country has deep oil wells that are expensive to drill.

The reasons behind the current low oil prices are; first, we have some oversupply of oil on the market because when prices were high at over $100 a barrel, everyone invested in drilling more wells, exploration of new types of oil and use of new technologies.

Second is the China factor. The decision to change the country’s pattern of growth from one that was export-led to one that’s driven by internal consumption saw its growth cut from double digit to single digit growth. This lowered the demand for oil because China was one of the leading buyers.

These fundamentals have affected the price of oil which at some point went as low as $40. This will gradually correct the market as producers with expensive deposits will gradually ease out due to high cost of production that can’t be sustained given the current low price for a barrel.

This explains why Saudi Arabia, whose production cost is less than $10 a barrel, is an important factor in the correction of the market. Regardless of the low oil prices, Saudi Arabia is making money, which is also why the Organisation of Petroleum Exporting Countries (OPEC) met but failed to agree on cutting supply.

Clearly, members of OPEC are divided; they used to influence things when they were united. With disunity and the rise of the US as a leading producer of oil, do you still think OPEC can help stabilise the global oil prices?

Yes, especially if Saudi Arabia decides to play ball; it’s in the interest of Saudi Arabia to displace high cost producers like those in Canada and US after all, the largest consumer of oil is still the US.

Saudi Arabia’s key target is to retain its market share in the US and, by sustaining supply at the current low prices, they are pushing out high cost producers inside America and Canada.

How long will it take for Saudi Arabia to get results from this kind of approach?

It’s already seeing results because their market share continues to be the same and a number of high cost producers are beginning to cut investments in the US and as a result, prices may start improving.
Overall, the trend is visible and even though we don’t hit $100 a barrel again, we might see $70 for a barrel which is better than $40 or $50 a barrel.

What’s your reading of the fate for African current and prospecting petroleum producers? How do you see the unpredictable price for crude affecting foreign direct investment in the medium and long term?

Certainly, there will be – or there’s already – a reduction in investment flows to Africa, especially for the expensive deposits for all extractive commodities, doesn’t matter whether it’s oil, gas or solid minerals.
If a country has what we call a marginal deposit for oil or minerals, it will certainly be taken out of the portfolio of any company because all mining or oil companies, do what they call ‘managing margins’ during periods of low commodity prices.

It’s about reducing costs as much as possible to remain solvent and financially sound. Therefore, we will see an overall drop in exploration expenditure in the extractive industry.

Secondly, we will or we are already seeing investors demanding for better terms of investment because according to them, the terms signed during the super-cycle period can’t be sustained in current circumstances of low commodity prices and this is where we started from; should countries give in to these demands by going through a period of revisionism of their legal and regulatory policies to appease investors? What options do they have?

What should be done by these countries especially those such as Kenya and Uganda that were banking on a new era of oil production? What are their options?

There are some structural issues here. First, we still have a sector that is heavily dominated by foreign investors and as we discuss issues of commodity price volatility, we will always be exposed to those ones. So one of the options for consideration is developing domestic commodity resource companies while being careful not to be seen as going back to the nationalisation drive of the 1960s and 70s that was dominated by state-owned companies.

This is really about creating competent, well run and competitive domestic firms (private or private-public partnerships) to be integrated in the local economies.

The second strategy is for governments to negotiate deals with investors that promote greater local value addition of these commodities. A good example is Uganda’s President Yoweri Museveni, whose advocacy in having the Ugandan oil refined locally is in perfect sync with this local value addition strategy.

These are options that need to be explored further. For example, if you have mining companies that are more concerned about royalties, income tax and so forth, then you enter into a win-win conversation where in lieu of reducing their royalties from, say, 5 per cent to 3 per cent and income tax from 35 per cent to 20 per cent, government would suggest they advance more local procurement of goods and services so that domestic firms enter into the supply chain; or hire more local personnel, including at higher managerial level or you propose more local value addition of the commodities.

Essentially, governments need to look at the extractive industry from a much broader understanding of its benefits to go beyond the revenue streams from royalties and income taxes and look at the role of extractives in promoting local industries and small and medium enterprises that can enter into the production and supply value chains.

It’s also about the role of an enabling resource based infrastructure to play a much more dynamic role in enhancing economic opportunities in other sectors of the economy such as agriculture and tourism; it’s about more value addition and multiplying jobs creation.

So that’s the complete package that governments should negotiate in such a situation of low commodity prices and reluctant investors who want more incentives to invest.

What I advocate against is creating another race to the bottom where countries compete against each other, eroding the tax package and reducing environmental obligations in order to attract investments that will not be sustainable to everybody.

I am afraid that ‘race to the bottom’ seems to be already in play. Countries seem to be promising heaven on earth to investors.

I beg to differ there. For example, Kenya is formulating its new mining policy to incorporate a country mining vision, which is a national effort to try and bring everyone concerned in a dialogue to explore the available options that can enhance benefits from the extractive sector.

I see several countries engaging in this process and central to a national mining vision is to make it a multi-stakeholder dialogue where all available options are considered through a conversation involving all stake holders and not a proclamation.

So, it’s not true that we are already racing to the bottom; there are signals, voices that are advocating for governments to block the advancement of some of the policy options that I have discussed earlier.

By the way, these are policies contained in the Africa Mining Vision which was adopted by the African Union in 2009.

The Africa Mining Vision is about linking the extractive industry to the local economy through greater local addition value and so on. There are forces out there arguing that given the current unfavourable market circumstances, governments have to tread more carefully with investors but I think it’s the right moment for African governments and private sector and other stakeholders to try and have a serious conversation about moving from a model where mining in Africa was an enclave and give guarantee to everybody, the so-called ‘social licence to operate.’

We have seen social licence to operate in DR Congo, Guinea and elsewhere, where you have contracts that only have one party winning. Sooner or later, those contracts will be denounced and people demanding a renegotiation, normally the process isn’t healthy for anybody.

My suggestion is we maintain the overall principles of the Africa Mining Vision that envisages a respected mining sector, regulated by the highest standards of transparency, governance and environmental protection and linked to the local economies.

So that’s the conversation that we must promote in Africa instead of saying, because of tight commodity prices, we have to favour the economic interests at the expense of the others.