Commentary: Resource nationalism and mining reforms could mean more international disputes

Ernst & Young listed resource nationalism as the number-one risk threatening the mining sector in 2013 — a sharp increase over five years ago, when resource nationalism appeared at the bottom of Ernst & Young’s top-10 list of business risks facing the mining and metals sector.

Amidst a struggling global economic context, increasing mineral and metal prices have fuelled host governments’ efforts to seek a greater take from the mining sector. These efforts have translated into a new wave of mining reforms that impose or increase royalties and mining taxes, introduce local-beneficiation requirements under penalty of increased export levies or limit foreign ownership of mining assets. 

These contemplated or newly enacted mining reforms have generated uncertainty, and caused mining projects around the world to be deferred, or cancelled altogether.

These reforms — with their dramatic impact on existing projects’ risk–reward equation — have caused, and are likely to continue to cause, a significant number of international disputes between international mining companies and resource-rich host governments, including Peru, Bolivia, Venezuela and Mongolia. 

Faced with the threat of resource nationalism, existing and prospective foreign investors must develop strategies to protect and preserve their rights. These strategies include securing optimal protection under available bilateral investment treaties (BITs), laws and contracts — in particular, obtaining or preserving the right to dispute resolution before international arbitration tribunals, thus avoiding the local courts — and engaging with governmental entities to delineate areas of responsibility and foster a greater understanding of the value that natural-resource development brings to the host states.

A new wave of mining reforms

Robust mineral and metal prices over the past few years have led resource-rich countries to enact or contemplate overhauling mining legislations aimed at capturing an increased share of the mineral rent. In that respect, this trend compares to some oil-producing countries’ efforts to enact “windfall-profit” taxes on oil production from 2005 to 2010.

Australia announced a proposed Resource Super Profit Tax in 2010, aimed at capturing a large share of profits from coal and iron-ore mining in the country. This initial proposal evolved into the Minerals Resource Rent Tax, which came into force on July 1, 2012, and provided for an additional 30% tax on the profits generated by iron-ore or coal companies in excess of A$67 million. Tony Abbott’s recent election as Australia’s prime minister, however, may result in an overhaul of these taxes.  Prior to his election, Abbott stated that if elected, he would introduce legislation to repeal the country’s Minerals Resource Rent Tax and Carbon Tax.

Australia’s approach had a ripple effect around the world, prompting numerous governments to announce similar increases in mining taxes and royalties in 2011 and 2012. For example, Chile and Peru enacted new mining tax and royalty reforms in 2010 and 2011. Both regimes aim to tax profits, and not only gross production. The levies are based on the net-mining income of the local operators, with certain adjustments, including the impossibility to deduct interest payments.

Since 2011, more countries have announced or enacted new mining regimes providing for increased taxes or royalties. These countries include the Democratic Republic of the Congo, Ghana, Mongolia, Poland, Canada, Bolivia, Zambia and the U.S. Most of these fiscal regimes provide for more taxes on the mining companies’ profits in the country. The DRC, however, adopted a different approach by imposing a 20% capital-gain tax on any share transaction in mining companies.

Many host governments have gone — or are contemplating going — beyond taxation in seeking to capture an increased share of the mineral rent. South Africa, Zimbabwe, Indonesia, Brazil and Vietnam recently introduced an in-country beneficiation requirement for mineral and metal exports, that is, the obligation to process the raw ore into higher-value material in the country where it is extracted.

In-country beneficiation requires the mining companies to invest considerable resources into establishing refineries and/or smelters in the country, which result in higher export tax income for the host states as higher-value products are exported.  Mandatory in-country beneficiation results in more investments, augmented risk and potentially diminished returns for foreign mining companies previously operating in the country. To further the beneficiation agenda, some countries, such as Indonesia, are moving to impose steep export levies on unrefined ores, leaving mining companies with no other choice than to build local refineries or smelters in order to export transformed products. 

Another way for governments to retain the profits associated with mineral exploitation consists of imposing state or national ownership requirements for in-country mining projects. Although local participation requirements do not constitute a new phenomenon (and in fact have been widely used in the hydrocarbon sector over the past decades), some mining countries have recently pushed to introduce or increase similar mandatory participation mechanisms.

In addition to existing mandatory ownership programs, South Africa is contemplating a mandatory participation requirement for a state-owned mining company in local mining operations. Meanwhile, Mongolia and Zimbabwe have introduced 49% caps on foreign ownership for certain mining projects.  Similarly, Indonesia recently announced a plan to cap foreign ownership of local mining projects to 49% after 10 years of operation. China and India have also moved to restrict foreign exploitation of certain mineral resources. These ownership requirements significantly alter the risk–reward profile of a given project, and may jeopardize a foreign investor’s ability to derive a profit from its investment, or even meet its debt burden. They may lead mining companies to re-evaluate their development–investment projects and/or to sell their stakes in specific projects — often at depressed prices. 

As mineral and metal prices rose over the past few years, local stakeholders developed an appetite for the benefits associated with mining projects, especially in emerging economies where governments have sometimes struggled to develop the means to meet the needs of their citizens. In some cases, the sustained profits generated by the mining sector have fuelled local expectations (whether at the governmental or communal level) that mining and metal companies undertake community development, social and logistics infrastructure programs. These expectations also encompass preferred hiring and local-procurement policies, investment in social program or infrastructure and redirection of governmental mining profits back into the production area.

While these programs have become an essential part of the investment process, they can result in significant conflicts if the economic realities of the project do not — or no longer — allow the mining company to shoulder the burden of expansive social programs or infrastructure investments. These conflicts may severely impact the profitability or viability of mining and metal projects. 

Available risk-mitigation strategies

Facing resurging resource nationalism and adverse mining reforms, parties engaged in international mining projects are advised to pay particular attention to ensuring that they can navigate potential disputes under the best conditions possible. These conditions may be optimized in the contract, in the investment structure and in the relationship with the host–state government. 

First, all of the parties involved should clearly delineate
individual areas of responsibility for the risks associated with mining projects  — political, fiscal, trade, environmental, supply or price risks, to name a few — and provide for adequate adaptation and dispute-resolution mechanisms. Parties may allocate these areas of responsibility on the basis of their nationalities, competencies and role in the project. As a way to achieve that allocation of risks, parties to mining agreements should consider the opportunity to provide for stabilization and/or “freezing” provisions in their contracts, or negotiate separate stabilization agreements. Parties should also consider force majeure clauses, perhaps even economic force majeure clauses.

Foreign parties in mining projects must obtain or preserve the right to seek resolution of their contractual disputes before international arbitration tribunals. Recourses to a neutral forum have become difficult in a number of resource-rich countries that have sought to impose the jurisdiction of their local courts for public and private contracts involving the mining and metal sector.

Second, all parties involved in mining projects should actively manage the structure of their investments to obtain or preserve access to investor–state arbitration in case of adverse regulatory actions. A party should invest through a corporate vehicle from a country providing comprehensive treaty coverage (BITs, free-trade agreements, or multilateral agreements NAFTA or DR-CAFTA) to obtain optimal protection.  In that respect, Bolivia, Ecuador and Venezuela’s recent denunciation of the ICSID Convention — the largest forum for investment disputes — does not affect the validity or the investment protection afforded by the BITs concluded by these countries (to the extent that such BITs provide for non-ICSID arbitration) because these treaties exist independently from the ICSID Convention.

Subject to the provisions of the applicable investment treaty, the definition of investor and investment (enabling treaty protection and investor–state arbitration) will generally cover the investment and activities of the wide array of parties in mining or metals projects. Operators and direct investors — as well as lenders, long-term purchasers  and traders — should evaluate how to structure (or restructure) their activity in a way to maximize available treaty protection. Adequate investment-treaty protection plays a substantial role in procuring political risk insurance (particularly when offered by international organizations or public entities) and/or reducing the insurance premiums associated with international projects and operations.

Finally, mining and metal companies should engage with governmental entities and develop a better understanding of the value that a project brings to the host country and its population. This may in turn help foreign investors secure a seat at the negotiating table when mining reforms are being discussed. Fostering a positive relationship with host governments may allow mining companies to better negotiate appropriate trade-offs that preserve the value of their investments. 

Mining companies investing in emerging economies could also partner with foreign state-owned companies that have strong state-to-state ties with a host government or its state-owned companies. Judicious choices of lenders and financial partners will also play an important role in a dispute. This includes involving public or multilateral lenders, such as the World Bank, the European Investment Bank or the Inter-American Development Bank. Backing from powerful lenders (and potential lenders to the host state at issue) can play a crucial role in unlocking disputes caused by adverse governmental actions. 

— Based in New York City, Henry Burnett and Caline Mouawad are partners with the Business Litigation practice of law firm King & Spalding. Louis-Alexis Bret is an associate in King & Spalding’s New York office.

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