The amount of investment being undertaken in Africa is burgeoning to the point that some commentators say that it will be a major region of opportunity for resource companies.
Equities Portfolio Manager
What the rise of Africa means for commodities and resource investors
The International Monetary Fund (IMF) forecasts that Africa will be home to 12 of the world’s top 15 fastest growing countries to 2015. These include Ethiopia, Mozambique, Uganda, Ghana, Angola, Tanzania, Kenya, DR Congo, Nigeria, Botswana and Zimbabwe. Only China, India and Vietnam come close.
This growth will come from various sources – resources being a major one. There are two major opportunities for investors in the sector:
Africa is believed to be one of the world’s best undeveloped sources of minerals and hydrocarbons. There are 200 Australian-listed mining companies working on more than 1,000 projects in Africa. Will the exploration and commercialisation of these projects bring riches to these companies?
The tremendous population and economic growth in the continent has investors wondering whether it will soon adopt China’s mantle of becoming a major source of demand (and share price support) for commodities.
Unfortunately, we think investors may be disappointed on both fronts.
Why the accelerated focus on Africa?
One reason why there is greater focus on Africa is that many of the best mines in the world’s most amenable mining regions (such as Australia, Brazil, Chile and the US) have been extensively drilled and developed - or can never be developed for environmental or social reasons (close to major cities and national parks). In contrast, Africa has a land mass that is greater than that of China, US, India and Central Europe combined, with much of it unexplored for resources.
Africa accounted for around 10% of the value of global mining production in 2012. But this will undoubtedly rise, given that the region accounts for around 15% of global exploration projects, 17% of definitive feasibility stage projects and 16% of construction projects. The main focus is on gold and copper.1
Who bears the risk?
Africa is also considered to be one of riskiest places to build and operate resources projects. Many of these are unfortunately often serious enough to be headline news, including earlier this year in Algeria jihadist Islamises took over a gas plant owned by BP killing 38 foreign hostages.2
The operational challenges are great. New ‘greenfield’ projects in Africa often require large amounts of associated infrastructure such as ports, rail, power plants, water pumping and treatment and labour camps – requiring hundreds if not tens of thousands of local people to be engaged and/or displaced.
But the majority of financial risks are more discreet. Resource nationalism is a major concern among the region’s 54 independent countries, with several cases of governments imposing stealth taxes or even seizing resource rich land owned by international resource companies.
Ultimately, we have concluded that the majority of the economic rent goes to governments rather than investors. Despite assuming the majority of the risk, equity returns to investors are just the residual.
Not all countries are the same
Using the Fraser Institute survey of mining companies 2012 as a guide (which ranks countries on political stability, tax, corruption, legal, infrastructure and environmental regulation) the prospects of African countries can be loosely categorised into three camps (our interpretation):
Good: Botswana, Burkina Faso, Zambia, Ghana, Republic Congo and Mali
Bad: South Africa, Madagascar, Mauritania, Tanzania and Namibia
Ugly: Zimbabwe, Guinea, DRC, Liberia, Angola, Nigeria and Chad.
Energy is preferred to mining
While there are several metal and mineral projects being developed and myriad others being evaluated and explored, we believe some of the better opportunities are in the energy sector.
Oil and gas projects typically differ from mining projects in three key aspects:
1 - Payback periods from first production are much shorter, typically 3-4 years rather than the 8-9 years for large mining projects and returns are much higher (around 30-40% IRR versus 15-20%)
2 - Africa’s oil and gas projects are also mostly located offshore. Although they require a lot of pipes to gathering and processing facilities which are built on the shoreline, it is a lot less involved than for mining
3 - Oil and gas companies have a lot more political sway due to their size and the fact they generate a lot more government income and much earlier.
As such, the rewards may justify the risks for large oil and gas companies to enter frontier regions such as east and west coast Africa. In contrast, for miners it’s difficult to generate a high enough return (well above 20%) with a short enough payback to justify the risk unless you have an exceptional and long life project
Africa (and India) will not be commodities’ saviour
China’s growth rate has been slowing and commodity supply rising, resulting in sharply lower commodity and share prices. There is some hope that Africa and India will provide the second wave of massive demand growth for commodities, such as for Australia’s iron ore and coal industry. The thinking is premised on two factors:
Africa and India both contain just over 1 billion people, and Africa’s young demographic is expected to result in its population doubling by 2050, accounting for half the world’s total population growth, and surpassing China’s population in 2023 which starts to decline from 2015
Africa and India’s capital stock of infrastructure is only 20-50% of that in China in terms of urbanisation and power consumption and the scope for major ports, roads, rail and airport investment is immense.
However, we believe that the trajectory and commodity intensity of growth in Africa and India will be very different to what has been seen in China. This is largely due to the differing political systems (fragmented democratic states rather than centralised command modelling) and its piecemeal economic development is less likely to have a meaningful demand ‘shock’ for commodities correlated to industrial growth such as iron ore and base metals. Rather, it will be more related to commodities correlated to demographic growth such as fertilisers, disease control chemicals and seed treatment technology. Africa imports 60% of its food requirements and its crop yields are approximately half that found in the Americas.
What does it mean for investors?
Investors should be aware of the risks. Political uncertainty and resource nationalism will continue to dominate in the region and global resource companies will need to learn to operate in a more political world. Choose your country exposure carefully
A barbell approach to investment makes the most sense – with exposure to top quality exploration teams in highly prospective regions, or big players with truly world class deposits where the companies have demonstrable track record of successful operation
More favourable risk reward opportunities are available in oil and gas
Africa and India will not provide Australia with the silver bullet required to keep the iron ore and coal industry booming post the peak in China’s industrialisation
The agriculture, infrastructure, logistics and banking industries will likely benefit most from the huge demographic dividend Africa will enjoy over the next 40+ years.
1 Standard Chartered
2 Financial Times, March 2013
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