Talk about nationalisation adds to the negative environment

International analysts and investors are increasingly viewing South Africa’s once world-leading mining sector – already suffering from a variety of serious pressures – in negative terms. The latest is a suggestion by Bank of America Merrill Lynch that Anglo American plc should split its international assets from its South African operation and thereby up its value by as much as 17%. Renewed talk about nationalisation is the last thing this sector needs, as the country’s largest employer.

The African National Congress Youth League (ANCYL) has been able to persuade its parent organisation to place the issue of possible nationalisation of South Africa’s mines on the agenda of its forthcoming National General Council (NGC), with the Youth League claiming it is not a matter of if, but how the nationalisation will be implemented.

Meanwhile, research by Bank of America Merrill Lynch concluded that Anglo American should split into two London-listed companies worth $30 billion and $34bn respectively. This is the second time within months that such a suggestion has surfaced in international financial circles. The same suggestion was previously made in respect of AngloGold Ashanti.

Such a move would lay both companies wide open for takeover bids from major competitors and it is unlikely that either company would follow this advice. The South African government is likely to oppose any such move vigorously.

It should nonetheless serve as a serious warning to the government to get its house in order concerning the mining sector. Furthermore, this negative judgement on the state of the South African mining industry is in a sense also an indictment of the broader South African economy, as a number of the underlying factors that negatively impact on the mining sector affect most other economic sectors in the country.

The mining sector was long recognised as the most prominent economic sector in South Africa, but in recent years it has slipped back from pole position to being only the fifth or sixth largest contributor to total gross domestic product. The sector is nonetheless still regarded as a cornerstone of the economy, but has in recent years been at the receiving end of a number of crises and negative developments, some of which are listed in the Bank of America Merrill Lynch report as part of the underlying causes of its negative perception.

Relief from the effects of most of these pressures lies within the political realm and thus within the power of the government to help effect positive change. Among the pressures and issues that are shaping these negative external impressions are the following:

·      Eskom power crisis: The Eskom electricity supply crisis in late 2007/early 2008, caused by an ailing national power supply infrastructure, had a severe impact on the mining sector, with more such problems being anticipated from 2011 onward. The 2007/08 crisis first forced some shut-downs of mining operations and then, due to power rationing by Eskom, resulted in reduced production. Global platinum and palladium prices hit record highs in January and February 2008 as South African mines – which, among others, supply 85% of the world's platinum and 30% of palladium – were cutting back on production due to the Eskom crisis. Due primarily to the impact of this power crisis on mining companies, economists at the time significantly downgraded South Africa’s GDP growth forecasts. Other current Eskom supply problems to the industry are highlighted by the example of a delay in supplying power to the Great Basin Gold’s Burnstone Mine in Mpumalanga – the company’s first operation in South Africa – which has put the mine two weeks behind schedule in reaching commercial production. Meanwhile, Erica Johnson, Eskom's chief officer for customer network business, said in March that South Africa's power supply is seen as a serious concern from 2011 onward until new power stations become operational, with the country needing to replace ageing plants. Eskom needs to build an additional 20 gigawatts of power by 2020 and 40GW by 2030 to meet fast-rising demand, but the interim period between 2010 and 2020 faces severe pressures.

·      Global recession: The Eskom power crisis was followed by the global recession in 2008/2009, which impacted severely on the mining sector due to a fall in exports and commodity prices. Mining production fell alarmingly in 2009 after the highs of January 2005, with sales plummeting 30% between October 2008 and October 2009. This resulted in an estimated loss of some 50 000 jobs, which could have been far more severe save for intervention by mining companies, the government and labour unions. The recession and the resultant developments forced most mining companies to cut back on production and either reduce or cancel major capital-intensive projects. While recovery was under way at the end of 2009, Frost & Sullivan's mining industry outlook for 2010 warned that the challenges faced by the sector would include electricity supply shortages, skills and safety concerns. Analysts were further warning that the recovery of commodity prices, particularly in the gold, platinum and coal sectors, were likely to lead to increased wage demands from the labour unions. In the end, little came of the government’s bailout plans, particularly regarding the so-called layoff training scheme designed to save jobs.

·      Labour laws: An often cited impediment to economic growth and investment In South Africa, which also impacts adversely on the mining sector, is the country’s rigid labour legislation regime that is stacked in favour of labour. This has further contributed to ongoing falling employment rates in the country, with the focus shifting to mechanisation. Just this week, Econometrix Treasury Management managing director George Glynos warned that the focus must shift to production and not mechanisation in order to fight off unemployment. A widely welcomed, if minor, adjustment to the labour laws regime aimed at improving the employment outlook was announced by Finance Minister Pravin Gordhan in his Budget speech earlier this year in the form of a proposed youth employment subsidy. However, so far nothing has come of this, and Gordhan recently told parliament that it was still under discussion in the government. No other forms of relief on the labour legislation front are anticipated, and foreign investors therefore continue to take a negative view.

·      Labour demands, strikes: Coupled closely to the rigid labour law regime in South Africa, are the high, often unrealistic wage demands by labour unions, frequently leading to militant labour action. In its 2010 outlook for South Africa’s mining industry, Frost & Sullivan warned of unions exploiting the recovery from the recession to demand unrealistically high wage increases. This has indeed been the case in South Africa, with unions exploiting the hosting of the 2010 Fifa Soccer World Cup to demand wage increases that far exceeded inflation numbers. For example, the National Union of Mineworkers – which is affiliated to the ANC’s ruling Alliance partner, the Congress of South African Trade Unions – has been demanding a wage increase of 15% this year, including in its negotiations earlier this month with South Africa’s second largest platinum producer, Impala Platinum. South Africa produces 80% of the world’s platinum – a major contributor to cutting global carbon emissions, as platinum is largely used to produce catalytic convertors to reduce car exhaust pollutants.

·     Exchange rate: The volatile rand exchange rate has frequently been criticised as making South African exports uncompetitive. Trade unions say the volatility has produce weaker exports, resulting in job losses. South Africa has a floating exchange rate system coupled to inflation targeting in a 3%-6% target band. While there has been much pressure both from business analysts and economists and from labour on the government to opt for a fixed exchange rate and abandon inflation targeting; and while there have been some indications this year that the government may consider some changes – Minister Gordhan recently reaffirmed existing government policy.

·     New order mining licences: While there were some concerns over the effect on existing mineral rights and some criticism of the government’s new Mineral and Petroleum Resources Development Act introduced in 2005, the new law did lead to a significant increase in transactions, with more foreign companies getting in on the local mining act. But there remain serious reservations about aspects of the Act, particularly pertaining to black economic empowerment (BEE) and abuses of the Act by those who are politically connected. The new legislation creates a “use it or lose it” principle that was previously absent and has provided many BEE companies an opportunity to acquire or increase their stake in mining.

·      Corruption and the Kumba debacle:  A prime example of scepticism toward the new-order mining rights in South Africa, coupled to corrupt practices, is contained in the Bank of America Merril Lynch report. The report refers to the Kumba debale earlier this year when ArcelorMittal apparently failed to apply for a new-order mining licence for its share of the Sishen iron-ore deposit, with control over the deposit reverting to the state as a result. The report states that as operator of the deposit, Kumba – which is a subsidiary of Anglo – seemed the obvious company to obtain the licence. “Instead, the licence has been granted to a company which appears to be politically connected,” the report says. Indeed, some of the directors or shareholders of the company that was granted the licence have direct links to senior ANC leaders. Bank of America Merril Lynch concludes that it believes “these issues will persist and will continue to be an overhang on Anglo American shares”. In the past, other analysts and commentators have regularly referred to the high levels of corruption in South Africa, as well as unsavoury political intervention in business, which are present in the mining and other sectors.

·       Mining Charter and BEE: Analysts abroad – including the latest Merril Lynch report – are sceptical of South Africa’s mining charter introduced in 2002, which includes provisions for BEE and which compelled mining companies to reapply for mining licences and sell stakes in their businesses to BEE vehicles. The Merrill Lynch report is rather scathing when it concludes that “mining equity underperformed the wider market and miners with more exposure to SA underperformed the sector”.

·      Nationalisation threat: Confidence in the future of South Africa’s mining sector is being negatively affected by the ongoing, much publicised threats to nationalise the sector. The current debate on the issue was started when the ruling ANC’s junior partner, the ANCYL, and more specifically its controversial president Julius Malema, demanded that the government should nationalise South Africa’s mines. Since then, a debate has been raging with government leaders, including President Jacob Zuma, frequently saying that nationalisation was not policy. None, however, has given unequivocal assurances that it will not become future policy and, indeed, last week the ANCYL was able to persuade the ANC to place the issue on the agenda of its upcoming NGC, a mid-term conference that reviews policies and activities. With such a threat hanging over the sector, it can hardly be expected that existing or proposed new mining operations will attract investment, either locally or from abroad.

The South African mining sector has consistently veered toward becoming less competitive in the global market due to some or all of the above factors. This has been exacerbated by the rise in new global mining competition by countries that are proving to be more competitive as is illustrated by China overtaking South Africa as a major gold producer. There are many other examples.

As the Bank of America Merrill Lynch report suggests, the problem is the overall mining environment in South Africa which, the report says, seems to move “from crisis to crisis”. The report states that it “really struggle[s]” to be positive on the outlook for the metals and mining industry in South Africa.

As we have mentioned, many of the problems and pressures informing these negative international views of South Africa’s mining sector – much of it shared by the local mining companies – fall within the political realm of South Africa, and it will therefore be up to the ruling ANC and its government to address these issues satisfactorily, bring relief to the sector and reinstate confidence in its future.