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South African mining recovery to be short-lived as mining charter policy uncertainty continues

BMI Research reports that the mining sector will continue to face headwinds from policy uncertainty regarding the passing of the draft mining charter.

This will hinder the potential of a recovery in 2016 from becoming solid. BMI Research, (a unit of Fitch Group), forecasts the domestic mining industry value to continue to decline over the coming years.

Policy uncertainty a stumbling block

South Africa’s mining sector will continue to feel the effects of the impending implementation of the new draft mining charter, announced almost one year ago, on 15 April 2016. Even as a rise in iron ore and gold prices have improved the outlook for major miners in the country, policy uncertainty regarding the final conditions of the charter and a generally declining investment environment in the country will mean any recovery is short-lived.

BMI Research forecasts the domestic mining industry to contract from US$33.8 billion in 2017 to $32.9 billion in 2021.

The Department of Mineral Resources published the new draft mining charter, with amendments to the original charter of 2010. However the implementation has been continuously delayed due to disagreements with the Chamber of Mines and the domestic mining industry over certain revised requirements.

In particular, controversy emerged regarding new efforts to align the charter with the codes of good practice is sued by the Department of Trade and Industry under the Broad-Based Black Economic Empowerment Act (BBBEE) of 2003. Under this act it is mandatory for all enterprises operating in South Africa to work towards reaching 26% ownership by black people. More specifically, issues have arisen over the target of ownership requirement which now needs to be met throughout the life of the mine.

Under the previous charter of 2010, as long as a mining company fulfilled the 26% black ownership participation quota at some point in its life, the company would still be entitled to retain its mining rights, due to the principle of ‘once empowered, always empowered’.

However, the new draft mining charter stipulates that a mining company must fulfil the owners hip requirement at all times and thus must make the necessary adjustments to ensure it abides by the participation target if ever it falls below the 26% threshold.

The introduction of the mining charter will further dent South Africa’s investment environment, as miners are forced to adhere to stricter compliance of black owners hip participation rates, which must be implemented within three years of the passing of the charter.

Other amendments seek to increase royalties on the industry by as much as R3.5 billion by claiming part of the current expenditure the industry spends on human resources and through the introduction of a 0.5% levy on revenue which will be invested in local communities.

Bodies such as the South African Chamber of Mines are likely to take the government to court if the charter is implemented in its current form, only adding to the existing policy uncertainty regarding the full details of the final approved draft and time-frame of implementation.

These developments have been factored into our newly revamped mining RRI scores, reflected in South Africa’s relatively lower mining regulation sub-indicator score. For instance, South Africa is placed behind countries such as Angola and Mauritania in terms of mining regulation, despite the fact that both these countries score lower in terms of political risk and in our overall RRI index.

Factors influencing investor hesitation

At the same time, the country’s level of investment openness has been considerably eroded in recent years on the back of threats to foreign investor property rights, infrastructure deficits and labour unrest. Labour unrest in particular has been commonplace, and although new recommendations have been put in place for a minimum wage increase, BMI Research’s country risk team’s view is that these could be relatively ineffective in curtailing futures trikes.

Furthermore, there has been a recent uptick in populist rhetoric coming from the South African government in recent months as President Zuma attempts to mobilise support ahead of the December National Elective Conference. While calls for radical economic transformation such as land expropriation are unlikely to be put into place, this will nevertheless undermine an already fragile investor perception of the country which is already taking its toll on foreign direct investment inflows.

Price rally only a temporary boost

The imminent passing of the charter means that South African miners could well be impacted from this fallout amid signs of a financial recovery – following the commodities slump of previous years.

For instance, in Q4, 2016, Anglo American produced 11.9 Mt of iron ore through its Kumba Iron Ore facilities, amounting to a 9% year-on-year increase on the corresponding quarter, as the rally in iron ore prices during H216 stimulated production once again.

This also meant the company managed to reduce its debt by 34% year-on-year in 2016, while group EBITDA increased by 25%, an improved financial and operational performance that has been reflected in rising share prices .

Ultimately, however, firms are far from fully recovered and are s till looking to strengthen their balance. While recent reporting shows signs of improvement, Anglo American retained bloated debt levels of R8.5 billion as of Q4, 2016, while the firm reduced capital expenditure by 37% year-on-year in 2016, in an effort to restore an investment grade rating and resume dividends payments in 2017.

Higher compliance and adjustment costs from the mining charter will therefore be a blow to mining firms which are looking to take advantage of the iron ore surge to increase their cash positions and finance their ongoing debt obligations.

As an added headwind, iron ore prices have already headed below $90/t since February, and BMI Research forecast this drop to continue and for prices to retreat to close to $60/t in H2, 2017 and retest lows by 2018, putting further downside pressure on diversified miners margins in the coming years.

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