Ecuador: Resource Nationalism Has Predictably Failed

| About: Kinross Gold (KGC)
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Kinross May See its Property Reinstated

Readers may recall an article we posted exactly one year ago, entitled “The Limits of Resource Nationalism”, in which we talked approvingly of the fact that the management of Kinross Gold (NYSE:KGC) told the government of Ecuador 'thanks, but no thanks". It took the difficult decision to walk away from one of the best gold discoveries of recent decades rather than agree to what amounted to extortionist demands by a government that appears to be run by economic illiterates (not that it is a big surprise to find a government being run by economically illiterate people – that is per se quite normal).

The government's not very well thought out reaction to this was to resort to blackmail, by declaring that Kinross would essentially be expropriated if it didn't agree to its demands. Thus it was signaling to mining companies all over the world that property rights mean nothing in Ecuador and that they must expect to be sitting ducks that will be robbed at the government's whim once they have invested hundreds of millions of dollars. In typically Orwellian fashion, the whole escapade was misnamed "Ecuador's ambitious plan to attract mining companies" (see also below).

Now we learn via "" that Ecuador's government is apparently rethinking its handling of the Kinross matter.

“Canada’s Kinross Gold Corp., the company that took a $720 million write-down when it halted its $1.3bn Fruta del Norte gold-silver project in Ecuador last year, is in negotiations to get back part of the investment, Bloomberg is reporting.

The miner said in June last year it was abandoning all efforts to develop the project because of the high taxes demanded by the Ecuadorean government, which refused to renegotiate a plan for a 70% windfall tax on revenue, allow Kinross to sell Fruta or extend the company’s license beyond an August 1 deadline.

For Kinross, the project was a calculated risk that simply didn’t pay off. For Ecuador, it was a major blow to its ambitious plans of attracting mining companies to develop the industry.

Since 2012, the country has signed only one investment contract for a large-scale mining project with the Chinese-owned Ecuacorriente S.A. for the open-pit Mirador copper project, scheduled to start production at the end of 2015. A member of the country’s mining chamber told BNamericas earlier this month (subs required) the project sale was still ongoing, and that the potential buyer “would have to be approved by the government.”

One of the rumoured bidders is Chile’s Codelco, the world’s largest copper producer, which is already involved in the Ecuadorian mining sector. But people familiar with the matter told Bloomberg that President Rafael Correa’s administration may agree to renew the company’s rights to the concession, removing legal hurdles to the prospective sale.

Another option, says the report, is for Kinross to just sell data gathered from its prospecting operations. Fruta del Norte, found in 2006, is one of the world’s biggest gold discoveries, containing about 6.7 million ounces of proven and probable gold reserves and 9 million ounces of proven and probable silver reserves, according to Kinross’ website.”

(emphasis added)

We take issue with the formulation of this sentence: “For Kinross, the project was a calculated risk that simply didn’t pay off. For Ecuador, it was a major blow to its ambitious plans of attracting mining companies to develop the industry.”

This makes it sound as though Kinross could just shrug its shoulders and wave good-bye to a $1.3 billion project as though it were nothing. It also makes it almost sound as though an evil Kinross had "dealt a blow" to an essentially innocent, if overly "ambitious" Ecuadorian government.

Let us not forget here that this government tried to blackmail Kinross and when that didn't work, simply expropriated it without further ado. If that "dealt a blow" to the country's mining ambitions, then the government has only itself to blame (our above mentioned article on the altercation details why exactly the demands by Ecuador's government were completely unreasonable).

Middle of nowhere, Ecuador: the Fruta del Norte project. It would be a great mine, but it won't be developed unless the owners can be sure of a reasonable margin of safety through the entire cycle and can expect that their property rights will be respected.

(Photo via / Author unknown)

Can Mining Companies Even Afford to Take a Gamble on Ecuador?

The idea that Codelco, or anyone else for that matter, will develop the project at lower gold prices without getting at least the concessions and assurances Kinross wanted to get, is in our opinion nothing but a pipe dream. We believe this is just disinformation to make it appear as though there were actually genuine interest. Note that the much-trumpeted "involvement" of Codelco in Ecuador's mining industry to date amounts to exploration spending totaling $3.5 million, essentially a rounding error in the company's budget. It doesn't sound like the kind of commitment one would expect to see if property rights in Ecuador were actually secure.

There is certainly absolutely nothing wrong with the deposit, quite the contrary, but the small sentence about the "data" Kinross has in its possession is actually quite important in this context: prospective new owners have the choice of either spending a pretty bundle on exploring the property all over again, or trying to buy KGC's drilling data and studies.

They will almost certainly do neither if they must fear that they will then be forced to jump through similar hoops as Kinross. Moreover, any arrangement that grants concessions to newly appointed owners that were withheld from the actual owner prior to the expropriation of the property may well be challenged in international arbitration courts (although Kinross has thus far not sounded eager to attempt to challenge the expropriation, presumably judging it a lost cause). Such a challenge may not succeed, but it sure would produce another well-deserved PR disaster for the government.

Mining is a highly capital-intensive activity. Gold mining companies have rightly been accused of wasting a lot of capital in projects that subsequently failed to produce the expected returns. Political risk is extremely high in the business, almost regardless of the location (obviously, there exist quite different risk profiles at any given time, but as the recent example of the destruction of the US coal industry in the name of stopping the imaginary danger from "global warming" shows, such risks are not the exclusive preserve of developing countries). The new management of Kinross decided to control what it can control. Namely, as its CEO Paul Rollinson stated when explaining the decision to walk away from Fruta del Norte:

“We have said that we will exert strict capital discipline across our Company, that we will allocate our capital only to projects which meet our investment criteria, and that we will only enter into agreements that are in the best interests of the Company and its shareholders.”

This is exactly as it should be. As an aside, in spite of the new management's focus on capital discipline, KGC has been a very bad performer in the stock market, especially lately (all gold mining stocks have performed badly, but KGC has been one of the worst). This is once again due to political risk rearing its head, as the stock sold off in concert with the worsening crisis in the Ukraine. Some of the most profitable Kinross mines are in Russia, and investors became antsy when sanctions were imposed on Russia.

It is presumably feared that Russia could retaliate and it is of course well known that mining companies are 'sitting ducks". In this case we believe the market has overreacted, but it is clear that the situation remains in flux (as an aside to this, the Ukraine has inexplicably disappeared from the Western mainstream media, in spite of the worsening civil war in the East. We will soon post a more detailed comment on the situation). It would be reckless to state there is no risk, but we happen to believe that the situation has actually created an opportunity, just as an opportunity has been created in Russian stocks.

KGC, weekly, via StockCharts – most recently, the already beaten down stock was waylaid by events in the Ukraine.


We certainly hope that Kinross succeeds in obtaining the approval to sell the project and then proceeds with actually selling it, instead of hoping for Ecuador's government to change its stripes. The project is an enticing one and it is bitter that it had to be let go, but in this case the political risk evidently really is too high. It would be a pity to invest more than a billion dollars in developing the mine and then be confronted with another blackmail attempt. At that point, walking away would be very costly indeed.