Mining in Spain - what’s the risk?

Published: Monday, 22 July 2013

Dr Elizabeth Stephens, JLT Specialty Ltd, UK, explains the risks involved with developing a project in Spain and discusses recent developments in the Spanish minerals sector

Spain has some of the most mineralised territory in western Europe and one of the most diversified mining sectors, producing mostly significant quantities of industrial minerals and stone.

The country is a leading EU producer of natural sodium sulphate, slate, and strontium minerals and is the world’s third-largest producer of gypsum, fifth-largest producer of sand and gravel and sixth-largest producer of fluorspar.

Spain has an established mining history and is attractive to local and overseas mining companies. Its highly prospective geology is complemented by the country’s stable regulatory framework and transparent legislative standards. The fiscal environment is favourable for the extraction of natural resources and is further boosted by the provision of nonrefundable government grants for exploration and mine development.

Spanish minerals are owned by the state. The Mining Law of 21 July 1973 and the Hydrocarbon Law of 7 October 1998, govern the mineral industry and the Direcci—n General de Pol’tica EnergŽtica y Minas implements these laws. Under Law-20 of 5 June 2006, the Finance Regime of government-owned holding company, Sociedad Estatal de Participaciones Industriales (SEPI), was modified and it has mining as one sector in its portfolio. SEPI owns a number of mines in Spain and has a stake in others. The sector is comprised of state-owned companies, joint ventures between state and private companies and privately owned companies, including international mining companies.

Mineral fuels and derivatives accounted for around 5% of total exports and 15% of imports in 2011. Aluminum accounted for 1.2% of total exports and 1% of total imports; iron and steel, 3.3% of total exports and 4.3% of total imports; industrial minerals, 2.6% of total exports and 3% of total imports; and base metals, 2.3% of total exports and 2% of total imports respectively . Spain’s top import and export partners are other EU member states, plus China.

Impact of the global financial crisis

Spain was severely impacted by the global financial crisis and its industrial minerals sector is still under pressure from the Eurozone recession. Between 2008 - 2010, industrial minerals output decreased by 50% in response to the economic downturn that affected major end markets for construction materials and ceramics. In 2010 the minerals sector contributed 1% of Spain’s GDP and employed over 80,000. By 2011, as demand contracted, the contribution of the mineral sector had fallen to 0.8% of Spain’s GDP and employed around 60,000 people.

Throughout 2011, market confidence remained weak, and Spain saw a substantive reversal of foreign investment in the second half of 2011 and early 2012. For instance, Alcoa, Spain’s leading manufacturer of aluminium, announced that production would be curtailed by mid-2012 at its Aviles and La Coru–a aluminum smelters, which have production capacities of 93,000 tpa and 87,000 tpa, respectively. An uncompetitive energy position combined with rising raw material costs and falling aluminum prices, which decreased by more than 27% from their peak in 2011, led to the curtailment of the facilities.

In particular, cement production fell by over half from around 42m tonnes in 2008 to just 20m tonnes in 2012. The primary drivers of this were a near halt to new construction activity in Spain and the Eurozone more broadly, including budget cuts that hit public works spending. Production drops for fluorspar were less severe, falling from around 150,000 tonnes in 2007 to 120,000 tonnes in 2012. Gypsum production has held steady at around 11.5m tonnes.

Spain’s speciality minerals like sepiolite (an alluminate silicate clay) and iron oxide have fared much better and consumer demand remains more consistent.

Subsidies and industrial action

A rise in protests and other forms of industrial action have been triggered by the government’s response to the financial crisis. Subsidies to the coal industry were one of the main casualties of the austerity budget, introduced by Mariano Rajoy’s conservative government when it came to power in December 2012, and a casualty of EU directives. EU member states are not usually permitted to subsidise national industries but because of the importance of coal to Spain, accounting for 30% of electricity production, an exception was made in 2002. The exception expired in 2010 and Spain is set to stop subsidies to non-profitable mines by 2018. European coal is uncompetitive to produce and the EU is against the subsidising of industries that cannot survive on their own. EU initiatives to reduce fuel emissions by 20% by the year 2020 also make it illogical to subsides a sector with high emissions.

The Spanish government is speeding up these cuts and reducing the subsidies it pays to the mining sector by 63% next year. The miners say the current Spanish government should stick to an agreement, signed by the previous socialist government in Spain, to reduce the subsidies by only 10% in 2013. Around 8,000 mineworkers from over 40 coal mines in northern Spain staged a nationwide strike in June 2012 organised by unions bitterly opposed to reductions in coal subsidies from Û300m ($391.63*) to Û110m. The subsidy cuts are intended to save Spain millions as it seeks to reduce its budget deficit and borrowing needs at a time when it is challenging to raise loans at sustainable interest rates.

Mining unions claim the cuts will put 8,000 mining jobs in jeopardy and affect the towns and communities that depend on the salaries for their survival. With unemployment at 25% (50%, among the under 25s), the prospects for miners to find alternative employment in the future is limited.

The subsidy cuts are made more contentious because Spain has limited energy resources, causing many to view coal as a strategic sector amidst a huge dependency on energy imports. The country has one offshore natural gas field (2.5bn cubic meters), no significant oil reserves (150m barrels) and coal mines that contain low-quality coal (530m tonnes). Spain’s output of mineral fuels is insufficient to satisfy domestic demand, and the country will continue to be a large-scale importer of fuel minerals.

Investing in Spanish minerals and mining projects

The Spanish minerals sector continues to be of interest to domestic and foreign mining companies, with the Iberian Peninsula a notable target for mineral exploration because of past discoveries of large volcanogenic massive sulfide (VMS) deposits. Operating in an established mining region is advantageous as some crucial infrastructure will already be in place and local communities will have experience of working with mining companies.

While Spain is a developed territory, the potential for an adverse political risk event to affect mining operations remains. Given the current level of country economic risk and the need for the government to raise income receipts, the risk of non-payment or changes to the legal and regulatory framework affecting mining concessions pose the most significant risks.

There are a number of steps mining companies can take to minimise the risk to mining projects in Spain.

The first step is to understand that all risk is local and that an integral part of the due diligence process is to review the specific environment in the specific region of the country for their specific project. A review of security on the ground, legacy issues, reputational risk, social impact, environmental impact and relations with the current and potentially future political decision-makers in the host country is essential. This is exemplified by the changes that occurred in subsidy policy towards the mining sector in December 2011 when the socialist government was replaced by the conservative government of Mariano Rajoy Brey.

The second step to reduce country risk for a mining project is to identify the range of stakeholders and their respective interests. Stakeholders are not limited to those entities that finance the project and include the host government, local government, community groups or tribes, project sponsors, lenders, offtakers and NGOs. Active engagement with the full range of stakeholders at the onset of the project will contribute to the establishment or a stable operating environment.

The third step is to ensure equitable reward sharing between project sponsors, the host government and other participants. A major driver for resource nationalism has been perceived inequality in returns when commodity prices rise. This is a particular issue in the mining sector where agreements between a multinational enterprise (MNE) and a host government initially reach favour the MNE but where, over time as the MNE’s fixed assets in the country increase, the bargaining power shifts to the government. One way to address this is to link government royalties to profitability and commodity prices. Direct government equity participation in projects can also be a risk management tool and may be an alternative to the royalty structure.

While resource nationalism is more usually associated with emerging territories, many cash-strapped western governments have used taxation to extract greater revenue from natural resources projects.

The fourth step is to engage with non-governmental stakeholders. Many operational NGOs are more appreciative of the developmental benefits of investing in the resources sector and are willing to work with foreign investors. Their local expertise may prevent the project company from inadvertently creating new risks and, for example, in developing local infrastructure can advise on balancing the interests of competing tribes, employing from across ethnic groups and sensitivities to such things as religious and historical sites.

The fifth step is to consider the benefits engagement with multinationals may bring. As a preferred sovereign creditor, the World Bank wields considerable influence in the event of contractual disputes and defaults with emerging governments. This influence is reinforced by the World Banks’s role as a key source of liquidity when a country is in turmoil.

The sixth step is to consider recourse under bilateral investment treaties (BITs) which have long provided a valuable source of risk mitigation and valuable safety net to counter the worst excesses of government behaviour. This is particularly beneficial in the case of Spain which has signed 61 BITs and ratified the majority of them.

The seventh step is to provide adequate protection for personnel, particularly in territories with histories of kidnap for ransom and active terrorist groups. In conjunction with ensuring operational continuity, companies owe a basic duty of care to their employees and must ensure that suitable security plans are implemented and regularly reviewed to minimise the risks of an incident occurring. Risk cannot be completely removed from a project and should an event happen the company needs to have an effective crisis plan in place, which will include access to specialist third party service providers for medical or political evacuation or kidnap response.

The eighth step in the risk management process is to insure these risks. Political Risk Insurance (PRI) can insure against loss to foreign lenders, investors, suppliers and traders with mining companies. There are a range of perils that these risk participants may be exposed to depending on the specific project, the basis on which it trades, the location and associated contractual agreements.

Local politics matter

A key issue that is often misunderstood when looking at political risk in the mining sector is the idea that the key asset to be insured is the energy reserves. In the private sector the asset is in fact the right to explore for and receive a share of the revenue derived from natural resources, not an ownership right in those resources. This means that the fundamental peril for investors and lenders to resources projects is often the repudiation of the operating agreement by the host government and not the confiscation of the mining assets. This is a crucial in an era where government action may take different forms that are not of the character of expropriation as has been traditionally understood but do constitute a repudiation of existing operating agreements, often through a process of ‘creeping expropriation’.

The private PRI market, comprising of over 40 syndicates and companies, has theoretical capacity for a single project in excess of $1bn. Securing this capacity and agreeing conditions and a competitive price is most successfully achieved by demonstrating clear identification of the underlying perils and appropriate risk management. Political risk underwriters of resource projects pay careful attention to due diligence and do distinguish between the qualities of similar projects in the same territories.

PRI won’t fix a bad deal or contract. But when a project is well structured and the correct PRI coverage purchased, PRI does act as an effective safety net for your investment.

*Conversion made July 2013