Production of metals and industrial
minerals are already a significant contributor to the economies
of Iran and Turkey, while metal production is a factor in the
nonfuel economies of Bahrain, Oman, Qatar, Saudi Arabia, and
the UAE.
Abundant natural gas supplies,
particularly within Iran and the GCC and the ease of ocean
transportation provide a solid basis for the region’s
development of energy-intensive mineral industries to produce
aluminum (primary and secondary), crude steel, direct-reduced
iron (DRI), fertilisers, petrochemicals, and rolled steel.
These industries are essential for the economic diversification
efforts in the region, especially in the countries that depend
heavily on hydrocarbon exports to sustain economic growth.
While the governments of many
states in the region retain majority ownership of the companies
that operate in their mineral sector, some, like Saudi Arabia
are actively encouraging private investment in mineral projects
and are expected to remain attractive to domestic and
international investors. Yet behind these potentially lucrative
investment opportunities a range of political risks lie.
Artifical
stability
In those territories most severely
impacted by the Arab uprisings, rulers had provided investors
with stability at the expense of the rule of law, individual
rights and political participation. Under these circumstances
investors should consider the long term political risks
associated with their trades and investments. From an actuarial
perspective, if stability is dependent on a dictatorial ruler,
even without a revolutionary uprising, the leader will pass
away at some point, potentially ushering in an era of
instability. Qatar’s preemptive handover of power from the
61-year-old modernising emir, Sheik Hamad bin Khalifa, to his
33 year old son, is an exception to the rule of succession in
the regions hereditary monarchies. Ailing monarchies in other
territories are clinging tenaciously to power and are reluctant
to pass the reigns to the younger generation.
Through fair means and foul, the
Arab world’s remaining eight monarchies have so far
managed to head off popular pro-democracy revolutions that
erupted in January 2011 and ousted the dictators of Tunisia,
Egypt, Libya and Yemen and embroiled Syria in conflict. Despite
this, King Mohammed VI of Morocco, King Abdullah of Saudi
Arabia, King Abdullah II of Jordan, Sultan Qaboos bin Said of
Oman and the various sheiks of the Persian Gulf are less
certain of their grip on power than a decade ago and the
monarchies of Jordan, Bahrain and Saudi Arabia face particular
challenges.
The sovereign credit ratings of all
these territories reflect this potential for instability, with
agencies penalising them by around four notches for a lack of
democratic institutions and the separation of powers.
Heightened
risk?
It is inaccurate to say that the
entire MENA region is a riskier investment destination due to
the Arab uprisings. The region is complex, multifaceted and the
risk profile of every country differs to that of its neighbour.
Continued violence in Syria, the troubled political environment
in Egypt, lawlessness across broad swathes of Libya and the
real risk of Iraq being engulfed in civil war, creates the
impression of a tumultuous region in which business
opportunities are scarce.
Following the uprisings, investment
sentiment towards the MENA soured and those companies less
familiar with the region began to pull out, even from countries
relatively insulated from the unrest. Those who stayed and
maximised the opportunities available found themselves in a
better position as competition diminished.
Political risk management
strategies
Investing in MENA is far more
complex than the television images of protests and violence
which can act as a deterrent. There is rarely such a thing as a
‘good’ or ‘bad’ country. In reality it is
more appropriate to think in terms of a good or bad risk. While
historically, management of political risk by corporations was
considered an oxymoron, today we recognise that companies
change and influence the political risk environment they
operate within. As such, there are several startegies companies
can adopt to manage and mitigate the impact of political risk
on their investments.
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. In Syria, international oil
companies had developed such strong relationships with local
communities that they were able to continue operating for many
months into the conflict, with communities defending
installations against rebel forces.
The second step to reduce country
risk 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. Western oil
companies operating in Libya behaved in an exemplary manner
when the uprising took hold in Libya. While political violence
forced them to abandon their assets, they did not abandon their
local workers and continued to pay them throughout the crisis.
By maintaining good relations with local communities the
transition back to operating within the country at grassroots
level has been smoother.
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. 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.
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.
The seventh step is to provide
adequate protection for personnel. There is a direct
correlation between the security vacuum that emerges following
the overthrow of an authoritarian government and the prevalence
of kidnap incidences. Kidnap rates have risen in all
terrirotires impacted by the Arab uprisings. 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.
PRI and political
risk
A key issue that is often
misunderstood when looking at political risk in the minerals
sector is the idea that the key asset to be insured is the
mineral 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 in 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 nearly 50 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 effectively neutralises country
risk and provides an effective safety net for your MENA
investments.
*Elizabeth Stephens is head of
credit and political risk analysis at JLT Specialty
Ltd