Technical File with Grain Malunga: The Nature of Mining Contracts – Mining & Trade Review (May 2016)

The “Technical File with Grain Malunga: The Nature of Mining Contracts” featured below was initially published in Malawi’s Mining & Trade Review Issue Number 37 that is circulating this May 2016.

The full edition is available for download here.  This monthly publication is edited by Marcel Chimwala.
2016-05 Mining & Trade Review Malawi Technical File Grain Malunga Nature of Mining

TECHNICAL FILE by Grain Wyson Phillip Malunga FIMMM Mining and Environmental Management Expert

THE NATURE OF MINING CONTRACTS

Abstract

Mining contracts are agreements entered into between government and a mining company with an aim to develop mineral resources. They cover issues related with government revenue and other social economic issues affecting mining communities. Security of tenure and stability clauses are included. To avoid revenue from the natural resource sector benefit a few influential individuals, Mine Development Agreement becomes the most important document which is guided by the constitution, mining laws, business and labour laws, taxation acts and related regulations.

These contracts become relevant where governments are characterized by weak institutions, corruption and political instability. One of the most important contracts is the Mine Development Agreement. Negotiations are done with a team of experts in natural resource development and development economics.

In order to build national consensus in the development and utilization of revenue from natural resource exploitation, these agreements should be accessible to the public.

1.0 INTRODUCTION

Mineral resources development has a long period of gestation from exploration to mine   development and post mining. Several contracts are awarded and these include; Mineral Rights Agreements, Environmental Management Licence, Mining Development Agreement and Community Development Agreements.  All these try to bring national consensus on issues related with extraction and utilization of benefits from minerals sector.

Transparency, accountability and beneficial ownership become the main issues of concern and are aimed at mitigating against resource curse which is common among resource rich poor countries.

2.0 TYPES OF MINING CONTRACTS

Minerals and petroleum resources are usually owned by the state on behalf of its citizens. Their exploration and exploitation rights are often granted to private companies or in partnership with state owned companies. Where well-developed legal system exists and governs the rights and obligations of the state and private companies, mineral rights are granted without subsidiary contracts. Common mineral rights/contracts are Exclusive Prospecting Licences (EPLs) and Mining Licences (MLs). Where mineral laws are weak or inadequate, mineral rights are granted to private companies through individually negotiated agreements that contain most, if not all the rights and obligations of the concerned parties.

These negotiated agreements are in form of Mining Development Agreements (MDA) and Production Sharing Agreements (PSA).Production Sharing Agreements are common in oil and gas sector.

Modern agreements include or support inclusion of ancillary agreements that include responsibility for the development of infrastructure, promotion of local content and Community Development Agreement (CDA).

3.0 REFERENCES FOR NEGOTIATIONS

Mining contracts or agreements are usually a product of existing policies, legal and regulatory framework and international standards/framework.

EXISTING POLICIES

  1. Social: The Mines and Minerals Policy (2013) points out that government shall ensure that mining related social issues are adequately addressed by mining companies. These include economic empowerment of local people, corporate social responsibility, mainstreaming issues on gender and HIV/Aids and other diseases, and resettlement issues related with mining activities.
  2. Fiscal: Mining Contracts cover taxation and fiscal issues protected under a stability period, especially in countries with unstable governance regime. In order to mobilise resources from shareholders and finance institutions and to protect revenue for the host country and its people, mining contracts become a safety net.  The most important document becomes the Mining Development Agreement (MDA). Taxation and fiscal regime covered in this DA include equity in the project, Corporate Tax, Resource Rent, Royalty, Value Added Tax, capitalization in terms of debt: equity ratio and means of Capital Write Off for tax purposes. Government has reviewed the taxation and fiscal regime in the mining sector in order to come up with a coherent and standardized fiscal package for mining contracts. There will be no discretion in grant of fiscal incentives such as royalties, resource rent, corporate tax.  Issues of ring fencing and double taxation will be reviewed in such a manner that they will not bring potential loss of revenue for the country.
  3. Environmental: The 1996 National Environmental Policy provides how the principles of sustainable development in mining can be reviewed. Environmental Management Plans (EMP) and compliance with international standards for occupational health and safety form part of the Development Agreement.

4.0 EXISTING LEGAL AND REGULATORY FRAMEWORK

Chapter III of the constitution of Malawi spells out fundamental principles of the constitution and national policy. These include sustainable development of natural resources, wealth creation through responsible economic management and guarantee of public trust and good governance.

The legal and regulatory framework to be included in the Mine Development Agreement must comply with the constitution through the laws and regulations governing the mining sector.

The following regulatory framework has to be referred to:

  1. Environment: Mining can have a serious negative impact on the environment. Air and water gets polluted from dust and chemicals while landscape gets deformed through pits and waste pilings. Noise can be the order of the day. These are mitigated through guidance from Environment Management Act and sectoral specific policy guidelines. Social impacts are also mitigated through community engagement in order to obtain Free Prior Informed Consent (FPIC). Malawi’s Environmental Management Act came into effect in 1996. Mining Sector Guidelines were prepared in 2002. Other Natural Resources Laws that need to be consulted include the National Parks and Wildlife Act (2004), Fisheries Conservation & Management Act (1997) and Forestry Act (1997) because they deal with conservation and management activities.
  1. Mining: Mineral activities in Malawi are governed by the Mines and Minerals Act 1981 (CAP61:01), and complemented by the Explosives Act (CAP14:09).  The new Mines and Minerals Bill is awaiting parliamentary approval. This has had wide consultation and covers areas of corporate social responsibility, community development agreement and entrusting ownership of the mineral resources in the state. Community engagement to obtain Free Prior Informed Consent cannot be taken lightly.
  1. Business: Business laws will inform how parties to the agreement will form consensus on issues related with equity participation, human resource development, employment and settlement of disputes. In Malawi, Business laws include The Business Registration Act 2013, Companies Act, Chapter 46:03, The Labour Relations Act, 1996, The Employment Act, 2000, Workers Compensation Act, Occupational Safety, Health and Welfare Act, 1997 and Technical, Entrepreneurial and Vocational Education and Training Act, 1999.
  1. Taxation: Taxation Act guides how government collects its revenue for budgetary support. Government realises most of its revenue through Excise Duty, Customs, Company Tax, Non Resident Tax (NRT), Pay As You Earn (PAYE), Withholding Tax (WHT), Fringe Benefit Tax (FBT) and Value Added Tax (VAT).Financial incentives (grants and low cost of loans) come from this group while fiscal incentives (tax holidays and reduced tax rates) come from this taxation.  Most companies that invest in machinery, plant and equipment enjoy waivers on customs duty, excise and VAT. Malawi taxation issues are guided by Taxation Act (CAP 41.01). It is important to understand the conditions under which mining can become profitable and how to calculate highest taxation below profit line. It is not enough to talk about investment subsidy or governments losing potential revenue through tax incentives without understanding mining project risks.
  1. Land: The Malawi Land Act (1965) and Lands Acquisition Act (1971) deal with issues of ownership, land transfer, use of land, and compensation. Mining will most likely occur in customary land and guidance from these Acts is very important on top of seeking consent from owners of land.
  1. Water resources: Water abstraction and discharge of treated water are dealt with in Water Resources Act (1969), Waterworks Act (1969). Any water abstraction should allow for environmental flow and take into recognition of users downstream.  Any treated water discharge has to be in line with chemical parameters as prescribed by Malawi Bureau of Standards (MS214:2005, MS 691:2005) or internationally recognized standards such as those of World Health organisation.

4.1 INTERNATIONAL STANDARDS/PRACTICE

  1. Equator Principles: These are a baseline and framework for developing individual, internal environmental and social policies, procedures and practices. Member Finance Institutions will finance projects that promote sustainable environmental and social performance and those that lead to improved financial, environmental and social outcomes. This standard for due diligence, undertaken by banks, helps to mitigate against risks that come with projects in terms of building consensus for project acceptability in affected communities and mitigating risks against project finance losses. 
  2. Corporate Social Responsibility: Corporate Social Responsibility (CSR) is a voluntary action or business that is conducted by a mining company with the aim of reducing negative environmental and social-economic  impacts of mining through improving living conditions of the local communities where it operates. CSR helps to mitigate against unexpected social conflicts resulting from lack of satisfaction with      infrastructure, social capital and human capital within mining communities. Areas of intervention include water, electricity and hospital (infrastructure), family planning and HIV/AIDS programs (social capital) and education and skills transfer (human capital). Recognition for this is given under ISO 14001 and 26000.
  3. Public-Private Partnerships: Governments can enter into development agreements through Public-Private Partnership (PPP). This is an arrangement whereby the state enters into service agreement with a private entity to manage a business in which government has interest. The post-colonial era saw establishments of state owned companies to nationalise businesses and bring about accelerated economic transformation in neglected or strategic areas. Due to poor management and political interference in these companies, most governments realised the need to remain as a regulator and not a manager of business. Most companies were privatized and government remained with minority shareholding.  Other arrangements were service agreements in which government owned the infrastructure and contracted private entities to manage the business in exchange for management fees or production sharing arrangements. In order to maximize its benefits, government should safeguard its interests through a state owned company that goes into equity participation with a private company.  The state owned company should be free of political interference with management positions filled on competitive arrangement.

5.0 NEGOTIATING PARTIES

Mining contracts are negotiated with the aim of mitigating against political interests and changing political environment. As shown below certain clauses such as stabilization clauses provide assurance against unpredictable legal, regulatory or political changes that could affect the commercial viability of the project. Political economies usually have frequent changes on taxation and fiscal regimes and this needs to be mitigated against.

All these uncertainties require a team of experts in each party to come out with the best deal. These experts will be appointed by the Mining Company and Government.

  1. Mining Company: The mining company engages its Project Development Team that includes local manager, geologist, business development specialist, community relations specialist and lawyer.
  1. Government: Challenges in coming up with a negotiating team are many. Government lacks experience of the industry and marketing of mineral products. Luck of trust in its employees and high turnover make negotiations difficult and lengthy thereby affecting costs and period of negotiations. A team of senior advisors is recommended headed by Chief Secretary while the political side decisions can be made by the cabinet. The negotiating team should include relevant ministries responsible for mining and environment, finance and economic planning, justice, labour; and Investment and Trade Centre.
  1. Technical Specialists: Technical specialists may be required in government as advisors when there is lack of relevant expertise in mineral resource development. Those sought are experienced geologists, mineral resource valuation specialists, mining engineers and mining finance modelers. It is  important to note that these are usually very expensive and often assist through sponsorship and pro bono arrangements. Care must be taken in understanding the conditions under which they come in as those that sponsor them may have vested interests. When these work as advisors, they should ensure that government owns the process and that their role is to build consensus among negotiating teams.
  1. Community Representatives: Community representatives need to be involved when issues dealing with environmental protection, community development, and social impact management come on the table for negotiation. The parties under this group may include the District Commissioner, Traditional Authority and representative of the Civil Society (or Natural Resources Justice Network) where mining will take place. Prior to negotiations, they need to be made aware of how the central budgeting system works and what benefits they may have through mining  activities in their area.

6.0 TOPICS FOR NEGOTIATIONS

  1. Equity Participation: Equity participation by host government can be through State Owned Enterprise and not through central government due to more focus on (government) executive duties which leads to poor participation in monitoring and participation of the decision making process in the  running of the companies.
  2. Mining and Beneficiation: In order to promote beneficiation and value addition, parties should ensure that more mineral processing is done in Malawi in order to promote mining value chain/local content and reduce export of labour through further beneficiation abroad.
  3. Marketing: The parties should agree on market arrangements and how prices of minerals will be determined with reference to the global metal exchange prices. Of particular interest is avoiding transfer pricing, purity of the processed metal and taking note of minor metal credits in the final product for export.
  4. Environmental Management: Parties to the agreement must comply with the approved Environmental Management Plan and reporting.  Any breach of existing Environmental Laws will be treated according to prescribed fines or penalties.
  5. Equity Participation: Equity participation is usually agreed after consideration of costs of exploration and   development by either party.  It is always proper for government to own its equity through an independent state company through which it will collect its dividends. Equity participation by government through taxation or fiscal subsidies must be discouraged to avoid potential loss of revenue.
  6. Taxation and Fiscal Regime: Governments should strive to offer a stable and competitive taxation and fiscal regime that is clear and with stability period that coincides with loan servicing. Thin capitalization should be discouraged as it affects taxable profit.
  7. Local Content: Economic linkages with local businesses generate economic diversification and employment creation. This also strengthens relationship between mining companies and local communities. Mining Development Agreements should strive to promote this as it is a source of sustainable development.
  8. Infrastructure Development: Mining in rural areas opens up infrastructure development such as roads, water and electricity.  Government should endeavor to partner in improving supporting infrastructure and essential services for the benefit of local communities. Support to this initiative helps develop local businesses.
  9. Community Development Agreement (CDA)and Corporate Social Responsibility (CSR): CDA is a means of reducing risks in mining business through managing mining community expectations and contributing to development activities without taking over government obligations. A well drafted CDA will even take away CSR initiatives as all stakeholders including local government, mining communities and the civil society will be party to the agreement and will ensure that there is a transparent process through Free Prior Informed Consent. The MDA will have to recognize the need for entering into CDA with the local communities.
  10.  Termination: Termination of an MDA can automatically happen if procedures laid in the Mines and Minerals Act are followed.  This is in case where the resource is exhausted, the concession period has expired and if market conditions of the commodity are not favourable for future rebound.
  11. Settlement of Disputes: In terms of settlement of disputes, negotiations should take precedence. Where big differences arise and negotiations are not possible, the parties can call for mediation with the International Centre for Settlement of Investment Disputes.

7.0 CONCLUSION

Licensing and contracting are two regimes that government offers to regulate mineral resources development. Licensing is for mineral rights and contracting is for development agreements. In countries, such as Malawi, where mining is at its infancy stage and its regulatory framework is outdated and inadequate, there is need to enter into development agreements in order to give confidence in promoting mineral resource development and to give assurance to citizens on benefits that will be accrued for economic development.

Government needs to build capacity in the mining sector and ability to understand commodity markets in order to maximize benefits arising from development agreements. Regular audits of production, export volumes, mineral valuations and cost calculations will help government manage its relationships and staying in regular communication with the company and local communities. Reliance on civil society to undertake this task is dangerous as CSOs are sometimes manipulated by their sponsors whose interest is to destabilise the path to economic independence.

It should be emphasized that investment incentives that are granted in projects with marginal profits can go a long way in building history of mining through attracting more mining investment. It is not enough to talk about investment subsidy or governments losing potential revenue through tax incentives without understanding mining project risks. In order to believe that government negotiates in good faith for the benefit of its citizens, there is need to be transparent in all contract dealings.

8.0 REFERENCES

  1. Crabb Rick. 2013. A Stabilisation Agreement in Operation Gives Support but Needs Support. Paladin Africa Energy Limited
  2. Mary Vitelli. 2013. Minerals contract negotiation
  3. Mohammed Adam. 2015. The political Economy of Extractive Industries Management
  4. Republic of Malawi. 2013. Mines and Minerals Policy of Malawi
  5. Republic of Malawi. 1981. Mines and Minerals Act
  6. Revenue Watch, Open Oil, International Senior Lawyers Project, and Vale Columbia Centre. 2013. Mining Contracts.
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One response to “Technical File with Grain Malunga: The Nature of Mining Contracts – Mining & Trade Review (May 2016)

  1. Pingback: Link Roundup for Extractive Industries in Malawi: May 2016 | Mining in Malawi·

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