How can financial models of mining and petroleum projects assist African governments?

Eye on Malawi's Extractives Rachel Etter-Phoya

EYES ON MALAWI’S EXTRACTIVES with Rachel Etter Phoya

How can financial models of mining and petroleum projects assist African governments?

In October 2016, Grain Malunga and I participated in OpenOil’s financial modelling sprint to build an open financial model of Kayelekera Uranium Mine using data that is available to the public. We discovered that the uranium price would have to more than double if the mine was to restart production and break even. As it stands, the uranium price remains low, so production continues to be suspended, and Paladin Energy is also in administration. We also learned that the reduced royalty rate awarded by government to Paladin had resulted in USD 15 million foregone revenue, but this reduced royalty rate did not substantially affect the project’s profitability.

Financial models are used by mining, oil and gas companies and investors to understand the feasibility of a project – put simply, under what technical, operational, market and legal/regulatory scenarios will the project make a profit? This information is necessary for companies to determine whether a project should go ahead. Governments can also use these models to evaluate potential revenue under different fiscal regimes at different stages of a project, which is useful in contract negotiation and revenue forecasting for budgeting. Of course, caution is important given the volatility of commodity prices and the assumptions that go into making projects. Models using historical data can also assist governments in assessing and auditing revenue streams once a project is online.

Malawi negotiated three petroleum contracts without finalising a financial model to assess the fiscal package it was giving to the government. It is perhaps therefore of no surprise that Oxfam’s analysis (‘Malawi’s Troubled Oil Sector: Licences, Contracts and their Implications’, February 2017) reveals that the expected Malawian government take is between 20-30% compared to the IMF recommendation of 65-85%.

A year after I worked on my first financial model, OpenOil with the African Development Bank released a study, examining how African governments prepare financial models of extractive projects. Nearly 200 public officials were surveyed including over 40 from 19 African resource rich countries to understand how these financial models are used.

According to their findings, financial models are increasingly being used by governments across the continent, particularly during negotiations with companies.

However, detailed analysis suggests that the impact and effectiveness of the models could be significantly improved. Models, where they are used at all, are rarely updated regularly and are seldom used for revenue monitoring. Also, there seems to be a substantial gap in access to data that are key inputs for financial models (p.5).

This highlights the importance of introducing and enforcing company reporting requirements including country-by-country reporting standards, which are being implemented in Canada and the European Union.

Extractive Policy Cycle and Financial Model 2017 OpenOil AfDB Running the Numbers Fig. 1

The Extractive Policy Cycle and Financial Model (OpenOil & African Development Bank 2017, Figure 1).

A useful model requires data that is kept up to date, solid interpretation of data, and well-informed assumptions. The study reveals that central agencies generally have lower access to data than sectoral ministries, highlighting the need for improved institutional coordination. However, the largest gaps for accessing data relates governments knowledge of capital and operating costs for mining and petroleum projects. This is important information because

without cost data, it is not possible to determine at which point the project will turn a profit and therefore when some of the profit-based taxes will start yielding revenue’ (p. 24).

Interestingly, many contracts on the continent give governments the right to information about costs but only some governments demand that companies provide this data regularly. And the use of available public data sources (such as corporate listings) is limited.

80% of the African countries surveyed have financial models, but only about half of these models carry out project-level analysis. Sectoral models are useful for budget forecasting, but they rely on more assumptions and are of no use for tax audits or contract negotiations of specific projects. Most of these project-level models are used by African governments in contract negotiation, but rarely to monitor compliance. This may be because most models are produced as part of external technical assistance and 40% of public officials felt that they did not receive adequate training.

For these financial models to have a greater impact, that is, to ultimately help governments turn their natural resource wealth into long-lasting development outcomes, the African Development Bank and OpenOil make a series of recommendations. These include:

  1. Calibrate models to test their reliability against actual results
  2. Improve information sharing between government institutions to increase access to data
  3. Ensure sustainable training for use of financial models
  4. Legislate and include contract provisions that require companies to share data with government, particularly for key data where there are currently many gaps (cost, reserves and production)
  5. Adopt a modelling standard such as FAST or BPSM that are widely used by companies or the IMF’s FARI system and where possible ensure regional cooperation on the standard

For further information, please see:

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This piece was initially published in Malawi’s Mining & Trade Review Issue Number 55 (November 2017).

The full edition is available for download here. This monthly publication is edited by Marcel Chimwala.

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