risk focus - JLT Specialty

RISK FOCUS MINING BULLETIN NOVEMBER 2016

Black cloud – how political activism is undermining Colombian coal* On 3 October 2016, the international headlines were filled with the news that Colombian voters had rejected a peace deal with Marxist guerrilla group the Revolutionary Armed Forces of Colombia (FARC) in a shock referendum result. Yet while undoubtedly the result is a blow for investors, for coal mining companies, the referendum result hardly tops the list of concerns. Instead, three pivotal legal decisions have taken place in 2016, which will directly impact coal miners.

THE RISE OF ENVIRONMENTALISM Coal, like oil, has long been a pillar of the Colombian economy. From 2005 as the security threat from the FARC reduced and as prices for thermal coal rose, investment into Colombia rapidly increased. Changes to the legal and regulatory environment were designed to streamline the licencing process for miners, while tax breaks helped incentivise. From 2006-2010, nearly 9,000 mining licences were granted.

When prices for commodities, including coal, began to fall in 2012, mining investors across South America began to witness a political shift in perspective around environmentalism. Miners of all sizes were starting to be held to account for pollution, environmental damage and industrial accidents. Recognising the economic cost of environmental damage and the impact on social cohesion, governments in Peru, Brazil, Chile and Colombia all took action against miners through a tightening of the regulatory environment, the imposition of penalties

*This article will be featured in World Coal magazine in November 2016.

and fines and, in some cases, through the scrapping of controversial foreign investment projects where there had been local opposition. This government commitment to environmentalism continued and gathered pace despite the ongoing fall in commodity prices and, despite the risk of environmental reforms and tougher regulatory requirements impacting investor sentiment. All signs pointed to this new-found focus on protecting the environment and the sustainability

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JLT MINING | Risk Focus | November 2016

of operations as a permanent shift in thinking and therefore unlikely to be reversed. In Colombia, a moratorium of licence issuance in 2012 stalled around USD7.3 billion of investment. By 2015, coal miners had been required to make significant investments in order to adjust their day to day operational practices, in order to abide by stricter environmental regulations. Those that fell short incurred hefty fines. Then in November 2015, the Samarco tailings dam failure occurred in Brazil. An iron ore tailings dam in Mariana state failed, causing 60 million cubic metres of iron waste to flood two villages and pollute the nearby Doce River. The mudflow reached the Atlantic Ocean just 17 days later. The incident was labelled by the Brazilian government as the worst environmental disaster in the country’s history and immediately saw the spotlight turned onto mining companies and the environmental impact of their operations.

AN UNCERTAIN LEGAL & REGULATORY LANDSCAPE Governments across South America are keenly watching the legal case around the Samarco disaster and

a range of legal and regulatory reforms for the Brazilian mining sector, which will likely to be replicated more broadly across the region, including in Colombia.

the Brazilian government’s response.

For South America the outcome

Already, insurers in Brazil are now

of the legal case around the

refusing to offer insurance coverage for failure of tailings dams. For South

Samarco disaster will be a

America, the outcome of this case will

pivotal milestone for the

be a pivotal milestone for the mining

mining sector.

sector; precedent will be established around miners’ liability for environmental damage, questions will be raised

For Colombia, this translates into a

around the adequacy of government

continuation of heightened legal and

monitoring of mining operations, and

regulatory risks for miners. The push

new benchmarks for fines and penalties

to implement stricter controls around

will be established. In addition to fines

licensing, operational processes,

of around GBP92 million imposed on

transport of commodities, reclamation

Samarco, there is now separate legal

of land, and structuring a framework

action for GBP40 billion of damages

for penalties for non-compliance has

and 21 executives connected with the

continued apace. While the Samarco

case are being personally charged.

legal case continues, already in 2016,

The outcome will undoubtedly usher in

three pivotal decisions have been made

www.jltspecialty.com | Risk Focus

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by the Colombian Constitutional Court,

The second decision has far reaching

decisions in Bogota around licencing and

which will have an immediate impact

implications for the Colombian

which areas can be excluded from the

on miners.

mining industry. In late May 2016,

permitting process.

The first decision of note took place in February 2016. In Colombia, nearly 70% if the population’s water supply comes from high altitude moorlands, called ‘paramos.’ These moorlands are particularly crucial for water supplies for Bogota. In 2011, new mining operations were banned in the paramos. However, those mining companies with licences dating to before 9 February 2010 were permitted to continue operating until the expiration of those licences under a loophole in the National Development Plan 2014-2018. The decision of the Constitutional Court in February now overturns that decision, and all mining activity is now banned. Around 347 licences have now been revoked by the ruling.

the Constitutional Court struck down a provision within the 2001 Mining Code, which handed decision-making

While in 2014 and 2015

for permitting exclusively to the

attempts were made to require

federal government, and barred local

the federal government to

governments (departamentos) from contesting the issuance of licences or

co-operate with local authorities,

creating exclusion zones. This decision

these rulings still had the balance

was highly controversial, as local authorities were unable to manage

of power.

the concerns of their constituents and lost political influence to protect their jurisdictions. While in 2014 and 2015 attempts were made to require the federal government to co-operate with local authorities, these rulings still had the balance of power tilted towards the national government. The decision in May effectively means that mayors and their local governments can overrule

The third decision of note occurred in June 2016, with the Constitutional Court revoking a government decree from 2012 that legalised mining operations in the eastern plains, Pacific rainforests, and the Amazon. Strongly backed by indigenous groups, the Court ruled that in issuing the decree, the government

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had ignored the rights of these local

of the FARC peace agreement has

mining operations. The province of La

communities. Again, this ruling raises

been changed by the public, the three

Guajira, the home of the Cerrejón project,

the risk of licence cancellation or

decisions outlined above were made as

has seen its retained mining income fall

renegotiation for those miners operating

a result of the people taking legal action

from 70% to 25%.

in these regions.

to overturn long-standing government

Taken together, these decisions indicate firstly, that the legal system in Colombia is tightening and to some extent, mining companies have lost much of their lobbying strength. Secondly, that the political influence of local communities has increased. Just as the direction

policy. Undoubtedly, the fact that over the last few years the system of mining royalty distribution has changed will also have become a determining factor in inspiring mining communities to take action; since 2015, mining regions only receive 20% of royalties directly, but bear the full environmental cost of hosting

JLT COUNTRY RISK RATINGS FOR MINING IN COLOMBIA JLT COUNTRY RISK RATINGS FOR MINING IN COLOMBIA NOVEMBER 2016

Currency Inconvertibility & Transfer Risk 10 9

Country Economic Risk

8

Sovereign Credit Risk

7 6 5 4 3

War & Civil War

Expropriation

2 1

P

Contractual Agreement Repudiation

Terrorism

COLOMBIA 1 = Low Risk 10 = High Risk

Strikes, Riots & Civil Commotion

Legal & Regulatory Risk

P = Under Review

The spider chart is generated by JLT’s proprietary country risk rating tool, World Risk Review (WRR), which provides risk ratings across 9 insurable perils for 197 Countries. The country risk ratings are generated by a proprietary, algorithm-based modelling system incorporating over 60 international sources of data

FINDING THE OPPORTUNITIES The timing of these decisions is interesting when we consider the outlook for the Colombian coal mining industry. It is estimated that production of coal in Colombia will increase from around


against Colombian shipments.

scale mining is strong and as such,

Now, with the expansion of the Panama

the renewal or issuance of licences will

Canal almost complete, and as freight

likely be a long and drawn out process.

rates have reduced, buyers in South Korea and Japan have returned to importing significant amounts of Colombian coal.

tons within the next four years and

Production of coal in Colombia

theoretically, 2017 should present an

will increase from around 87.2

coal is slowly beginning to rise (at the

million tons to over 105 million

time of writing, prices for Colombian coal

tons within the next four years

are USD 60.95 per metric ton, which

These rulings are indicative of a period of instability which will influence the Colombian investment environment over the next few years. In addition to further court rulings, the fallout from the FARC

87.2 million tons to over 105 million

opportunity to investors. The price of

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referendum also has some significance for miners. While many will point to continued security uncertainty, in reality, serious clashes between the government and the FARC are unlikely to resume. Instead, the outcome of the referendum (which failed on a margin of 50.2%

is roughly on par with prices from late 2014) and demand for Colombian coal

This should represent an opportunity

against, and 49.8% for) has far-reaching

is increasing. In 2015, coal exports to

for those miners that are considering

political and economic implications.

Turkey, Colombia’s number one export

Colombia, or for those that want to

The result signalled that the government

destination for coal, increased 24%.

expand operations, yet the changing

of Juan Manuel Santos has seen its

While Colombian coal is of a similar

legal and regulatory environment is a

popularity and influence decrease;

grade to Australia’s high quality coal,

barrier. Even in Colombia’s two main

currently Santos’ approval rating is

in the past, freight rates and voyage

coal producing departmentos, el César

hovering around the 38% mark.

times of two months used to work

and La Guajira, opposition to large-

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However, perhaps most crucially, the

where already there is overwhelming

result of the referendum could delay

evidence that the tide is turning against

the passage of the tax reform bill.

coal miners. Furthermore, there is a

The reform bill was set to increase tax

presidential election on the horizon in

rates to bolster revenue by almost 1%

2018, which will spell further uncertainty.

of GDP - crucial for offsetting the lost revenue from the energy sector on account of sustained low oil prices. The bill has been seen as pivotal for Colombia to maintain its BBB investment grade rating and a sizeable portion of the proceeds were set to be put aside for anti-poverty programmes. While Santos has a coalition that usually holds congressional majority, there is a block of opposition lawmakers willing to fight the bill and water down its terms. Without passage of the bill, Colombia risks its sovereign credit rating, a further widening of the fiscal deficit, and the implementation of broader public spending cuts. The delay to the bill simply represents another layer of uncertainty in an investment environment

MANAGING THE RISKS The best way of managing heightened political risks, such as a rapidly shifting legal and regulatory environment, or local community protests, is to find

Rapid and inconsistent policymaking

ways to differentiate your company

and a changing legal and regulatory

from the pack. The old rules around

environment poses considerable risks

corporate social responsibility (CSR)

to coal investors. Shifting rules can

and social licence to operate still apply:

mean unanticipated costs that can place

transparency, accountability, clarity

immense pressure on operating margins,

about the benefits and remedies available

or costs that immediately hit the balance

to the community, and adequate due

sheet. However, it is crucial to note

diligence. Miners in Colombia must

that investors of course can shape the

now take their CSR commitment to the

risk environment in which they operate.

next level – this is about demonstrating

Non-compliance with environmental

best practice in all facets of the mining

laws, or a dismissal of corporate social

operation if expectations of regulators

responsibility will inevitably attract the

and local authorities are to be

attention of industry regulators and

managed appropriately.

the government. This is particularly the case where a relatively small number of companies dominate the market; in Colombia’s case: Cerrejón, Prodeco, Drummond and Murray Energy.


HOW TO MANAGE YOUR CSR COMMITMENT • Don’t pare back CSR projects simply as a means to cut costs. In addition to the implications to the project at site level, governments could read this as a sign of wavering commitment to a project, in turn heightening potential political risks. In addition, insurers will want to see an ongoing commitment to CSR projects as these help mitigate social unrest and government interference, thereby improving the risk profile of the company. • Don’t forget the growing power of social media in emerging markets. Gone are the days when a mining company could operate within a bubble in the middle of nowhere. When cutting workforces there is always a risk that disgruntled workers may seek to damage the company’s image. The posting of a single photo of poor worker conditions or pollution can wreak havoc on reputation • Do include your supply chains as part of your CSR to be truly proactive. Build reputational capital, and recognise that while having a CSR will not eliminate all criticism, it will help control the impact of criticism. In the mining sector where there is such scrutiny on worker conditions at mine site particularly in emerging market, mining companies must not forget that worker conditions along the supply chain are also important. Proving that the company has foreseen a problem and is working on it, rather than being caught unawares or unprepared, is the goal. • Do seek to be a social purpose leader and embrace this as part of the company brand. Setting the standard for the industry and being a force for change, particularly during difficult times, will stand the company’s reputation in good stead. CSR is far more than a PR exercise, it is an operational strategy and true commitment to CSR will pay dividends in terms of mitigating political risk.

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JLT MINING | Risk Focus | October 2016

The mining industry continues to face one of the most marginal operating environments seen in a decade. To succeed in this climate means taking risks and so partnering with the right broker is paramount. JLT Mining is a specialist broking team, with an exclusive focus on risks spanning the entire mining project lifecycle. We manage a large and established client base of mining companies, contractors, traders, and financiers, across a range of commodities and regions. Acknowledged as placement leaders, our brokers know how to position complex mining risks to deliver the broadest coverage terms, for the best possible rate. We deliver local service, but with global reach, by leveraging JLT Group’s network of 10,000 specialists across 135 countries. Our in-house claims division has collected over GBP3bn since 2010, while our consultancy team helps clients identify, understand, and mitigate risk more effectively. Our objective is simple: to provide a competitive advantage by enhancing our clients’ resilience and empowering them to take risks.

By going further in all aspects of CSR, a mining company will be better placed than its peers should a host government target the industry on account of its conduct – including workforce reductions. While political risks cannot be entirely neutralised, mining companies that work harder on CSR will reap reputational rewards which may, in the future, pay dividends when confronted with political risks. Finally, for those risks that cannot be entirely mitigated, Political Risk Insurance (PRI) offers an effective safety net against licence cancellation, selective discrimination (such as tax hikes), currency inconvertibility and transfer risks, expropriation, forced abandonment and loss of equity or default of debt as a result of strikes, protest risk, war risks, terrorism, to name just several of the coverable perils.

CONTACT Amy Gibbs Head of Global Mining +44 (0) 20 7558 3958 [email protected]

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