risk focus - JLT Specialty

RISK FOCUS JLT MINING OCTOBER 2016

Papua New Guinea: Opportunities for the bold Richly endowed with natural resources, a decade ago Papua New Guinea (PNG) was one of the fastest growing economies in the Asia-Pacific. Yet the end of the commodities supercycle has seen the country’s economy contract considerably, with serious implications for future political stability. While undoubtedly the mining sector holds considerable promise, the fact that two of the world’s largest mining companies have exited the country in the last three years demonstrates the sheer scale of the challenge in investing in PNG.

POLITICAL CONTEXT While the economy of (PNG) developed during the boom years of the commodities supercycle on account of its large reserves, the country’s political environment has historically been characterised by volatility, executive dominance, rampant corruption and deficient institutions. Despite the mining sector’s considerable potential, and the existence of world class mining project

such as Porgera, Lihir and OK Tedi, PNG’s reputation as a viable destination for foreign investment has been repeatedly tarnished in recent years. The country operates under a parliamentary system but the surrounding political and legal infrastructure is poorly developed. PNG has had a high turnover of governments between elections which has largely deterred foreign investors, by making it difficult to plan ahead.

Across the country, partisan allegiances are continually undermined by more important ethnic, regional and tribal affiliations. This is particularly dangerous where it applies to the armed forces as it increases the likelihood of military interventions in political disputes. This was demonstrated during the 2011-2012 power struggle between then Treasurer Peter O’Neill and Prime Minister Michael Somare. After a period of absence on

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JLT MINING | Risk Focus | October 2016

“The mining sector accounts for 15% of GDP, gold accounts for 22% of exports and copper are 14% of exports” account of illness, parliament voted to install O’Neill as acting Prime Minister, and thereby displacing Somare, and his acting Prime Minister, Sam Abal. Multiple coup attempts ensued with the involvement of both the military and sections of the police force, as Somare challenged the parliament’s vote. The constitutional crisis was eventually resolved in August 2012 when Somare agreed to support O’Neill as the new prime minister. More constructive political dialogue is further precluded by patronage networks being tied to cabinet positions as this encourages MPs to acquiesce with the government rather than hold it to account. Political affiliations mean little in PNG, and as a result, the opposition is weak and fractured. The judiciary also lacks any real power, is largely politicised and is unable to effectively challenge the prime minister’s authority. Another crisis in mid-2014 saw opposition MPs make allegations of corruption against the prime minister for payments made to a local law firm. The judiciary and law enforcement agencies refused to investigate the matter fully, which meant the allegations resulted in no action being taken against O’Neill. General institutional weakness continues to be conducive to high-levels of corruption throughout the political elite. In turn, this has a detrimental effect on the economy as revenues from foreign investment in the energy and mining sectors are mismanaged. Wealth does not trickle down from the government to the communities at project site, making it more difficult for investors to manage the expectations of local communities and increasing the

importance of a commitment to corporate social responsibility. On account of PNG’s over-reliance on natural resources exports, the collapse of oil and precious metals prices in recent years has led to an increase in economic risks. The mining sector accounts for over 15% of GDP; gold accounts for 22% of exports, and copper ore 14% of exports. At the start of 2015, the Asian Development Bank predicted PNG would be one of the world’s fastest growing economies with a predicted GDP growth rate of over 21%. Nearly two years on, the fall in oil prices has had severe implications for future political stability as the economy struggles to readjust to reduced revenue streams and to diversify away from commodities based income. Government spending has had to be, and will continue to be, cut back. These cuts, particularly as an election approaches in June 2017, will be

highly contentious. O’Neill’s government has little room to manoeuvre; public spending increases before the oil price collapsed will be difficult to claw back, while ongoing debt servicing payments still make up nearly 10% of government expenditure. As a result, a foreign exchange (FX) crisis has been gathering pace over the course of 2015-2016, resulting in credit rating downgrades by Moody’s and S&P. By May 2016, FX reserves had fallen to USD1.7bn (ten months’ import cover) from USD4bn in 2012, resulting in the government and the Central Bank being forced to publically reassure investors, while simultaneously the exchange controls remain in force and payments to foreign suppliers have been delayed. The International Finance Corporation’s refusal to commit to a USD230m loan facility to ease pressure on FX reserves has resulted in the 2017 budget planning even deeper

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cuts to spending. In addition to falls in commodity prices, a severe drought has impacted revenue from the agricultural sector, while there is also a longstanding USD959m commitment for the government to host the 2018 Asia Pacific Co-operation Summit. It is estimated that the costs of holding the June 2017 election will amount to nearly USD60m. While the current pressure on access to FX may be a concern for investors, the result of the upcoming election will also have a significant influence on PNG’s investment environment. There are signs of growing disenchantment with the leadership of O’Neill and his People’s National Congress party, and it is possible that one of the main parties in the country’s coalition government,

Pangu Pati, is planning on joining forces with the opposition in an attempt to force O’Neill from government. This disenchantment is likely to have grown in recent months as O’Neill has struggled to build and maintain parliamentary support by allocating constituency funds to each MP’s district. As central government funds have dried up, loyalty to O’Neill has been waning. The challenging economic conditions in PNG, combined with the upcoming election, only adds a further layer of complexity to investing in the country, which may see miners delaying investment. The decision of Rio Tinto in June 2016 to relinquish its stake in the Panguna copper and gold mine (Bougainville Copper Ltd) following a

JLT RISK RATINGS FOR OCTOBER 2016

dispute with the government stretching back to 2014, and decades of controversy surrounding the mine, is the second high profile exit of a major mining company from PNG. In 2013, BHP Billiton withdrew from the OK Tedi copper mine. While there is a trend for mining companies globally to exit or divest projects that would require unsustainable levels of capital expenditure, or which would see the company taking on unacceptable levels of risk, Rio’s decision further underscores the risks that mining investors can encounter in PNG, and these risks are highly likely to increase further as economic pressures continue to mount up.

Currency Inconvertibility & Transfer Risk 10

9

Country Economic Risk

8

Sovereign Credit Risk

7

6

5

4

3

War & Civil War

Expropriation

2 1

Contractual Agreement Repudiation

Terrorism

PAPUA NEW GUINEA 1 = Low Risk 10 = High Risk P = Under Review

Strikes, Riots & Civil Commotion

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Legal & Regulatory Risk

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

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POLITICAL RISKS AND THE MINING LEGAL & REGULATORY ENVIRONMENT In PNG, the predominant legislation

although this requires qualification.

In the 1970s, the PNG government

relating to the mining sector is

Crucially, BHP effectively divested its

was receiving around 20% share of the

the Mining Act 1992, which is

interests in the mine in 2002 in return

profits of the mine, operated by Rio

supplemented by additional regulations,

for legal immunity after the project was

Tinto, while Bougainvilleans received

including the Mining (Safety) Act &

found to have caused pollution while

around 0.5%-1.25%. The severity of

Regulations 2007, the Mineral Resource

under its operation since the 1980s.

the dispute is said to have been one of

Authority Act 2005 and the Environment

BHP placed its stake into a special trust

the triggers that sparked an insurgency

Act 2000. Gold miners also need to

called the PNG Sustainable Development

that cost an estimated 20,000 lives

abide by specific gold export licence

Programme (SDP), the purpose of which

and saw the mine close in 1989.

requirements. The Mineral Resources

was to reinvest the mine’s revenues in

Decades later and the dispute remained

Authority is responsible for industry

local development projects.

unresolved. Even after Rio Tinto’s

regulation and has granted mining titles cover to more than 80% of PNG’s landmass. The Mining Act 1992 contains a number of fairly standardised clauses around mining operations, taxation and licencing: state ownership of all minerals, provision for the state to back-in to projects by acquiring a 30% interest in mineral discoveries, provisions for arbitration and prohibition of expropriation without compensation, provisions for negotiation of a range of tax concessions and requirements for compensation payments to affected landowners. All mining rights are acquired through application, rather than a bidding process.

Towards the end of 2013 the government then passed legislation enabling it to bring the SDP assets under its direct control, effectively nationalising the mine and casting BHP’s legal position in the country in doubt. The SDP claimed expropriation by the government and referred the matter to the ICSID. While on the face of it this would appear to be an instance of the government responding to political pressure arising from environmental concerns and the interests of rural communities, the fact that BHP had already effectively divested its interests is an important mitigating factor. Some mining companies said that the government interference in this

decision to withdraw from PNG, the PNG government and the Autonomous Bougainville Government (ABG) have failed to reach an agreement for this economically vital mine. In August 2016, the PNG government wanted to give landowners on Bourgainville a minority shareholding in Bougainville Copper Limited (BCL) in order to prevent the ABG from having the controlling share. The ABG threatened to cancel BCL’s licence for Panguna should the PNG proceed. The dispute again demonstrates how political volatility can severely impact the investment environment to such an extent that even mining majors opt to exit the country – despite considerable mining

Yet while the Mining Act sets out the

case was sui generis, having its roots in

legal and regulatory framework for

the particular circumstances of Ok Tedi.

mining in PNG, in reality, there have

However, the case still raised doubts

been numerous examples of political

about the government’s handling of

interference within the sector that has

the case on account of the legislated

damaged the country’s reputation as

removal of BHP’s previously granted

Authority is responsible

a destination for foreign investment.

immunity. The dispute highlighted how

The scale of these investor disputes

the country’s weak legal and regulatory

for industry regulation and

with their host government has almost

environment, combined with increasing

certainly dented investor confidence in

international scrutiny of the practices

cover to more than 80%

the potential of PNG.

of large multinationals, can affect those

of PNG’s landmass.”

There are two disputes of note. The first regards the Ok Tedi mine in the West

investments that can even be considered to be of national / strategic importance.

Sepik province. In the early 1980s, BHP

The second case of note relates

(now BHP Billiton) secured the lease to

to the Panguna mine, located in

the project and by 1984 the company

the autonomous island region of

reached operational phase. The 2013

Bougainville, which has been engaged

seizure of BHP Billiton’s stake in Ok Tedi

in a long-term struggle with the PNG

demonstrated the level of governmental

government over ownership of the mine

interference in the mining sector,

for decades.

opportunity.

“The Mineral Resources

has granted mining titles


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The Mining Act was set for a review in

However, it is important to note that

of political risks. However, it is important

2012, with existing operations as well as

the government recognises that on

to note that there have been examples of

new investments to fall within its scope.

account of the current mining cycle,

the PNG government refusing to abide by

However, the review and passage of

that changes to the law need to be well

the decision of an international arbitrator.

a new act was delayed on account

balanced in order to avoid deterring

In 2013, an international arbitration case

of political instability and to date, the

foreign investors and to this point, since

settled that the government was to pay

review has not moved ahead. It is

August 2016 the PNG Chamber of

USD130m to Nautilus Minerals for a

likely however, that this review will take

Mines and Petroleum has been lobbying

30% stake in a deep sea mining project

place in the near future, possibly after

the government to ensure that the

called Solwara 1. The dispute lasted until

the elections, and so investors should

revised act is conducive to investment

December 2014 when the government

be mindful of potential changes in the

and that changes are properly analysed

finally paid USD113m, considerably

investment and trading environment.

in respect of the potential impact on the

setting back Nautilus’ project progress

For example, new provisions around

mining industry as a whole. This should

since 2012.

online applications and approval are

assist in mitigating the risk of major

likely to be included, requirements

changes to the mining act that render

around community consultations and

investments unfeasible.

distribution of profits amongst local communities will also likely be adjusted, and potential changes to royalty and tax schemes. The Mining Act 1992 currently applies a 2% royalty on net proceeds from mineral sales, with 20% of that sum payable to landowners of the project area.

The PNG government is a signatory to the International Centre for Settlement of Investment Disputes (ICSID) and has bi-lateral investment treaties in place with the UK, Australia and Germany, which should give investors from these countries an additional layer of security in respect

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OPERATIONAL ENVIRONMENT: INFRASTRUCTURE Infrastructure gaps continue to be

balance sheet, Ok Tedi Mining Ltd was

transmission lines. Significant upgrades

a prominent obstacle to foreign

forced to reduce expatriate and local

across the network are required.

investment in the mining sector. The

staff numbers, and dismiss contractors

absence of high-quality road and rail

in an effort to control high labour

networks and the remoteness of PNG’s

costs as the suspension of production

mines means that metals and minerals

continued. Similarly in October 2015,

are typically transported by waterways,

Barrick Gold was forced to suspend

but these in turn are vulnerable to

operations at the Porgera gold mine in

closure in extreme weather conditions,

order to conserve the project’s water

particularly long periods of drought.

supply, citing low levels of rainfall that

For example, the temporary suspension of operations at Ok Tedi represents the

had depleted supplies in the mine’s Walie Creek reservoir.

scale of the problem. The project, which

Power blackouts occur regularly in PNG

produced around 76,000 tons of copper

and miners in particular will need robust

concentrate in 2014 and accounted

back-up power generation capacity.

for nearly one-quarter of government

While there is sufficient existing generating

revenue, suspended operations in July

capacity within the three main power

2015 and remained closed until March

grids (Port Moresby, Ramu and Gazelle

2016 as El Nino exacerbated drought

Peninsula) operated by government-

conditions that saw shipments of

owned supplier, PNG Power Ltd.,

copper ore halted from the key river port

blackouts occur on account of inadequate

at Kiunga. In addition to impacting the

maintenance of power plants and

These limitations in respect of water supplies, transportation and power, are unlikely to be remedied in the near future as the government attempts to address the deficit by scaling back on infrastructure projects as budget cuts deepen.

SECURITY ENVIRONMENT The authority of the government in PNG does not extend far beyond the main urban centres and even in the towns and cities, the state’s monopoly over the means of violence is weak. Violent crime remain a major impediment for investors in PNG, particularly in the capital Port Moresby, Lae, and the Highlands, requiring stringent security precautions to be put in place for local workers and expatriates alike. Small arms have proliferated across the island and over the last few years this has fuelled tribal conflicts, electoral violence and banditry. As a result, fixed assets and supply chains are vulnerable to damage and disruptions, particularly in the Highlands.


the Autonomous Region of Bougainville

the high level of arms proliferation in the

has improved dramatically since the

country, any protest carries a heightened

end of the conflict, yet there remain

risk of injury to protestors and workers,

regions of Bougainville that are

in addition to the risk of damage to

essentially closed to outsiders, while

property equipment. Heavy-handed

foreign investment in the region’s

tactics used by mine-site security guards

mineral resources are still viewed with

are a common catalyst for protests and

hostility and cynicism by many. Regular

violent clashes.

intertribal violence in the Highlands region will continue, but will only persist for a few days and not transform into full civil conflict. Similarly, Bougainville, the location of secessionist conflict during the 1990s, is largely stable following an effective disarmament process and it is unlikely the region will experience a fullscale return to war, although violence may flare in the run up to 15 June 2019 – the date set for a Bougainville

There are many on-going and underlying

independence referendum. If the date

disputes between the country’s

of the referendum is delayed, again that

numerous tribes and when these flare

may result in protests; technically the

up properties often sustain collateral

PNG government has until June 2020

damage and supply-routes between

to schedule the vote according to the

remote mining locations and the

terms of the peace deal struck in 2001.

country’s few export terminals can be cut-off. The assets of foreign companies are also sometimes targeted directly which reflects the generally poor relationship between rural communities/ customary landowners and foreign companies, specifically those in the extractive sectors. It is widely held among the countryside that foreign companies, aided and abetted by the government, have wantonly exploited the land; a view which has been reinforced by the massive pollution caused by some mining projects.

from pay and working conditions at mine site. In 2010, more than 500 Ok Tedi workers went on strike for several weeks in protest against poor working conditions and higher wages for expatriate workers. This came after a shorter strike at the mine over wage increases in 2008. Similarly, in June 2015, Barrick Gold’s sale of its stake in the Porgera mine to the Chinese Zijin Mining Group was met with outrage from local workers who feared being replaced by Chinese employees. Looking ahead, rising sector unemployment, as mining projects are divested or stalled, also increases the possibility of civil commotion and strike action in industrial

continues to be relevant for mining

areas. Deteriorating socio-economic

projects elsewhere in PNG. In February

conditions could fuel resentment towards

2012, a gold mine operated by Barrick

employers and the government.

in the north of the country was attacked by illegal miners, leaving machinery damaged and personnel injured. Violent incidents have also been reported previously at the PNG LNG project as a result of tensions between the projects management, workers and the local population. Though the risk of an all-out civil conflict is low in the present context, relations between mining ventures, the government and local populations remain

indigenous population of Bougainville

poor and the risk of low-level violent

(just off the main island’s east coast) and

incidents is still high. Although local

Rio Tinto, which operated the Panguna

police will intervene to protect sites, given

scale independence war with the PNG

In the past strike action has also flared

The experience of Bougainville also

In the late 1980s, disputes between the

copper mine at the time, led to a small-

More broadly in respect of civil commotion, the negative economic outlook continues to force the government to make considerable cuts to expenditure. In early September 2015, the treasury indicated that it would draw back spending on key areas such as health, education, tax concessions, and crucial infrastructure projects. The budget for 2017 will also feature sizeable cut backs on public spending. This may heighten the risk of civil unrest as economic challenges continue. In June 2014, students defied

government, with support from Australia

“There are many on-going and underlying disputes between the

and New Zealand. The mine was forced

country’s numerous tribes and when these flare up properties

into closure and in 2000 Bougainville

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achieved autonomy from Port Moresby.

often sustain collateral damage and supply-routes between

The situation in what is now known as

remote mining locations can be cut-off.”

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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.

a police ban on public demonstrations

the treasury’s plans fail to rejuvenate

and took to the streets in Port Moresby

economic growth and diversify into

to protest against government integrity.

other industries, particularly in the face

This year, police fired on student

of prolonged low commodity prices

protestors in the capital in June when

and current disenchantment with the

an anti-corruption rally turned violent.

government, such incidents will become

The incident triggered a day of looting

more frequent in urban centres.

and rioting across the capital. Should

JLT Mining is a specialist broking team, with an exclusive focus on risks spanning the entire mining project lifecycle. Part of JLT Group plc, we manage a large and established client base of mining companies, contractors, traders, and financiers that work across a range of commodities and regions. Our objective is simple - to provide our clients with a competitive advantage to secure new opportunities by enhancing their resilience and empowering them to take risks.

INSURER APPETITE AND INSURANCE REGULATION From an insurance regulation perspective, compulsory covers relevant for the mining industry include motor third party bodily injury, workers’ compensation, and oil pollution cover for any company chartering ships carrying oil in cargo. Non-admitted cover and fronting is not permitted

CONTACT

in general; however, a local broker

expropriation. Cover for arbitration award default may be particularly pertinent in the case of PNG. However, for some mining companies, there may be some benefits in considering the strategic use of Political Risk Insurance (PRI). PRI can offer an effective safety net, particularly as some country risks, such as selective discrimination (such as tax hikes), currency inconvertibility and transfer risks are far more challenging to manage.

is required to arrange local covers,

Since every mining project is different,

manage adherence to taxation and

every insurer views each mining risk on

other regulations and seek exemptions

its own merits. Pricing for PRI in PNG

with the relevant insurance authorities

for a multiyear policy currently stands

for fronting practices. On account of

in the range of 0.75-1% per annum

the recent foreign exchange shortages

depending on the precise project(s)

and related Central Bank restrictions

location, ownership structure, and

on transfer, there have been instances

operational nature of the project(s).

JLT Specialty Limited The St Botolph Building 138 Houndsditch London EC3A 7AW

where tax and premium payment

Underwriters will be keen to understand

processes have been delayed.

the experience and reputation of the

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adept at handling political risks, and are

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

On the whole mining companies are experts in engaging government and local

Lloyd’s Broker. Authorised and regulated by the Financial Conduct Authority. A member of the Jardine Lloyd Thompson Group. Registered Office: The St Botolph Building, 138 Houndsditch, London EC3A 7AW. Registered in England No. 01536540. VAT No. 244 2321 96. © October 2016 272925

community stakeholders to minimise risks of protest and licence cancellation and

mining company operating in PNG, and whether there have historically been any periods where the investor’s relationship with the host government has become challenging.

This publication is for the benefit of clients and prospective clients of JLT Specialty Limited. It is not legal advice and is intended only to highlight general issues relating to its subject matter but does not necessarily deal with every aspect of the topic. If you intend to take any action or make any decision on the basis of the content of this bulletin, you should first seek specific professional advice.