MINING SECTOR MALAISE WORSENS

UNCLAS SECTION 01 OF 03 LUSAKA 000080

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: EMIN ECON EFIN ZA
SUBJECT: MINING SECTOR MALAISE WORSENS


1. (SBU) Summary. Zambia's mining sector has been hit hard
by the fall in commodity prices induced by the global
economic recession. Responding to pressure from the private
sector, the Zambian Government (GRZ) has announced its
intention to withdraw its windfall tax on mining revenue as
well as make several other small concessions to the mining
industry. The gesture is mostly symbolic, however, as the
windfall taxes do not apply at current price levels, with
copper prices currently hovering around USD 1.50/lb.
Although appreciative of this development, mining companies
remain deeply concerned about the viability of their
operations in Zambia, given high production and
transportation costs, inadequate local smelting capacity, and
the still onerous tax regime. Although troubled by rising
unemployment, Mines Minister Maxwell Mwale expressed
confidence that the sector will absorb these shocks and
maintain profitability. He affirmed that the Ministry has no
intention of nationalizing the closed mines. End Summary.

Government Withdraws Windfall Tax


2. (SBU) On January 30, Finance Minister Situmbeko
Musokotwane announced to parliament that the GRZ intends to
withdraw its windfall tax on mining revenues. The windfall
tax had been part of a new minerals tax regime that included
higher corporate tax and mineral royalty rates. The taxes
had been the source of much contention since their unilateral
introduction in early 2008, with mining companies claiming
that the new taxes abrogated their (still treated as secret)
development agreements with the GRZ. The GRZ's response
(supported by the World Bank and several bilateral donors)
had been -- and continues to be -- that the terms of the
development agreements, which the GRZ had signed to lure
investment during privatization, had been too generous and
did not significantly compensate Zambia for its natural
resources. According to an industry analyst, the Zambian
Chamber of Mines had been lobbying for months against the
windfall tax and had seized the opportunity of lower prices,
mining closures and downsizing, and a sympathetic Finance
Minister to push for its revocation. The Director of the
Chamber of Mines Nathan Chishimba claimed to emboff that the
combination of the windfall tax on revenue (vice profits)
plus variable profit, corporate, and royalty taxes had the
potential to cost a mining company USD 1.05 for every USD 1
of revenue, had it been implemented.


3. (U) The windfall tax withdrawal will cost the government
nothing at present, given that the taxes do not take affect
until copper prices rise above USD 2.50/lb. The concession,
however, marks a symbolic relaxation of the GRZ's mining
reforms and a recognition of the need to conciliate with its
mining companies. During his presentation to parliament,
Finance Minister Musokotwane also announced that the GRZ
would allow companies to depreciate their capital investments
by 100 percent in the first year (rather than by 25 percent
per year over a four year period) in order to encourage
mining sector investment. To reduce operating costs in the
ailing mainstay of the Zambian economy, Musokotwane said the
GRZ would cut import taxes on heavy fuel oil (from 30 to 15
percent),allow mining companies to add hedging income to
(and presumably deduct hedging losses from) their taxable
income, and defer value added tax on copper concentrate
imports from the Democratic Republic of Congo, effective
February 1st.


4. (SBU) Although the private sector welcomed the moves,
mining companies remain deeply concerned about their economic
prospects, particularly given high production and
transportation costs. The managing director of Kansanshi
Mining (a company owned by First Quantum Minerals of Canada),
told emboff that the new tax structure is still more
"onerous" than the terms that the GRZ had offered to most
mining companies in their individual development agreements.
He also pointed to the 15 percent export levy on copper
concentrates, making the export of unprocessed copper a
"money-losing proposition" at current copper price levels.
Additionally, he noted that existing and near-term smelting
capacity in Zambia is less than half of that which is needed.
Consequently, mines that produce concentrate in excess of
that which the Zambian smelters can treat will either produce
less or shut down altogether, he projected.

Mining Closures and Cutbacks


5. (SBU) Mines Minister Maxwell Mwale appears to share
little of Musokotwane's concern about the impact of the
global economic crisis on Zambia's mining sector. In a
meeting with the Ambassador on February 2, Mwale acknowledged
that mining companies had been hurt by declining commodity
prices and that this had sent shockwaves to other segments of
the Zambian economy. Mwale, however, said that he believed

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mining companies could operate profitably at current world
price levels. He also maintained that Zambia had spare
smelting capacity. Mwale pointed to petroleum prospecting in
Northwestern, Eastern, and Southern Provinces as well as
impending uranium production. He speculated that this would
be particularly feasible for Equinox's Lumwana Copper Mine,
which he said intends to extract uranium mineralization in
order to produce uranium oxide ("yellowcake"). (Note: In
early January, Lumwana announced the postponement of its
uranium treatment plant, due to difficulties securing project
financing. Lumwana, however, will continue to stockpile
uranium-bearing material for potential processing at a later
date. End note.)


6. (SBU) Mwale opined that many of Zambia's mining companies
had priced their investments according to historically high
prices, rather than industry averages, and had been operating
inefficiently. He projected that this was particularly true
for Luanshya Copper Mines (LCM),a joint venture between
Swiss-based International Mineral Resources and Ben Stein
Group Resources of Israel, which closed its operations in
December 2008. According to Mwale, LCM had been outsourcing
much of its operations, which become economically untenable
after the fall in metals prices. Mwale opined that LCM's
transfer pricing arrangement for smelting services from its
affiliate, Chambishi Metals, had been to LCM's disadvantage.


7. (U) Mwale expressed regret about the unemployment
resulting from LCM's closure, pointing to the ripple effect
on mining service providers. He estimated that LCM's closure
may result in as many as 6,300 lay offs, consisting of 1,300
LCM employees and perhaps 5,000 contractual laborers, service
providers, and suppliers. Closure of the Chambishi Metals
smelter and down-sizing at both Kansanshi Mining and Mopani
Copper Mines could bring the total number of job losses to
about 8,000, Mwale suggested.

GRZ Response


8. (SBU) Countering local media reports that the GRZ would
take over failing mines, Mwale said that it was the GRZ's
role to create an enabling environment for private sector-led
growth. Mwale affirmed that the GRZ does not intend to
nationalize LCM, although an almost entirely government-owned
holding company, Zambia Consolidated Copper Mines (ZCCM-IH),
may operate it until the GRZ finds a suitable investor.
Mwale said that he had received expressions of interest from
Russian, Chinese, South African, and Middle Eastern
companies, but that the GRZ did not want to transfer
ownership o the mine until it had resolved questions related
to LCM's outstanding liabilities to "domestic sharholders,"
presumably referring to ZCCM-IH's 15 prcent stake in LCM,
which it bought for USD 1.5 illion in 2005. Ambassador
urged Mwale to condut an open solicitation for investors
rather than ust deal with those who come calling. He said
sch an open solicitation should include an honest asessment
of LCM's assets and liabilities. (Comment: Mwale seemed
interested in such an approach. End Comment.)


9. (SBU) In a separate meeting, Chamber of Mines Director
Chishimba claimed there was little investment interest in the
mine due to enduring investor skittishness since the GRZ's
unilateral imposition of the new tax regime in 2008, even
though the windfall tax was subsequently revoked.


10. (SBU) The Ambassador briefed Mwale of Zambia's
qualification for a Millennium Challenge Account Compact,
which could entail a major infusion of funding to reduce
poverty through economic growth. The Ambassador emphasized
the importance of making continual strides on
anti-corruption, in order to maintain Compact eligibility,
and suggested that the GRZ's eventual participation in the
Extractive Industries Transparency Initiative (EITI) would be
a useful signal of the GRZ's commitment to integrity and the
rule of law. Mwale noted that the GRZ has an EITI committee
in place, chaired by the Secretary to the Treasury, and is
seeking government and stakeholder approval for its draft
work plan. Chishimba said the Chamber of Mines actively
supports the EITI but senses the GRZ is only focused on
industry obligations for EITI, not its own.

Comment


11. (SBU) The true viability of Zambia's mining sector
probably lies somewhere between the Mines Ministry's optimism
and the private sector's despondency. Mining executives
continue to resent the GRZ's unilateral abrogation of
development agreements that offered long-term concessions to
attract international investors. Although the elimination of
the windfall tax may hearten investors, the Zambian
Government may have forfeited much of its credibility over

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the past year, and the Zambian market may have lost much of
its appeal for mining investors, at least at current
commodity prices. Although this may not fend off all foreign
investment to the mining sector, it may attract a lower-tier
of mining companies that have a larger appetite for risk. It
may also dampen Zambian economic prospects and delay the
mining sector's expansion beyond the global economic recovery.

BOOTH