CHAPTER 2 Orientation and Overview Problems of Foreign Investment in Natural Resources

• Jurisdiction: United States

International Minerals Acquisition and Operations
(Oct-Nov 1974)
CHAPTER 2
Orientation and Overview Problems of Foreign Investment in Natural Resources
Dr. Thomas N. Walthier
Director-Corporate Exploration St. Joe Minerals Corporation,
New York, N.Y.

Introduction

Mr. Chairman, members and guests of the Rocky Mountain Mineral Law Institute, let me first thank you for the honor of asking me to keynote this very important and timely conference. I would also like to thank you for extending this invitation, it forced me to formalize my thinking on the ramifications of the political events that have been happening over the last several decades.

My talk is divided into three parts. First, I shall review some characteristics of the mineral industry noting important differences with other industries. Next, I'll review, very sketchily, of course, selected parts of history as background for the world we face today. I'll conclude with how the mineral resource industry might best operate internationally, and specifically, the kinds of things a mineral company must assess and evaluate in going foreign.

This paper touches on many topics. As you can suspect, not all my colleagues at St. Joe view every subject in quite the same way. A few disagree with certain observations and perspectives. Over the years my opinions have changed, and might well again. I hope they do, for this is a changing world. So, what follows are my thoughts on foreign investment as I see the situation today.

The Nature of the Mineral Industry

What manner of animal are we? In simplist terms we provide society with the non-agricultural raw materials that are wanted. In those countries where the mineral industry is run by the private sector of the economy, the compensation resulting from providing these raw materials must be commensurate with the risk involved and the remuneration available in other types of business. If not, the risk capital will be diverted elsewhere. And incidentally, whether or not any company management considers the compensation adequate will be judged by its own criteria and not by some third party, or a government agency, saying such and such a return is sufficient.

However, over and above both the company and the government, the final aribiters of the required rate of return are those who provide the money: the banks and the investing public. But as banks don't lend 100% of the money to place a discovery into production, and almost never finance any of the early high risk exploration, it is ultimately the investing public that decides what areas should be explored and later decides which mineral discoveries will go on stream and which shall remain on the shelf. Any company management that ignores this basic investment fact, and puts its shareholders

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money into high risk and too low yield situations, suffers severe loss of confidence. Appeal of the stock withers, and the price slides. A lot of people become very unhappy. The banks become critical. Company profits remain low and new money via borrowings or stock issues dries up. At this point the management of the floundering company learns its lesson and strengthens its investment policies, or it faces ouster by the unhappy owners, or the company goes bankrupt.

The cold, impersonal decisions by millions of individuals on the merits and rates of return of thousands of stocks available around the world establish the criteria by which every company evaluates investments as attractive or not acceptable.

Unfortunately, governments have their own ideas what they think is adequate compensation. If the disparity of viewpoints is great, move on to other lands. Some governments just can't seem to tolerate a private company being successful making profits measured annually in the millions of dollars, regardless of the investment or the risk that was taken.

The sin qua non for a mining or an oiloperation is a rare, special concentration of mineral or hydrocarbon in the earth's crust formed by geologic processes acting over millions or billions of years. Man had absolutely nothing to do with its formation and man cannot change where it occurs in nature. He has considerable difficulty even finding where it is hidden. Man does, however, have everything to do with who has the legal right to explore for natural resources and, when found, who can exploit them. The second necessity for a successful natural resource venture, then, is for the investor to have sole rights to explore a large enough tract of ground, for a long enough period of time, as inexpensively as possible, so that a competent team should be able to find the sought-after mineral, if it exists. Later on I shall discuss how large an area, for how long, is needed to carry on a successful modern exploration and development program. Equally important if the occurrence is found, the discoverer must have full assurance that his legal rights extend beyond and allow him a fully adequate reward. This should mean he has the automatic right to exploit the deposit profitably, or be able to sell these operating rights to the highest bidder. Furthermore, the conditions of exploitation, as needed to yield an acceptable rate of return, should be spelled out in advance, without fear of subsequent capricious and discriminatory changes by the government. Everything that will be said here for the next two days will simply amplify and analyze the previous few sentences.

Even the biggest mineral deposit is finite, and the portion that is economically attractive to exploit any one time is usually much more restricted than the total geologic occurrence. Each ton of ore extracted, each barrel of oil and gas pumped, reduces the total available by that

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amount, and the remaining life of the operation is reduced accordingly. Changing economics, or technology may increase the amount of material that can be economically recovered but the reserves are still always limited. By contrast, an automotive assembly line or a glove factory or a chemical plant can be located at a number of sites and all be more or less equal. So long as the plant is well managed, the product remains in demand, the equipment kept in good repair and worn out parts replaced and modernized, and other industries provide the raw materials, the facility can go on and on without end.

Natural concentrations of mineral have been formed by a myriad of overlapping geologic processes, in endless combinations — each later one modifying the effects of the earlier ones and confusing the picture. Orebodies and oil fields are incredibly well concealed and difficult to find. We do not have by any means the knowledge or the instruments that point to mineral riches concealed beneath the surface 'right here.' On the contrary, the best techniques and the most experienced judgments merely say we have a better chance of success if we drill or dig here than over there or somewhere else. This "better chance" still has the betting odds of several hundred to one against us in hard minerals and for a significant discovery (a million barrel recoverable reserve) the odds are 43 to one in oil and gas exploration in the U.S. They are slightly lower outside the U.S., about 35 to 1. And the cost of this single test, depending upon location, depth of burial, etc. can range from several thousand dollars to several million for hard minerals and tens of thousands to several million dollars for oil and gas. Furthermore, this testing process must be repeated until the good one is found. This success must also be profitable enough to pay for the previous string of failures as well. Let's analyze this innocent sounding last statement. I assume you agree with the concept that the discovery must be good enough to compensate the effort and investment that led up to it, including the exploration attempts that didn't succeed. An example will clarify. Nine exploration ventures at a cost of one million dollars each failed, but the tenth, also costing the same, was successful. Ten million more dollars are needed to place the last into production. Total investment (ignoring tax credits for the nine failures, which will only modify but not change the example) totals twenty million dollars. In this type of risk investment an annual return on investment of 20% is not unreasonable, especially at today's interest rates. Even ignoring time discount of money, an after tax income of four million dollars per year is required for the 20% return. The local government must be tolerant of this kind of profit, lasting well over five years, simply for you to break even, considering interest charges. Now let us further assume that the nine failures were in Latin America and Africa while the successful one was, say, in a country called the Republic of Oz. How much was invested in Oz? — eleven million; yet we want an after tax cash flow of $4 million a year, or nearly 40% per annum as seen by the Ozians. Furthermore, your home country is not Oz, so what you want is the right to repatriate this $4 million annually. You are not going to find the Ozians very receptive to recouping your Latin American and African losses from their National Patrimony. One consequence is that exploration must be considered on a country-by-country basis, and hopefully your home country is enlightened enough to have a worldwide tax policy that ameliorates

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your worldwide losses against gains. A second consequence is that there is an inclination among investors not to do primary exploration around the world, but concentrate on buying into discoveries made by others. That of course begs the question of who is left to do the primary exploration.

Much has been written on the average industry cost and time involved in making an important new mineral discovery. I've quoted figures for the oil and gas industry. We don't have good statistics in the hard mineral field. Various figures have been cited but I discount them. In my...