My response

Thank you for giving me the opportunity of exchanging views on the possibility of renegotiating the Kamoto project in DRC.

I think a common starting point for any assessement should be as follows. Looking at the Kamoto project from the point of view of its industrial sponsors, the project is to produce a stream of Cu/Co over 20 years, the value of this production is tonnage of metals times their unit sales prices, the costs are a stream of direct operating costs and an initial capital cost to refurbish existing plant and equipment. This leads to an internal rate of return IRR, which in all cases is abnormally high for any experienced mineral expert. So the first question is why?

The reason is because the existing plant and equipment as well as the infrastructure of the underground mine and its exploratory work done to the stage of proven reserves, are not counted in the initial investment. This is the main cause of a high IRR. This being said, as for any project, its IRR depends on main factors of influence, of which production and unit prices are foremost. Because unit prices of 1.1-10$/lb Cu/Co considered in KML's project can be considered too conservative - a feature that can be argued based on historical prices and using GDP or price deflators - there is a further reason to expect a still higher value of the IRR. 1.10$/lb Cu is the 50 year average of Cu since the early 1950s that one calculated in the mid 1990s. So in 2007, this average price is much higher, and in addition the trend is an increase due to additional demand from emerging China and India, which will also involve mining lower grade ores, and therefore increased costs.

Using the sponsor's project data (as in the feasibility study; and these figures have changed - increased - because the sponsors have developed more confidence in the project), the project's IRR comes to 29.3%, a value which is exceptionnally high for any mineral expert familiar with integrated copper projects. The way to account for this is to provide a downpayment for the existing plant and equipment for which the sponsor does not have to invest. One can use "excel goal seek" to calculate a downpayment which will reduce the IRR to a goal value. The question is to decide what this goal should be. A 5-10% increase above opportunity cost of capital for the overall IRR of such projects is satisfactory, but this is most certainly not acceptable for the sponsors as an argument... One has to find other arguments.

Obviously, if the contract had been drawn on the basis of "projects" within the framework of international competitive bidding, there would be no need for us to discuss all this. If there would be some cause for dissatisfaction, Gecamines and DRC would only have themselves to blame. But because the contract was not open to international competitive bidding, there is a suspicion that it may be unfair to Gecamines/DRC. The more so as the agreement was reached under the previous Government and at a time of great turmoil for Gécamines. This internal report of the World Bank -which has been communicated to me confidentially - is particularly relevant in this perspective.

If there is a suspicion of unfairness, can it be substantiated?. Here is where different approaches can be followed. And as for any approach, they are just visions of the brain...

My approach

My approach was to calculate a downpayment to Gecamines and reduce the IRR to a "goal value"; but because I cannot set a goal value that can be accepted by the sponsor pressed for renegotiation, I calculate present worth values (PWV), using a discount factor of 12% (considered as opportunity cost of capittal in DRC), of the respective cashflow streams of the parties to the project. PWV@12% is just a way of expressing a stream of 20 annual values in one figure. And it must be emphasized that annual streams are just expansions of one annual value, for operating costs, production and sales and unit sales prices. This has to be borne in mind; we are dealing with a "model".

The results of this approach are best seen in the 25% equity share scenario to Gecamines, to which a downpayment is added for the plant and equipment and reserve inventory and its quality of certainty. It shows a downpayment of 181.3M$ and a reduction of the IRR to 19.9% in the base case, down from 29.3%. And with higher prices of Cu/Co say 1.25-10$/lb Cu/Co, a downpayment of 200M$ and a 24% IRR down from 38.8%.

I thank you for your comments; they have prompted me to highlight Gécamines+DRC benefits and to better explain how to use "my model".

Your approach

I do not intend to comment on your approach, which is just another way of looking at the issue of fairness. But I trust that the interpretation one may formulate, is not contradictory with my approach.


Mis en ligne le 07/11/2007 par Pierre Ratcliffe. Contact: (pratclif@free.fr) sites web http://paysdefayence.blogspot.com et http://pierreratcliffe.blogspot.com