Is Tanzania’s export ban a high stakes game of poker with Acacia?

OpenOil’s Excel model on the Bulyanhulu mine  is available to view the workings of the conclusions in this post. 

Tanzania’s decision to impose a ban on concentrate exports from its mining industry has gained wide coverage among industry watchers. The question is: what does the government hope to achieve with it, and what will companies’ reaction be to it?

In this piece, we explore the possibility that the ban particularly targets Acacia Mining’s gold production in Tanzania and that the objective is to pursue re-negotiation to increase revenues to government from Acacia’s three large gold mines, which generated turnover of over a billion dollars in 2016 but have yet to pay any corporate income tax.

We further consider the impact of the ban on Acacia, and on government revenues. Financial analysis suggests the following preliminary conclusions:

  • The government will lose $1 million or more per month in revenues, as falling sales translate into lower royalties.
  • The economics of the Bulyanhulu mine, which were marginal anyway, could be pushed over into operating loss (depending on gold prices), leaving the company with a tough decision about whether to shutter the mine, and that decision point could come in the next few months. Of Acacia’s three operating mines, Buzwagi could also face difficulties while North Mara lies at the other end of the spectrum and could continue to run at operating profit.
  • Acacia’s overall financial position could be materially affected as lower revenues and profits affect its leverage, and erode investor confidence. Shares dropped by 20 percent in the week following the government’s announcement of the closure and have only partially recovered.

Each of these points is dealt with in detail below.

The background to the ban on concentrates

Exports of concentrates and ores of all metallic minerals were banned on Tanzania on March 3rd.

Thomas Scurfield from the Natural Resource Governance Institute has rigorously laid out how the ban on mineral concentrates fits schematically into a broader push by many producing countries to increase beneficiation. In theory, more processing of raw commodities in-country helps add value and convert the mining industry into a broader engine of wealth creation. Against that has to be balanced the amount of capital and time needed to create such facilities in Tanzania from scratch and estimates of how much extra value would be created in this instance – from these mines, and with these commodities.

Scurfield’s article shows that in the Tanzanian case the specifics look challenging: it would take two to three years to establish a facility, a previous feasibility study suggested the economies of scale were not there to make a copper smelting plant viable, and the level of value added in the case of copper is also debatable.

At least according to media reports, the government’s decision seemed related to another issue, that Tanzania was not receiving enough income from its minerals sector, and that better physical auditing was needed as part of measures to redress this.

Acacia’s mines are the only scaled operations which are immediately affected by the ban. The other main producer of gold, Anglo-Gold Ashanti, does not export concentrates. There are plans for several large nickel projects in the future, which could also be affected, but these are several years away from execution and actual export.

Separately to the ban, the government of Tanzania has had a long-standing tax dispute with Acacia over payment of corporate income tax. The Tanzanian Revenue Authority raised a case against Acacia for $41 million withholding tax on dividends paid out to shareholders of the UK-based holding company. OpenOil issued an analysis of the tax dispute last June. Acacia’s last public comment on the case was in October 2016, when they said they would refile an appeal in the Tanzanian court system against the ruling. Because the Bulyanhulu contract has not been published, it is not immediately clear if the Tanzanian courts are the ultimate arbitrator in the dispute, or if some other arbitration or adjudication procedure is also specified.

Tanzanian loss of income: over a million dollar a month

The government of Tanzania is losing $1-1.2 million a month in royalty payments as a result of the export ban.

Acacia has stated that the export ban on concentrates affects 30% of its gold production. In 2016, the company reported paying royalties of $47 million. The simplest approximate calculation of the effect of the ban, then, is to assume a straightforward correlation between the percentage of production shut in by the ban and value in the market: $14.1 million a year, or just over a million dollars a month at current market prices.

If the ban continues for some time this revenue is unlikely to be recoverable as and when it is lifted, since there is a limit to how much concentrate Acacia can store at the mines, so it is likely to curtail production.

Will Bulyanhulu tip into operating losses?

Of Acacia’s three mines, the ban has the most drastic effect on Bulyanhulu where, according to Acacia, concentrates account for 45% of the mine’s production. The ban could push the mine over the economic limit, where Acacia would be running operating losses in order to keep producing at all.

To some extent the marginal economics of the mine, relative to Acacia’s other holdings, has become clearer this month with the publication of the company’s 2016 annual report. These have led us to revise near term future forecasts for revenues and positive cash flows down from our first publication of financial analysis of Bulyanhulu, which were based on an investor presentation published by the company in March 2015.

Acacia has for some time been advertising capital investment and management overhaul strategies to make the mine more profitable. In the 2015 investor presentation, still the company’s last public statement of forward looking estimates, it anticipated the pay off from these efforts to be a rise in production from 195,000 ounces in 2013 to 380,000 ounces by 2017, and a drop in cash costs from $890 per ounce produced in 2013 to just $480 per ounce in 2017. It was these two effects combined which would push the mine, at long last, into free cash flow.

But the company’s annual reporting since has given a different picture (see table below).

Bulyanhulu report vs estimated

Production has risen, and costs have dropped, but by considerably less than was predicted two years ago. In particular 2016 cash costs at the mine were $722 per ounce, substantially higher than the $540 per ounce anticipated in the 2015 investor review (we assume here that the reporting basis of these metrics remains constant, since the company has provided no information to suggest the contrary, as would be expected under normal reporting practices).

Accordingly, OpenOil has revised down revenue and earnings forecasts from Bulyanhulu. We still model the general trend of the company’s assertions about future performance at the mine – that production will go up and costs will come down – but by less and over a longer timeline than originally assumed (see table below).

Bulyahnulu financial model assumptions

If Acacia’s 2015 forward estimates had held the mine could have expected to generate around $150 million in 2017 in cash flow for the company at current market prices. But under revised assumptions this drops to just $25 million. This could rise to $75 million by 2019 and go over $130 million in 2020. In terms of the tax issue, these lower assumptions would push back the point at which Acacia would pay income tax from 2020, projected in last year’s iteration of the model, to 2022.

And that is before the concentrates export ban.

If we assume that Acacia’s statement that 45% of gold at Bulyanhulu is in concentrate form means the mine will simply produce and sell 45% less (something which remains to be confirmed from a more precise understanding of the geology of the mine), Bulanhulu’s cash flows turn negative. At current market prices, the company could run an operating loss of $40 million in 2017 from the mine. It seems unlikely the export ban is going to remain in place for years without movement one way or another – either a partial or total lifting of it, or, by contrast, the move to build facilities and therefore unlock the concentrate-based production. However, theoretically, if it did, Bulyanhulu might not get out from under operating losses until the next decade.

Interestingly, under the same assumptions about the impact of the ban on production, but keeping to Acacia’s original 2015 forward looking estimates on production and costs, Bulyanhulu could stay cash positive over the next few years with a ban – but only just. Positive cash flows could be in the region of $30 million a year for the next three years. The company would therefore not face a question of whether it needed to shutter the mine as it approached the Economic Limit.

Bulyanhulu Cash flow scenarios

North Mara and Buzwagi

We have not conducted full financial analysis on Acacia’s other two mines. One unresolved question here is how much production from concentrates come from these two mines, since Acacia has not specified this for them, unlike Bulyanhulu. Piecing the company’s statements together, it would seem as though an additional 115,000 ounces of gold production at the two mines could be locked in by the ban (since according to the company 30% of overall production is affected – about 245,000 ounces in 2016, of which Bulyanhulu, with gold production from concentrates at 45%, accounts for 130,000 ounces).

Nevertheless, North Mara’s clear status as the group’s cash cow, with the highest production and a materially lower cost base, makes it unlikely Acacia would face the same issue of operating losses there.

Buzwagi at first sight also could be precarious. There is concentrate production there but the proportion was not immediately known. The mine is approaching end of life, but has the highest all-in costs of the three mines – although its vulnerability to price volatility may be lower since the company locked in pricing agreements which apparently covered all of first quarter 2017’s production at a floor price of $1,150 per ounce.

Nevertheless further analysis needs to be done to determine the vulnerability of both these mines to a continued concentrates export ban.

Bulyanhulu rev scenarios

Acacia’s overall position

Clearly the concentrates export ban, if it shuts in 240,000 ounces or more of gold production in 2017, could materially affect Acacia’s financials as a whole. At current market prices it would lead to a loss in gross revenues of $300 million.

One of the reasons Bulyanhulu could be pushed into net operating losses is because the mine operation is still leveraged. Acacia’s 2014 annual report includes a reference to a $142 million loan. Terms of that loan are not available, but it is possible Bulyanhulu Gold Mine Limited, the Tanzanian entity operating the mine, could be repaying between $15 million and $30 million in interest and principal. Further research would need to be done to determine the company’s overall leverage. Acacia reported a net cash position of $218 million at the end of 2016, considerably better than 2015’s $105 million, so it is better placed to face loss of cash flows than it was a year ago.

Despite Acacia’s stronger 2016 performance, the ban still comes at a delicate time for the company. Market rumours persisted throughout 2016 of talks with South African firms of a possible sale of the company, whose majority position (63%) is held by Barrick Gold. When news of the ban first broke, shares in Acacia dropped 20% within a week. In the following three weeks they recovered half of that. But the impact of the ban itself is likely to make investors skittish, both in and of itself and in relation to what it might portend in terms of ongoing relations between the company and the Tanzanian government.

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