Expropriation: Pakistan's Message to Foreign Investors
February 2010
Pakistan's recent de facto expropriation of
one of the country's largest ever foreign investments—the Reko Diq mine in Baluchistan—has
sent a shudder through the foreign investment community. The government has
said that the deal originally agreed with the provincial government is unfair
and not in the country's long-term interests.
by Daniel
Wagner
Country
Risk Solutions and PFC Global Risk
This seems an odd time for Pakistan to be sending foreign investors a mixed
message with respect to the sanctity of contracts and unpredictability of government
actions. At the same time, there is an important lesson to be learned for foreign
investors everywhere: cutting a deal that is perceived as fair by all parties
will enhance the chance that a project will proceed, and be successful in the
long-term.
Rising Economic Nationalism
In January 2010 the government of Pakistan threatened to cancel the $3 billion
Reko Diq copper and gold project led by Canadian investor Barrick Gold and Chilean
mining company Antofagasta in the country's resource rich Baluchistan province,
citing the need to protect is strategic national interests. With an economic
life of 25–30 years, the project is expected to earn $40 to $50 billion from
the extraction of raw copper and gold, making it one of the largest mines of
its kind in the world. It is therefore not a surprise that the government is
interested in maximizing its potential long-term monetary benefits from the
project.
Given that the mine is located near the Afghan border, in a province that
has been at odds with the central government over revenue sharing from natural
resource projects, and the base of a nationalist insurgency for decades, the
original investors were given some incentives to proceed with exploration and
feasibility studies, and were in return given a lucrative deal. The government
now appears to think the deal is too lucrative, and that some of the terms agreed
upon are unfavorable to Baluchistan and the central government. Baluchistan
was required to provide 25 percent of the project funding in order to get a
25 percent return—a tall order for a province with limited financial resources.
Baluchistan now wants 80 percent of the proceeds.
The project is controversial. Proponents claim it will generate much needed
jobs and, if successful, act as a magnet for future investment in the province
and mining sector. Proceeds from the project should help fund infrastructure
development in the area. Opponents cite concerns about by-product pollution
from mining, security issues, whether revenues will actually lead to infrastructural
development, and whether corruption among local government officials would actually
be exacerbated as a result of the project.
These are all legitimate issues, but the bottom line is that Baluchistan
stands to gain from Reko Diq, as does the central government. Without the seed
capital to fund exploration and produce a feasibility study from private investors,
the project would never have gotten off the ground. Having accomplished that,
Pakistan now jeopardizes the 15 years it has spent to get to this stage by playing
the nationalism card, at a time when Foreign Direct Investment has fallen 57
percent in Pakistan since July 2009.
Extractive Enterprises are Particularly Vulnerable
Extractive industries are generally more vulnerable to adverse action on
the part of host governments for several reasons:
- They tend to be large and high profile.
- They employ thousands of people and have significant impact on local
communities.
- They are strategically important to host countries.
- They are subject to a wide range of legal regimes and laws, which frequently
change.
- They involve the production of waste products, which makes them more
highly scrutinized for environmental compliance than other forms of investment.
Mining projects, in particular, have been the object of numerous instances
of expropriatory-type actions on the part of host governments since the 1970s.
Interference by local or national authorities and revocation of mining or export
licenses are the most common ways in which governments indirectly expropriate
mining investments. Although rare, outright acts of expropriation on the part
of host governments do still happen, as has been demonstrated in recent years
in Bolivia, Ecuador, and Venezuela.
In addition, mining projects are prone to sustainable development-related
operational complications, largely due to the impact they have on local environments
and populations. Many mining companies have made great progress in taking the
initiative to avoid conflict with non-governmental organizations (NGOs) and
indigenous peoples by taking care to be inclusive in the planning, construction,
and operation of mines. Many recent investors in the sector have taken care
to establish strong relationships with tribal leaders and negotiate agreements
that give all participants a sense of fair play.
Among the most famous cases involving local population backlash for agreements
that were not perceived to be fair is Bougainville in Papua New Guinea, beginning
in 1989. Disputes over environmental impact, financial benefits, and social
change brought by the mine renewed a secessionist movement that had been dormant
since the 1970s and forced the mine to close permanently. The conflict led to
a war that lasted 8 years, claimed an estimated 20,000 lives, and resulted in
the island becoming politically independent. While an extreme example, Bougainville
serves as a reminder of how quickly events can spin out of control, and the
lasting impact of failing to take indigenous interests seriously.
Lessons Learned
That Pakistan has made such a bold move with Reko Diq, when it is facing
one of the worst political and economic crises in its history, implies that
governments can take action that is contrary to investors' interest at any time.
Pakistan has demonstrated that it will not hesitate to look after its own interests,
for its own benefit. International investment law states that governments have
a right seize foreign investments in the national interest, to the extent that
investors are given fair, equitable, and timely reimbursement. Even if a government
does not have the financial means to provide such reimbursement, it can still
take unilateral action, leaving investors to seek legal recourse through arbitration
or other means. This is indeed one of the risks of engaging in cross-border
investment.
One of the biggest mistakes international investors make is to focus on their
own future net income generation rather than on what makes sense from all parties'
perspective. Experienced investors in natural resource projects know that when
they agree to tariff, tax, or revenue sharing arrangements that give local participants
and host governments a real sense of fairness, their projects generally proceed
with minimal conflict. This minimizes operational complications and usually
ends up contributing handsomely to the bottom line. Yet, in the negotiation
process, too many companies make the mistake of being too focused on their own
well being, and not enough on what benefits local communities and the long-term
health of provincial and host governments.
The message in the Reko Diq case is that a cash-strapped government with
limited sources of revenue will naturally seek to protect its long-term interests
by either seizing high profile foreign exchange generating projects or renegotiating
them. Barrick and Antofagasta would have been wise to consider the possibility
of a change in Baluchistan's posture over the long term and negotiate a deal
that gave the province a better sense of genuine benefit and fair play. Many
other mining companies have learned the same lesson.
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