Tertiary and Mining Sector Contributions to Economy: hearings

FINANCE PORTFOLIO COMMITTEE
20 February 2007
TERTIARY AND MINING SECTOR CONTRIBUTIONS TO ECONOMY: HEARINGS

Chairperson: Mr N Nene (ANC)

Documents handed out:
Chamber of Mines Presentation
Arup Transport Presentation
Standard Bank Presentation

Audio Recording of the meeting

SUMMARY
The Chamber of Mines said that mining remained a key foundation of industry for South Africa, accounting for 15% to 20% of Gross Domestic Product (directly and indirectly). According to the PricewaterhouseCoopers annual survey of the fortunes of the global mining industry entitled “Let the good times roll,” 2005 was another spectacular year for the global mining industry. Gross revenue of the sector rose 25% to US$222 billion and net profit rose 59% to US$45 billion. However, despite the almost unprecedented global commodities boom, South Africa had missed out on the benefits.

Government and the industry were in agreement as to the reasons for this decline in performance. The first was the strength and volatility in Rand exchange rate between 2002 and 2006. There were also infrastructural constraints.

Some of the regulatory constraints were that since the new law became effective from the 1 May 2004, a large number of applications had been made so it was a big learning curve for all parties and there were capacity constraints in Government and industry to deal with the applications.

The industry did seem to have turned the corner though. Investment and mining production had started recovering in the second half of 2006 and investment was up 5.9% in the first nine months of 2006. Significant improvements made on the second draft of the Minerals Royalties Bill were welcomed and the Chamber remained convinced that a net based system was in the economic interests of the country.

Arup Transport said that some general findings were that transport investments made the biggest contribution to economic growth in areas with high economic growth potential. Also, transport investments with high benefit cost ratios made the biggest contribution to economic growth and job creation. Transport investments did not automatically lead to growth and job creation as collateral support actions were needed.

For passenger transport, investment had the greatest economic impact when the underlying trends were towards urbanisation and Central Business District consolidation. Rail transport could only ever cover its full costs when used for bulk trades and it generated very little tax revenue. On the other hand, road transport could nearly always cover its full costs via either taxes or tolls.

South Africa was one of the world’s low-density capitals with a weak public transport culture except for minibus taxis. Global experience showed that transit investment could not arrest urban sprawl. Heavy investment in transit was sensible only in support of pre-existing urbanisation or agglomeration trends.

Currently 85% of freight was transported by road and volumes could double in 12 years but
Transnet was planning to spend billions to win back market share to rail. General cargo rail freight business could require up to a 100% infrastructure subsidy but road transport could almost always cover infrastructure costs if required to do so. Rail management was often blamed but the real explanation was changed market realities. His estimate was that to win back a further 16 million tonnes to rail, Transnet would have to spend R10 billion.

Government should invest in rail only in sectors where rail was still efficient, that is bulk freights, focusing available funds on coal and ore. Regulatory policies should be used to encourage Transnet to implement these changes.

Standard Bank said that over the last few years there had been an enormous rise in debt take-up in South Africa. Indebtedness or debt stock in relation to income was going up. This was driven in part by the ‘wealth effect,’ for example someone’s house doubling in price. Another reason for the debt take up was the nominal interest rates. That is, the price of money was now cheaper than it had been in the past, and if salaries remained at least constant, people could afford more money and more debt.

What also drove financial sector deepening was upward mobility in income and wealth. Over the last five years over 450 000 formal sector jobs had been created and this meant that more people were contractible, and they could begin to accumulate debt. The market therefore was broadening and beginning to participate in the economy.

In terms of the GDP, there had been a downward profile in the GDP since the 1960s till the time when Mandela walked out of prison. South Africa’s downward phase bottomed out and since then it had been accelerating.

MINUTES
Chamber of Mines presentation
Mr Roger Baxter, Chief Economist, said that mining remained a key foundation of industry for South Africa, accounting for 15% to 20% of Gross Domestic Product (GDP) (directly and indirectly); 50% of merchandise exports (primary and beneficiated mineral exports); 12% of fixed investment (directly and indirectly); 30% of the market value of the Johannesburg Stock Exchange; 20% of formal sector employment (directly and indirectly); 50% of the volume of Transnet’s rail and ports; 93% of electricity generation via coal power plants; 16% of electricity demand and about 30% of liquid fuels via SASOL’s use of coal for example.

The real contribution of mining in backward linkages was R35 billion to the GDP (2.3%) and 150 000 jobs. Mining’s direct contribution to the GDP was R94 billion (6.2%) and 450 000 jobs. Its contribution in forward linkages was R25.8 billion (1.7%) to the GDP and 55 000 jobs. The induced effect was R91 billion (6%) to the GDP and 600 000 jobs. The total contribution of mining was R246 billion (16%) to the GDP and 1 260 000 jobs (about 20% of total employment).

According to the PricewaterhouseCoopers annual survey of the fortunes of the global mining industry entitled “Let the good times roll,” 2005 was another spectacular year for the global mining industry. Gross revenue of the sector rose 25% to US$222 billion, net profit rose 59% to US$45 billion (the profit margin rose to 20% versus 16% in 2004 & return on equity was 25% in 2005 versus 19% in 2004) and rising gross operating surpluses resulted in a 31% increase in
capital expenditures of the industry to US$31 billion in 2005. At the exploration level, US$1.7 billion had been spent since 2002. Expenditures had risen by 317% to US$7.1 billion in 2006. For a key mining country such as Australia, profit before tax rose 95% in 2005 for mining companies and investment rose 34.5%.

‘The Economist's’ All Metals Index also went up 250% in US$ terms over the current commodity bull phase between October 2001 and August 2006. However, despite the almost unprecedented global commodities boom, South Africa had missed out on the benefits. The strengthening exchange rate reduced benefits of rising US$ prices.

Investment in SA mining fell by 20% in 2004, 13% in 2005 before a modest recovery of 5.9% (in the first 3 quarters) in 2006 and mining production fell by 2.2% in 2006 (non-gold production fell by 1%). South Africa’s real export growth was only 1.3% in the first half of 2006 and this fed through into pressures on the current account (6% deficit as a percentage of GDP in the first half of 2006) which undermined the Rand and had inflationary and monetary policy implications.

Exploration expenditures in South Africa grew by 139% between 2003 and 2006 versus the global growth rate of 225%. South Africa’s exploration rank fell from number four in 2003, to number seven by 2006.

Government and the industry were in agreement as to the reasons for this decline in performance. The first was the strength & volatility in Rand exchange rate between 2002 and 2006. There were also infrastructural constraints. Logistical constraints in rail and ports severely hampered export growth (iron ore, coal, ferro-alloys). Shortages of water affected the development of mines and there were regulatory constraints as well with the new Act with a large number of applications being made (so a learning process was under way which created bottlenecks for industry and Government). There were challenges regarding the interpretation of the MPRDA and the Mining Charter as well. There were challenges in environmental licensing, such as dealing with three Government Departments, trust funds and water licences.

Some of the challenges with the Rand were that between first quarter 2002 and first quarter 2005, the Rand appreciated by 48% (from R11.53/US$ to R6/US$) against the US$ and this eroded most of the US$ commodity price gains. From the first quarter 2005 to now, the Rand had weakened by 16% and US$ prices rose strongly, providing a good boost to Rand commodity prices. The volatility in the exchange rate had also made planning more difficult. In the past 18 months, the Rand had weakened and US$ commodity prices had risen further resulting in much higher Rand prices.

Some of the infrastructure constraints were that for bulk commodity exporters in particular, specific rail and port constraints in 2004/2005 undermined the ability of the sector to
grow the volume of exports (coal exports fell in 2004 before a slight recovery in 2005, while iron ore exports showed no growth in 2004 before a modest rise in 2005). However, agreements on capacity expansions for coal and iron ore were concluded in 2005/06.

Environmental Impact Assessment constraints had delayed the Richard’s Bay Coal Terminal
expansion upgrade by one year and water constraints delayed projects in the Steelpoort area. The lack of sufficient pipeline capacity between Durban and Gauteng was a concern regarding the security of supply of fuel to the inland market.

Some of the regulatory constraints were that since the new law became effective from the 1^st of May 2004, a large number of applications had been made so it was a big learning curve for all parties and there were capacity constraints in Government and industry to deal with the applications. There were interpretational challenges; incomplete applications by mining companies; triplication of paperwork, funding of environmental trust funds, which in turn could delay mining rights; the lack of sufficient capacity in the Department of Water Affairs and Forestry to process water licenses was another problem area delaying mining projects and the 1.5 hectare mining licence was inappropriate for the alluvial diamond sector.

A program of action was instituted where a Mining Industry Task Team on Investment was established in November 2006. Several meetings had been held and the purpose of the Task
Team was to research and document constraints to investment in mining and to provide recommended solutions to the challenges. A Tripartite Monitor Gold Study was looking at extending the life of the gold sector, including task teams on productivity enhancement and cost containment, regulatory and investment and non-mining investment. National Treasury was investigating the concept of ‘flow through shares’ as a means of encouraging exploration and venture capital raising in the sector.

The industry did seem to have turned the corner though. Investment and mining production had started recovering in the second half of 2006 and investment was up 5.9% in the first nine months of 2006. There was high-level industry leadership engagement on the challenges facing the sector and agreements had been signed with Transnet for the upgrades of the Coalink line to Richard’s Bay, the rail line from Sishen to Saldanah, and the port of Saldanah and development of De Hoop dam started.

Some of the positive developments in recent months had been that 2495 new prospecting licences granted (94% finalized within the time frame, that is, either granted or refused), 341 mining rights were granted (65% finalised) and 1025 permit applications granted (84% finalised). The Chamber and the Department of Minerals and Energy were engaging on environmental licensing issues.

Significant improvements made on the second draft of the Royalties Bill were welcomed and the Chamber remained convinced that a net based system was in the economic interests of the country. The proposed two-tier system of royalty rates was a concern however. The higher penalty rate for primary exports could significantly undermine the competitiveness of certain
commodities (iron ore, coal, manganese, with very little downstream benefit) for instance. Rather than penalising mining, the focus should be on creating a competitive environment that attracted the manufacturing companies.

The Chamber and the mining industry wanted more interaction with Parliamentary structures and visits to mines to obtain hands-on information should take place regularly and the Chamber was willing to carry a portion of the cost of such visits.

Stakeholders needed to continue to deliberate on how to encourage a more stable exchange rate but planning over the past few years had been a real challenge. The social partners were working together at a high level to address infrastructure constraints, and they were working together at a high level to address the regulatory challenges affecting investment, job creation and growth in the mining sector.

Discussion
Mr S Asiya (ANC) asked what the industry’s suggestions were in terms of the exchange rate and monetary policy.

Mr Baxter replied that there had been many discussions about the exchange rate. From a national perspective, a stable exchange rate would be ideal, and it necessary to find a balance between what was best for importers and exporters. The point at which this balance could be found should be where the exchange rate was. Exchange controls and building up reserves would play in role in finding this balance.

Mr I Davidson (DA) said that Mr Baxter had contradicted himself in terms of the Rand. He had said that the Rand and the Australian Dollar faced the same constraints in terms of monetary policy but the Australian industry was doing very well. This meant that the pressures on the Rand were not that severe. The real problem was in the regulatory environment in South Africa, which made it hard for industry here.

Mr Baxter replied that commodity prices had been affected by the strength of the Rand. Australia also had a different metal portfolio to South Africa, and combined with a large infrastructure deficit (could be up to 60%) and a new regulatory environment, things were different here compared to Australia.

Adv Schmidt (DA) asked if Mr Baxter was satisfied with the progress of the MPRDA.

Mr Baxter replied that at the recent mining indaba, the Minister of Minerals and energy had said that a new amendment bill on the MPRDA was going to be drawn up with input from the industry.

Prof B Turok (ANC) said that it was not good enough to say that beneficiation should be the responsibility of the manufacturing industry alone. He did not accept that claim. Why should South Africa but gold rings from Italy when there was gold here for instance? Was the mining industry settled here or was it here just to extract the gold with people in the UK benefiting?

Mr Baxter replied that the problem with beneficiation was that miners did not participate in the final fabrication processes. The industry also had to compete with places like India where wages were much lower and the workers had about 2000 years of craftsmanship experience. Mining alone could not change this but Government had to help as well by creating an environment where manufacturers could compete. Mining companies were committed to South Africa, but to become ‘global players’ they had to ‘play’ in other countries as well.

Arup Transport presentation
Mr Andrew Marsay, Arup Transport's Economist, said that some general findings were that transport investments made the biggest contribution to economic growth in areas with high economic growth potential. Also, transport investments with high benefit cost ratios made the biggest contribution to economic growth and job creation. Transport investments did not automatically lead to growth and job creation as collateral support actions were needed.

Transport investment could not create economic growth potential where these aides did not already exist. Transport investment could only help release, and accelerate existing economic growth potential. For freight transport, investment had its greatest economic impact in connection with points of access to a country such as ports, airports and major trading/industrial areas.

For passenger transport, investment had the greatest economic impact when the underlying trends were towards urbanisation and Central Business District (CBD) consolidation.
Rail transport could only ever cover its full costs when used for bulk trades and it generated very little tax revenue. On the other hand, road transport could nearly always cover its full costs via either taxes or tolls.

Road generated huge tax revenues while rail transport projects rarely scored Benefit Cost Ratios (BCR) greater than 3:1. Most highway projects scored BCRs greater than 10, and some as high as 20. The environmental advantages of rail over road were rarely sufficient to made up for rail’s high cost (a n exception was very high-density urban areas).

Secondary routes/services had to be developed at the same time as primary routes/services.
Without good project management and monitoring, the benefits of transport investments would rapidly fritter away.

He said that an important question was whether there was a case for the Gautrain? South Africa was one of the world’s low-density capitals with a weak public transport culture except for minibus taxis. Global experience showed that transit investment could not arrest urban sprawl. Heavy investment in transit was only sensible only in support of pre-existing urbanisation or agglomeration trends. Although land use policies favoured densification, people were still moving away from public transport. However, consolidation of urban agglomerations was taking place and CBDs were seeing some commercial recovery. The property market was seeing rising densities and trends to CBD living.

To capture or optimise these trends, the National Railplan’s Priority Rail Corridors could be implemented so that people could use Metrorail to access the Gautrain. Investment had to be a
ccelerated in other quality road-based public transport systems because the Gautrain’s capacity was limited. The freeway system had to be expanded because most transport would continue to be road-based. Most importantly, the stations had to become integral, quality parts of the surrounding urban environment.

The Gauteng Precincts Initiative set an institutional framework for securing development
at and around the Gautrain and other interchanges and it set criteria for identifying and pursuing development opportunities that would serve public and private interests. It also set design principles by which transport functionality and property development opportunities were creatively blended, and it committed to the objective of making transport interchanges integral parts of the surrounding urban environment.

Currently 85% of freight was transported by road and volumes could double in 12 years but
Transnet was planning to spend billions to win back market share to rail. General cargo rail freight business could require up to a 100% infrastructure subsidy but road transport could almost always cover infrastructure costs if required to did so. Rail management was often blamed but the real explanation was changed market realities.

UK multimodal studies in the 1990s sought to level the road/rail playing field. A strong G policy steer led to two thirds of all investment proposals being rail and the others being public transport.
Rail projects had BCRs of 3:1 or less and did not even meet the UK Treasury’s socio-economic investment criteria (while most road investments had BCRs well over 10:1).

Monetarisation of environmental criteria showed that rail’s impact was just 25% that of road. He said that “in other words, rail was better” but of the environment costs were just 15-25% of the total lifetime cost of creating new transport capacity. So rail’s environmental advantage would be rarely sufficient to compensate for the low BCR.

The Gauteng-Durban transport corridor carried about 60 million tonnes of general freight.
Of this, 8 million tonnes (13%) was rail and 52 million tonnes (87%) was road, of which the majority, 36 million tonnes, was on the N3. To significantly increase the freight carrying capacity of the corridor, a freight-only dual-two carriageway to high load-bearing standard would cost about R12 billion. At an average of R5m/lane-km x 600km, this could cover civil works, structures, junctions and land. It would create capacity for about double the current N3 freight load, or 72 million tonnes per year, that is, all the N3 freight plus 100% new capacity.

A R4.00/km toll could pay capital, operating plus maintenance costs over 25 years.
Additional benefits were: a much reduced maintenance cost and extended pavement life on the existing N3; a large amount of new capacity on the existing N3; a much improved passenger safety on the road and a saving of about R200 million per year in current rail subsidies and leaving investment funds available for more economic investment in bulk.

Transnet quoted an investment of between R10 billion and R60 billion for freight, some of which was to win back the general cargo share on the Gauteng-Durban rail corridor. Capacity could be doubled to 16 million tonnes (relatively) inexpensively, at about R1.5 billion, but to win back much more rail business, huge investment in terminals plus operational subsidies would have to be made. His estimate was that to win back a further 16 million tonnes to rail, Transnet would have to spend R10 billion. With the (relatively) inexpensive initial 8 million tones, the total spend
of R11.5 billion (R1.5 billion + R10 billion) yielded a total gain of 24 million tones.
But it had to be noted that the investment would not generate the revenue to pay for itself. The turnaround time for trains and their availability may still not be as good as road and congestion, safety and maintenance costs on the N3 would continue to grow if extra road capacity was not also created.

The implications were that R11.5/R12 billion could buy 72 million tonnes capacity in road mode, but only 24 million tones in rail capacity. A major increase in general cargo capacity could be
achieved far more economically in the road mode and it would be a misuse of national resources to pump billions of Rands into general cargo rail freight capacity.

He advised that the Government should invest in rail only in sectors where rail was still efficient, that is bulk freights, focusing available funds on coal and ore. Regulatory policies should be used to encourage Transnet to implement these changes. Investment should be made on a dedicated highway infrastructure for general cargo freight. Regulations should also be used to maximize the road freight’s efficiency and mitigate its environmental impacts.

Discussion
Mr A Moloto (ANC) asked what the ideal solution was for public transport. Was just increasing the road network alone enough?

Mr Marsay replied that road transport could not do all the work alone in urban areas. Focus should be on the type of transport that had a competitive advantage here, and that was rail transport.

Prof Turok asked what would happen when the trucks on the dedicated freight road reached their destinations. Would they be allowed into cities? This could be hazardous.

Mr Marsay replied that the dedicated road would have to be dedicated. That is, used only for that purpose.

Mr Davidson asked what the arguments were for the Gautrain to be made an underground train.

Mr Marsay replied that there was actually a stronger case for rapid bus transport than the Gautrain but the Gautrain was important and it could be expanded if it was successful over time.

Standard Bank Presentation
Mr Goolam Ballim, Chief Economist, said that over the last few years there had been an enormous rise in debt take-up in South Africa. Indebtedness or debt stock in relation to income was going up. This was driven in part by the ‘wealth effect,’ for example by things like someone’s house doubling in price. The current spending patterns were shaped by the lifespan cycles of people’s wealth. This means that for example, if someone’s house was worth much more, their balance sheet was much stronger so financial institutions would be more willing to lend.

Another reason for the debt take up was the nominal interest rates. That is, the price of money was now cheaper that it had been in the past, and if salaries remained at least constant, people could afford more money and more debt. There was also a structural decline in the interest rate. The prime interest rate in South Africa over the past five years averaged 17.5% and over the next 15 years it would reach 17.5%. In fact, he foresaw the prime interest rate being in single figures. Therefore, people could have more debt stock but this did not mean that they were actually being burdened.

There was also the issue of diminished policy variability. This meant that there was a decline in the potential for the interest to rise to acute levels. Inflation was more subdued and less volatile. There were greater competitive forces in the economy, which led to less price volatility and the economy had become more globalised and this led to more price discipline in the local market. This all led to lower policy rate volatility.

Age also played a role. For example, if the average age of people in the country were 32, they would have a certain profile: they would have just bought their first car and/or first house. If the average age was 60, they would most likely have paid off their houses and all their debts. They would have accumulated wealth and would be spending it. Thus, the age demographic was an important driver for debt stock in the economy. Higher income individuals seemed to have more debt as they had more assets to leverage against the debts.

What also drove financial sector deepening was upward mobility in income and wealth. Over the last five years over 450 000 formal sector jobs had been created and this meant that more people were contractible, and they could begin to accumulate debt. The market therefore was broadening and beginning to participate in the economy. Between 1960 and 2007 the income growth of black people was growing much faster than that of white people. But it should be noted that white people still had a much bigger proportion of assets.

In terms of the GDP, there had been a downward profile in the GDP since the 1960s till the time when Mandela walked out of prison. South Africa’s downward phase bottomed out and since then it had been accelerating. The country had never had such a sustained period of growth. This represented a “nirvana” for wholesale banking and the expanding economy was welcoming new entrants.

Discussion
Mr Moloto asked if the proposed Government policy to make banks increase their reserves was viable. Would it work and what could be the benefits and drawbacks?

Mr Ballim replied that the reserve requirement could be used to reduce liquidity. As there would be less supply of money banks would lend less and reduce liquidity in the public. Thus, it was a risk mechanism. However, calculating reserves was a complicated process and banks had their own risk mitigation criteria. The reserve requirements were a “clumsy” way of limiting credit to consumers.

Due to time constraints, the meeting adjourned.