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Extractive Industries, Related Benefits and Financial Intermediation in Africa

February 2013

Sigam, C., Iddrissu, D. 2013. Extractive industries, related benefits and financial intermediation in Africa. GREAT Insights, Volume 2, Issue 2. February-March 2013. Maastricht: ECDPM

This article provides an overarching view of the key dynamics shaping extractive industries, distribution of benefits from procurement, financial intermediation and institutional capacity in host African countries. 

The benefits of extractive industries in development are well documented (1). Assuming an appropriate host-country financial infrastructure and a minimum level of development, studies show that extractive activities, through the creation of industry clusters and linkages, can trigger technology spillovers, assist human capital formation, contribute to international trade integration, help create a more competitive business environment and enhance enterprise development, notably through procurement services. These can contribute to higher economic growth, the most potent tool to alleviate poverty in developing countries. 

On average in Africa, the annual capital and operational expenditure of project operators on procurement of capital goods, consumables and services is greater than total contributions to government (2)For example, in 2010, BHP Billiton’s operating costs in Africa (i.e. payments to suppliers and contractors for materials and services) reached USD 3.6 billion, while payments to government amounted to USD 598 million). In the new competitive landscape of waning supply and increasing demand for energy and mineral resources, mining related activities are booming, which then translates into significant procurement spending. As such or in this context, companies in the extractive industries are pressured to find the lowest cost suppliers that can produce the required quality and meet delivery schedules reliably. This therefore represents significant opportunities for local enterprise development in the procurement service sector in Africa.

Challenges to domestic participation

Despite the opportunities, the benefits of extractive industries through procurement services do not accrue automatically and evenly across countries, sectors and local communities. The framework for reforms in the financial sector in Africa can increase the benefits of extractive industrial activities to national economies, particularly when focused on supporting domestic entrepreneurial participation in procurement services. The national financial facilities and infrastructure for procurement and pre-qualification schemes, for instance, are critical for reaping the full benefits from extractive activities for development. 

Since independence in Africa, financing (3) for entrepreneurial development and participation in procurement in extractive industrial activities has been constrained by poor capitalization and infrastructure, limited borrowing experience (no credit bureau and track record), inadequate legal and regulatory framework countries such as Nigeria), collateral issues (moveable assets not considered as collateral and no collateral registry), high transaction costs (similar resources needed to process small loans and large loans) and high borrowing costs due to perceived risks. This financial constraint resulted in the inability of small-and-medium sized enterprises (SMEs) to access funds, because of limited capacity and the financial sector’s low appetite for SMEs. 

The limited access to funds and their higher costs do constitute a comparative disadvantage for local entrepreneurs, who often lack the ability to finance projects, such as procurement activities when awarded contracts. Access to long-term finance is limited and the short-term facilities that may be available in the country generally attract high interest rates. Moreover the cash flow to service these debts often start when the project is completed and performing well, and lenders are usually not prepared to assume the risk of a borrower not being able to complete the project. Consequently borrowers are required to provide guarantees, which commit them to supply additional capital to the project in the event of cost over-run or to pay all or part of the project debt upon failure to attain completion. 

The challenge faced is so prevalent that even relatively mature SMEs rely heavily on their retained earnings or own funds as sources of finance. Figures in Nigeria and Kenya show that as much at 70% of funds are sourced from local supplier’s own funds and a quarter from supplier’s credit. In cases where financial support is successful, the costs are extremely high: small, medium and micro enterprises (SMME) reported 24% to 35% interest rates in Ghana. Expansion is therefore hampered for SMEs having market access, while start-ups are faced with entry barriers. 

Frameworks for reform

The past three decades have seen progressive frameworks for reform in the financial sector across the continent, especially in the countries where the extractive industry represents an important part of domestic production, such as Ghana, Nigeria, South Africa (4) or Angola. These countries have largely increased market capitalization and policies to force trans-national corporations (TNCs) to use local banks and create space for local financing to support domestic procurement of services. In Angola, new financial regulations were introduced in 2011, with the objective to strengthen domestic banking institutions capacities. Under the new banking legislation, companies operating in Angola, are now obliged to use local banking institutions to complete their financial transactions, including payment to third parties such as government taxes, and payment of suppliers or their expatriate workforce, whether based in Angola or abroad. The question is whether this reform will provide more incentives to allow for increased market appetite for SME operating in extractive industries.

Along the same line, in Ghana the “Borrowers and Lenders Act, 2008” introduced the use of movable assets in bank lending and created a collateral registry at the Central Bank. These developments resulted in an increase in the volume of financing for SMEs: some 20,000 loans were registered, accounting for more than USD 800 million in financing secured with movable property since 2010. This also allowed CAL Bank to set up a scheme, the “Purchase Financing Scheme for Gold Mining”, where more than USD10 million was allocated to more than hundred SMEs with not a single Non performing loan (NPL) in the 30 months since program commenced. 

Addressing the performance risks

A downside to these reforms however, is that TNCs are concerned with the performance risks associated with local suppliers. These include risks that the purchase of products might not work efficiently; that the project fails to perform as intended once completed; or failure to meet business requirements. These risks can, in turn, lead to schedule and cost risks if technological problems increase the duration and cost of the project. This is a major area to be considered when pursuing the reform, to ensure the objective of accommodating the domestic banks in the supply chain is useful and sustainable for economic growth.

Countries such as Angola, Ghana and Nigeria have considered developing an extensive supplier programme to address these risks by enabling local suppliers to attain the necessary quality and reliability. Technical, business management, financial support and risk guarantees may all be necessary. The supplier programme implies that TNCs enter into financial agreements to support local companies, including allowing loans at a relative low interest rate, with the contract as guarantee, or providing for more frequent payments in the contracts, to improve the liquidity of local companies.

 
Box: The case of Angola

The gap analysis conducted in Angola in 2003 recognised that one of the major components, as well as the largest constraint to SME growth necessary to promote local companies in conducting business with the oil industry, was “access to finance”. In a bid to increase local participation, government and TNCs have set up the Centro de Apoio Empresarial, an enterprise development centre. Initially, local SMEs were evaluated and provided with training and technical assistance. Successful SMEs were then indexed and certified in a “certified supplier’s directory”, allowing access to market. The programme was further developed in 2010 to help qualified suppliers gain access to finance, vital to execute contracts and critical for growth. By the end of the project more than 1500 Angolan-owned businesses had participated in the programme, 124 were certified as suppliers for the oil industry, 300 contracts were acquired, generating in total, more than USD 214 million and 2700 jobs for Angolans. 

 

But pre-qualification is often so onerous and time consuming that local firms can be discouraged from participating in procurement. The process could be simplified by using different levels of prequalification for different types of contract, or even post-qualification in some circumstances. All prequalification requirements should be clearly communicated in a manner which is readily comprehended by local enterprises.
Another challenge faced by the pre-qualified companies is the delay in responding to the requirements. This could be addressed by centralizing, for a group of local companies pre-qualified, services such as accounting. Furthermore SME are faced with liquidity risks due to the time lag between completion of goods and services and receipt of payments from TNCs. This could be tackled by providing more frequent payments in the contracts.

Conclusion

African countries need the benefits from extractive industries for their development. This requires a strong and stable financial infrastructure that lends support to the domestic entrepreneurs participating in the industry, particularly in the procurement services. The availability of financial services is dependent on the level of maturity of SMEs (unemployed subsistence, start-up, growing and mature) as well as the phase of the project or stage of value chain. Supporting local skills development and supplier marketability can be a key value proposition during negotiation with host governments for new business. Governments need to provide incentives for institutions to finance local SMEs and create an enabling environment for foreign companies to support domestic participation and contribute to the development of a local competitive industrial base. Therefore, frameworks to involve local entrepreneurs in extractive industries and financial sector reforms cannot be mutually exclusive.

Recommendations

National frameworks for reforms should encourage companies to have a long-term vision for local participation. For example, a joint venture (JV) between the lead contractor Fluor Daniel with local partners for the construction of the Cannonball platform in southern Trinidad in 2002 led to a cost premium of USD 10 million. However, after four years, in 2006 the JV engaged the same local firms for the design and fabrication of two new platforms, Mango and Cashima. Thanks to the suppliers’ experience and standardization of the platform, the project saved an estimated USD 11million in design costs. In addition, process improvements reduced fabrication time from 16 months (Cannonball) to 12 months (Mango and Cashima). This JV arrangement is worthy of emulation by African countries.

Furthermore, international and regional financial institutions (5) sources of funding in extractive activities should consider incorporating domestic supplier participation as conditionality in their financing frameworks.

Claudine Sigam is UNCTAD’s Project Officer for Optimization of Natural Resources Management in Africa. Dalila Iddrissu is an intern at UNCTAD.

Footnotes
1. Campbell B. 2009. Mining in Africa: Regulation and Development.
2. Extractive activities in Africa are mostly conducted through Foreign direct investment (FDI). In 2011, total FDI to Africa was USD 43bn and FDI stocks totaled USD 570bn. It is estimated that 90% of those amount went into extractive industries.
3. SME financing includes; leasing, supplier credit, factoring working capital finance, equipment finance, trade finance and mortgage finance. Providers for SME financing include institutional banks, multilateral and regional development banks, venture capitalists, owner funding, informal sources, specialized institutions and larger companies in the industry (usually advances from customers).
4. According to the South African Chamber of Mines, mining expenditure in 2010 was USD 49.4 billion, 92% of which was spent locally. In order to rectify the economic inequalities resulting from the apartheid regime, the government put together a Broad Based Black Economic Empowerment (BEE) Act No. 53 of 2003 which was also included in the Mining Charter. The Charter was established to increase Historically Disadvantaged South Africans (HDSA) participation, including ownership in the mining industry. An assessment in 2009 by the Department of Mines in South Africa showed that 89% of companies have not given HDSA companies preferred supplier status. Only 8.9% of local assets were owned by HDSA, well below the target of 15% by 2007. This was due to ambiguity and misinterpretations which resulted in appalling levels of non-compliance.
5. Iddrissu D. 2012. The financing of gas commercialization projects in developing countries: A comparative analysis of bilateral and multilateral funding assistance.

References

– Extractive Industries & local economic development, Incentivising Innovation by Lead Contractors through Contract Tendering Levers  & Pulleys, Briefing note 3
– Maximizing development of local content accross industry sector in emerging markets http://csis.org/files/publication/120517_Levett_LocalContentDevel_web.pdf
– Increasing Local procurement by the mining industry in West Africa, The World Bank, 2012
– The role of extractive industries in expanding economic opportunities: Holy Wise and Sokol Shtylla, Harvard Kennedy School of Government, 2007
– Commercial Value From Sustainable Local Benefits in the Extractive Industries:
– Local Content , Michael Hackenbruch, Jessica Davis Pluess, 2011 redress fairness
– Local Content in Procurement: Creating Local Jobs and Competitive Domestic Industries in Supply Chains, Michael Warner, 2011

This article was published in Great Insights Volume 2, Issue 2 (February-March 2013)

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Economic Transformation and TradeExtractive SectorsAfrica

External authors

Claudine Sigam

Dalila Iddrissu