Introduction
Last week I had indicated today’s column would continue to discuss potential pitfalls arising from Guyana’s heavy dependence on extractive export industries, and the likely deepening of this dependence in the coming time of oil and gas production and export.
In this regard earlier columns have addressed the traditional triumvirate of extractive mineral sub-sectors (bauxite, gold and diamond), which have constituted the core of Guyana’s mineral wealth. Following this, my intention was to start considering forestry (the leading non-mineral extractive sub-sector) this week. I have deferred this until next week because I recently came across an IDB 2015 publication (Policy Brief) that is so strongly bullish on the prospects for bauxite in Guyana and Caricom, that I believe this should be brought to the earliest attention of readers.
The publication is entitled: ‘Caribbean Economic Alchemy: Has Magic Returned to Bauxite?’ by Sarosh R Khan. Its Abstract posits: “After a long period of stagnating prices, global bauxite marketing is experiencing changes which are expected to drive prices higher”. These changes are portrayed as a function of 1) increasing Chinese demand, and 2) recent policy constraints, placed on the exports of two major bauxite exporters: Indonesia and India. The Brief argues that the confluence of these two circumstances, “presents an opportunity for Caribbean bauxite exporters to increase their share of a growing global market.” The remainder of the column identifies the key elements of this proposition.
Global demand
As regards global bauxite demand, the Policy Brief has highlighted several key features of the market: First, bauxite remains the only viable economic, if not technical, source for producing primary aluminium. The production function requires four tons of mined bauxite for each ton of aluminium. Second, technical market relations indicate aluminium prices are strongly correlated with bauxite prices. The key variable affecting this strong correlation, is prevailing levels of inventory holdings of these materials. Third, close analysis of trends in world prices has led to the identification of 1) the threshold for aluminium profitability, and 2) the point at which the marginal revenue of bauxite production exceeds its marginal cost. Fourth, recent price behaviour, for both bauxite and aluminium, has been very encouraging; the minimum incentive threshold for bauxite production has been fixed at US$42 per tonne. Fifth, analysis of the “intermediate alumina market”, over the medium-to-long-term (which Guyana no longer produces), confirms this favourable trend.
The Brief also indicates: “bauxite as a raw material that feeds more profitable downstream activities … has a naturally complex market structure”. This complexity arises because 1) substantial bauxite extraction occurs in separate geographic areas from aluminium production; and 2) both bauxite extraction and aluminium production are highly capital intensive. This latter generates significant scale economies in the industries, and barriers to new entrants.
Finally, the Brief interprets recent global bauxite consumption as being largely driven by China. Further, it confidently expects China’s imports to rise over the medium-to-long-term; despite the fact that it is the world’s second largest producer of mined bauxite!
Global supply
On the supply side of the relation, the Brief highlights several features. To begin with, empirical data show bauxite extraction, aluminium production, and intermediate alumina refining, are primarily driven by cost considerations. This is to be expected, given the capital intensity of these industries, which puts scale economies and barriers to new entrants at the centre of their operations. These effects are starkly revealed in their predominant oligopolistic market structures.
Two critical variables shape bauxite production, namely, energy prices and geo-politics. Arising from this, the Brief observes: “once developed, the bauxite-aluminum supply value chain is not easily changed”. And, more importantly, while presently global production of bauxite is encouraging, it is still not keeping pace with global demand!
The IDB Brief notes two recent policy decisions, which strongly favour Caricom. One is that, in 2014, Indonesia restricted raw bauxite exports seeking to encourage domestic producers to undertake further processing. And, in the same year, India doubled the export duty on bauxite, with the same intention. The Brief bluntly asserts that such actions increase the potential for the Region to increase its share of the bauxite market.
Caricom’s bauxite
While once a significant source of global bauxite supply, Caricom presently produces only about 6 per cent of global supply; Jamaica produces about 3.6 per cent, Suriname 1.3 per cent; and Guyana about 1 per cent. Caricom’s global market share, however, is significantly down from 9 per cent in 2008.
The Brief goes on to conclude that, a combination of 1) weak multinational mining companies operating in the Region; 2) price stagnation, after the Great Recession of 2008; 3) rising extraction, transport, and energy costs; and 4) real appreciation of regional effective exchange rates, have led to this decline, but there is now an opportunity for a regional “turnaround”.
Conclusion: Turnaround
Several proposals have been advanced for achieving this, including 1) regional cooperation to advance higher margin (more profitable) downstream activities; 2) deliberately diversifying the mix of multinationals operating in the sector, for competitive/innovative reasons; 3) emphasizing risk reduction through actions like those suggested at 2, and seeking “to repackage existing mining contracts into multiparty public-private partnership (PPP)”.
In the above processes the IDB is offering to help. In this regard it recommends that, national and regional task forces should be established as catalyzing/change agents. I strongly agree, and endorse the view that the IDB should play a “lead” role in the regional revisiting of its bauxite industry. This revisit/repacking should focus on 1) reviewing existing mining contracts; 2) promoting the “multi-party public-private partnerships (PPPs)” identified above; 3) compensating for weak institutional/technical/legal capacities in state-owned bauxite operations; as well as, operational concerns such as risk allocation between parties and public procurement. The Brief even “offers” IDB help in coping with public resistance to these changes!
