Blog 1

Seven things to consider when managing non-renewable natural resources

Degol Hailu, Senior Advisor, UNDP

February 2015

First, knowing the extent of a country's resource wealth is important. Most of the oil, gas and mineral resources in developing countries are yet to be discovered. The geological data is not also complete. Therefore, foreign companies that carry out exploration activities have the geological information before governments do. The resulting knowledge asymmetry creates bargaining asymmetry during negotiation of contracts. As clearly stated by the African Mining Vision, governments need to know their resource wealth ex ante to be able to negotiate as equals and not accept terms that just seem high to them. Hence, supporting initiatives that carry out geological surveys is an imperative.

Second, comprehensive legal and regulatory frameworks must be in place. A number of contracts and mining codes have been revised in recent years. Revisions are made when governments realize, sometimes under pressure from civil society, that tax rates are low, environmental protection laws are weak and re-settlement and compensation schemes are inadequate. As the recent Global Witness report showed, in a number of countries, such as Peru and Guatemala, local communities and indigenous people's are increasingly threatened, sometimes killed, by rapid encroachment into their forests and lands, mainly due to lack of clear property rights. Hence, supporting the drafting of participatory and consultative legislative changes is indispensable.

Third, governments must have the capacity to capture resource rents. The income earned from taxing resource extraction can be low. This is the result of two problems. The first is weak contract negotiating capacity. A popular anecdote sheds some light: at the negotiating table, highly skilled lawyers with years of experience in contract drafting represented the international mining company. In contrast, a divorce lawyer represented the negotiating government of the least-developed country. This is the asymmetry that needs to be broken by capacity development on the one hand and a mindset change by private companies from a purely extractive to a developmental one - by paying due taxes and avoiding transfer pricing schemes, for instance. The second problem relates to the absence of transparency and accountability in the management of revenues on the part of governments. Hence, advocacy must be targeted at encouraging fair contractual terms, open transactions and open budgets. These are important if the resource sector is to be a source of finance for productivity-enhancing social and physical investments needed for achieving the Sustainable Development Goals.

Fourth, domestic skills need to be nurtured. The extractive sector generates little employment. A World Bank report on jobs showed that most employment opportunities are created in the phase of construction and tend to be in low-skill and low-wage occupations. For example, in a large scale LNG project in Papua New Guinea, 9,300 jobs were created at the construction stage and only about 1,000 jobs during production. This is in part to do with capital intensity of the operation. It is also to do with the dearth of workers skilled in geology, engineering, ICT and management. Many countries, such as Mozambique, have taken steps to address these issues by expanding higher education and training institutes in the field. Supporting such initiatives is important for employment generation and incentivizing the establishment of domestic extractive companies.

Fifth, developing an integrated infrastructure is essential. The McKinsey Global Institute estimates that, given global demand for resources, more than US$1.3 trillion of annual total infrastructure investment will be needed until 2030. The investment will be in railways, roads, ports and power generation. The Guinea Simandu project is a case in point. However, there are plenty of cases where the infrastructure is only serving the resource sector. This is the infamous practice of enclave colonial infrastructure development: from the mine, over the rail, direct to the port, shipped out to destinations afar, all powered by a dedicated electricity generating plant. Supporting shared infrastructure development is therefore needed to foster access to markets by the manufacturing and agricultural sectors. For instance, something like the European Energy Union, at sub-regional level, could provide the much needed power supply, promoting the regional integration agenda of Africa.

Sixth, linking the resource sector with the rest of the economy still remains a viable way to stimulate industrial development. This is the well-established concept of economic linkages. First, oil, gas and mineral companies need inputs such as machinery, equipment and supplies for churning out their outputs. Procuring these inputs can be regulated by local content rules. The challenge, however, is the availability of such inputs domestically. Besides, being in conflict with WTO free trade rules, governments can have legal problems when trying to institute local content regulations. Local content rules can be easily met but without fostering domestic production. For instance, some locally registered firms in Liberia import the goods to meet the local content guidelines. At the same time, expecting multinational companies to procure non-existent or sub-standard inputs is unrealistic. The second type of linkage is domestic value addition. This is very much dependent on how developed the domestic industrial sector is and how feasible is it to process domestically. There is another possibility of developing related, but parallel industries. As Ricardo Hausmann noted, the Finnish, endowed with plenty of trees, did not aim to add value to wood and export furniture. Instead, they chose to develop a manufacturing capability to produce the machines (axes and saws) used to cut the trees. These innovations led to learning by doing and further expansion in manufacturing capabilities. Hence, industrial policy that addresses the need for economic linkages is necessary to generate employment and income in the linked domestic enterprises.

Seventh, countries must have a strategy for artisanal and small-scale mining. Compared to large-scale mining operations, the ASM sector creates more jobs. However, the potential for increasing incomes is limited because of the use of rudimentary technologies. The sector can also be a culprit for environmental degradation and social ills. The use of mercury is well known for impacting on health negatively, as well as causing soil and water pollution. The use of child labour is another problem in artisanal mining. The boomtown effect, following discovery of minerals, and the consequent migration can also lead to conflicts. Violent conflict arises as a result of contestation over resources such as water and land. The flourishing of sex work and higher incidence of transmitted diseases are also consequences of sudden influx of miners to an area. These problems could be addressed by supporting the design of ASM strategies and regulatory capacity development.

Building a team of experts with a thorough knowledge of the above issues is crucial to providing effective policy and programme support to the management of non-renewable resources.