Joëlle Rizk

Managing Consultant at Revolve. She has worked on regional cooperation and natural resources development in Afghanistan since 2009

23 February 2014

energy Feature

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Afghanistan’s Extractive Industry
23 February 2014
Joëlle Rizk | Managing Consultant at Revolve. She has worked on regional cooperation and natural resources development in Afghanistan since 2009

energy Feature by RevolveTeam

Extracting Afghanistan’s minerals is believed by many to be the gateway to economic prosperity in Afghanistan and to economic connectivity in Central Asia. Developing Afghanistan’s mining into a regional Resource Corridor is a major task ahead for the Afghan government. There are many governance, security and political challenges, and the extractive industry is still far from maturing. However, Afghanistan has made remarkable progress, and continues the process of building an enabling environment for Direct Foreign Investment. Is Afghanistan ready to become an international mining nation? Will Afghanistan re-invest mining revenues in its population and sustain its economy?

$1 trillion worth of undeveloped mineral resources: this figure has become a common reference to describing the potential of Afghanistan’s extractive industry. Referring to Soviet maps that were saved and preserved by Afghan geologists, the United States Geological Survey (USGS) team surveyed Afghanistan between 2004 and 2007 to map its mineral potentials. Data collection and site exploration were simultaneously done by both British and Afghan Geological Surveys. It then became clear that Afghanistan’s mineral riches are far beyond what the Survey was initially assessing. In 2010, while the world was desperate to hear good news from Afghanistan, the figures were published, which appeared to be an economic bonanza for Afghanistan. Then, in the midst of the hype about the transition process and worries about the economic future of Afghanistan once foreign troops withdraw by 2014 and international aid declines, the mining sector emerged as the solution to ensuring stability and economic growth in the country.

The Good Old News from Afghanistan

Mining has been taking place in Afghanistan for thousands of years – whether it was gold, copper, iron or lapis lazuli, emerald and tourmaline. For centuries, Afghanistan has been known as a mineral rich country with vast exploitable resources. Alexander the Great, the British, the Soviets and the Taliban all tried to tap into Afghan natural resources. Shortly after U.S. officials tagged Afghanistan’s minerals with a $1trillion value, the Afghan Minister of Mines, Wahidullah Shahrani, tripled that with an estimate of $3trillion. With the support of the World Bank, Afghanistan is keen to develop a “Resource Corridor” whereby investment will be multi- sectorial. This would induce growth of extractive activities and develop infrastructure, services, trade and agriculture, thus boosting Afghanistan’s domestic revenue. While data is not clear as to precise projections, estimates are that net revenue earning potential from extractives could reach $1billion by 2017 and contribute 2-3% of the GDP.

For more Rare Earth read Revolve#6:

Afghanistan’s minerals and to updating some of the existing data, the USGS and the U.S. Army Task Force for Business Stability Operations (TFBSO) have conducted on-site explorations on major mineral sites across Afghanistan. Significant deposits of Rare Earth Elements (REEs)* and uranium were identified in the Khanneshin carbonatite deposit of the Helmand province in southern Afghanistan, no less than 4.8 million tons (USGS, 2007). This site is estimated to hold as much as 218 million tons of Light Rare Earth Elements (LREE) grading 2.77% and 15 million tons grading 3.28% (MoM, 2012). It is also believed that Afghanistan has world class reserves of lithium, estimated at 350,000 tons (MoM, 2012), which can possibly bring Afghanistan to the forefront of mining nations.

Not Another Saudi Arabia

The figures estimating the total value of Afghanistan’s mineral and hydrocarbon resources are only theoretical. They are mostly a lip service that shapes public opinion and promotes political agendas, but are hardly useful to actually attract foreign investment and generate growth policies. The real value of the resources can only be assured after on-site explorations, and they remain subject to global market prices fluctuations, extraction, transportation costs as well as social and environmental feasibility.

Afghanistan is indeed rich with mineral resources that are worth trillions of dollars, yet these resources are still underground. The data that is currently available represents gross value of estimated potentials for extraction. The real value of these resources is the net value of production, which for most resources is not available, as they are currently undeveloped.

Developing Afghanistan’s extractive industry is starting from scratch; thus, there will be significant challenges involved. Afghanistan is landlocked and has a high-risk investment environment. Its internal transport sector and infrastructure are not competent. The required infrastructure for the development of the industry is often missing – roads and railways, power generation and water availability, a secure investment environment, and regional infrastructure. The net value of Afghanistan’s resources will drop significantly, after deducting the gross value, the costs associated with extraction, production, processing, transportation and shipping.

Additionally, the variety of commodities in Afghanistan’s minerals, while perceived as richness, does not actually help reduce production costs. There will be an array of varied requirements among minerals: specialized man-power, extraction methods, processing, storage facilities and transportation, which could multiply the costs.

Based on rough calculations of gross value and estimated production rates, some experts conclude that in the case of Afghanistan, where hard and soft mining infrastructure is lacking, the net value of an extractive project might not exceed 4% of the gross value of its undeveloped mineral resources (Lipow & Melese, 2012). It is then important to realize that even an optimistic development of Afghanistan’s extractive industry might only have a moderate economic output: the boom is expected to generate 120,000 jobs at best – the World Bank estimates no more than 20,000 jobs for currently known deposits. For a population of over 30 million with an unemployment rate of 35%, this figure, despite being positive, is very modest.

In the case of Afghanistan, the net value of an extractive project might not exceed 4% of the gross value of its undeveloped mineral resources.

However, projected revenues should not only be counted as direct fiscal benefits of corporate tax revenues and royalties, but should also consider indirect revenues due to direct fiscal investment of foreign companies. Foreign aid has mostly found its way out of Afghanistan since 2001 and was largely consecrated for security and reconstruction. In contrast, Foreign Direct Investment presents fixed investments into the economy and generates long-term fiscal and economic growth.

These figures are not constant. Afghanistan was mapped to identify its mineral resources, yet much further exploration is needed. Geologists agree that there is serious potential for much larger volumes of existing resources, and more intensive explorations will certainly lead to new discoveries.

Looking Beyond the Figures

The gross estimated value of Afghanistan’s resources is speculative, given the unstable global commodity prices such as copper and iron and their vulnerability to international political economy and financial stability. Yet, that does not make them any less important.

There is an opportunity, again, for Afghanistan that should not be lost. The geopolitical facts in the region are different now than they were in the 1960s-80s when these discovered resources remained untapped. Regional geopolitics is certainly more open and enabling for an economic renaissance in Afghanistan than they used to be. Afghanistan now has the backing of the international community, committed to secure its transition to a prosperous and stable economy. The facts are just right for Afghanistan to emerge as the regional economic bridge between Central and South Asia, as well as with neighboring resource-hungry China. It is now more feasible to export and transport Afghanistan’s resources than it would have been in the 1970s-80s. Developing Afghanistan’s Resource Corridor will only bring further growth opportunities to the region and will respond to more regional needs.

“Roughly twice as many countries have been blessed by resource booms as coursed by them”

Heber & Menaldo, 2010.

Serious worries persist that Afghanistan may fall victim of its own natural resources. Afghanistan is no stranger to corruption, human rights and environmental abuses. The country remains worn between warlordism and internal power rivalries at the national level. At the local level, inter-communal clashes persist between ethnic groups, warlords and tribes. Weak public and judicial institutions in such an environment are typical for a “resource curse” scenario.

“Roughly twice as many countries have been blessed by resource booms as cursed by them” (Heber & Menaldo, 2010). A realistic scenario for Afghanistan is one where the extraction of its natural resources will directly generate wealth for the economic and political elite as well as for the central state. Due to the development of its soft and its hard infrastructure, doing business in Afghanistan will become more feasible and the service sector will eventually emerge alongside.

The purchasing power of a growing middle class will be higher. Economic growth will be made possible in parallel with upstream and downstream extractive investments. While signs of anti- corruption measures will be witnessed, these developments will not put an end to corruption nor to warlordism. However, they will contribute to the stabilization of Afghanistan and the legitimization of its government towards its population and its region. Given the important role of warlords and government leaders in accessing power and maintaining stability, a realistic scenario to be expected in Afghanistan is a benefit-sharing model of co-insurance based on economic quotas.

Promoting a resource corridor around the development of its extractive industry is not a panacea; yet, properly developing the extractive industry is necessary with the right factors in place for sustainable development in Afghanistan.While the time does not look right with many political and security concerns ahead, the time is also exactly right to avoid a self-fulfilling prophecy of failure in Afghanistan and ensure the transition into the Transformation Decade (2014-2024) with sound international support.

Unlocking Foreign Investment

Afghanistan has the potential to attract $10 billion in foreign investment for the next decade (World Bank, 2013) but would not be the first country where geopolitics and local governance put international investors at disadvantage. The discovery of mineral resources is not all that is required to boost the extractive industry and the mining sec- tor, let alone developing it into a resource corridor. Bolivia, for instance, is referred to as the Saudi Arabia of lithium, and still, due to economic and political reasons, international investors do not develop its mining sector – despite increasing demand for lithium on the global market. This is largely due to local restrictions related to the social- political system and the fact that the extractive industry will be state-owned. In other words, there is no enabling environment that would attract international investment

All images: Mes Aynak copper mining, Afghanistan, May 2013. Source: Afghanistan Geological Survey.
Mes Aynak (“little copper well”) is a site 25 miles (40 km) southeast of Kabul, Afghanistan, located in a barren region of Logar Province. The site contains the world’s second largest copper deposit, as well as the remains of an ancient settlement with over 400 Buddha statues, stupas and a 100-acre (40 ha) monastery complex. It is also considered a major transit route for insurgents coming from Pakistan. Archaeologists are only beginning to find remnants of an older 5,000-year-old Bronze Age site beneath the Buddhist level including an ancient copper smelter. The Buddhist ruins were scheduled to be destroyed at the end of July 2012, but for several reasons, including political instability, this has been delayed, possibly until the end of 2014. (Wikipedia)

International and multinational companies – normally referred to as “western” in the case of Afghanistan – have been hesitant to invest or explore investment opportunities in Afghanistan’s extractive industry. Western governments have also not actively sought the mobilization of the multinationals and the global players to invest in Afghanistan. This disinterest is largely due to accumulative perceptions of instability and high risk in Afghanistan: 1) the hype about the risk of collapse of the Afghan economy, potential civil war and a Taliban take over as of 2014 when foreign troops withdraw, military expenditures and aid decline – and all the security risks implied; 2) the absence of infrastructure – roads, rail links, power and water supplies – and the inevitable geographic dependence of Afghanistan on its neighbors for supply routes and export of extracted material; and 3) rampant corruption and weak legal and fiscal regimes that hinder the business environment in Afghanistan.

Afghanistan is a challenging place to do business. Institutions are just beginning to find firm footing; there are ongoing security challenges which can seem to create an uninviting environment. Mining companies often wait until the industry matures to make meaningful investments. We were willing to deploy capital immediately for minerals exploration and also for service businesses that are supporting general sector development – we believe the sector will evolve very rapidly. The sector’s growth is dependent on a number of different dynamics, however and this point, time is a critical one. To maintain the interest of highly qualified investors that will introduce best-practice approach, that understand through experience how to optimize extraction of natural resources and who will undertake significant risk under appropriate circumstances – there must be a healthy relationship between the private and public sector. Afghanistan is in the process of introducing a well-developed, investor-friendly mineral-law and fiscal regime. This will be crucial for the development of the Afghan economy. No sector offers the same economic multiplier effect or the ability to generate fiscal receipts in the way the mining sector can. Whether Afghanistan capitalizes on its resources will be determined by our ability to bring in large-scale investment and mobilize capital soon enough.

These factors create an environment of severe lack of trust in the Afghan market and the capacity of the Afghan government to lead a productive industry that will transform its economy. The government of Afghanistan and the international community will need to prioritize infrastructure development, legislation, a sound fiscal system and reliable services, particularly financing and insurance.

Contract Realism, a Lasting Challenge

Only a few years ago, the Afghan government and particularly the Ministry of Mines lacked competence, a strategic policy, and a basic business plan. The ministry was unfamiliar with mining procedures and procurement. In 2006, when the World Bank granted the ministry $30 million to develop regulatory and commercial capacity, the ministry started playing a more active role in economic development. Since then various steps towards modernization and reform have been taken. The implementation of the Extractive Industry Transparency Initiative in 2010, and other confidence-building and transparency steps such as the shut- down of the ministry’s independent bank accounts, the publishing of hundreds of contracts as well as the minister’s and the president’s commitment to work towards full transparency, and reforming the Mining Law. The ministry has also been moderately responsive to civil society watch- dog roles, and to lessons learned from previous and ongoing practices.

Since 2006, the Ministry of Mines has been rapidly developing its sector. Hundreds of contracts have been issued. Hundreds of small scale gold, coal, salt and construction material operations have been formalized. In 2007, the China Metallurgical Group Corporation (MCC), owned 44% by the Chinese government, was awarded the largest contract in Afghanistan’s history to develop the Aynak copper deposit for a period of 30 years, renewable. Following Aynak, in 2011, China National Petroleum Corporation was awarded rights to three of the Amu Darya Oil blocks; in 2013 the Hajigag $1.8 billion Iron Ore deposit was awarded 75% to an Indian consortium led by state-owned Steel Authority of India, and 25% to the Canadian Kilo Goldmines.

Other medium scale operations, mainly copper and gold have been awarded to Turkish, Afghan, Arab and European companies. Later in 2013, oil rights of the Afghan-Tajik tender, the largest Afghan oil tender, will be awarded. In the past 6 years, the progress and reforms made by Afghanistan are remarkable.

Along with this progress comes a rush to develop the extractive industry. While the Afghan government is determined not to miss out on its opportunity, it has fell in traps of premature tender process development and contracts. Several setbacks have been reported, but the most illustrative is related to the failure of implementing the Mes Aynak copper contract. “The Aynak tender process progressed more quickly than did the Afghan Government and institutional development needed to support the tender” (Yaeger, 2010). As a result, production that was supposed to start this year is delayed until further notice. Reasons for the delays are attributed to the demining process of the site and archaeological excavations of ancient Buddhist sites believed to have been related to copper mining. However, speculations in Kabul are that the delays are related to political events before 2014. Geologists say that the site requires at least 3 years of construction prior to production.

However, there are rumours about a contract renegotiation that would entail serious setbacks, including: transportation of copper ore outside Afghanistan and thus backing off on the 400MW power plant; dropping off pending bonus payments; reducing royalties and the size of investments; and delaying the production date by refusing to build the North-East rail- way. The challenge is that Afghanistan wants to rush into securing domestic revenue generation before 2014. The world is watching Mes Aynak, where developments will have a big influence on the perceived stability of Afghanistan’s mining sector. Inflated scenarios and expectations can seriously hinder the development process.

Converting Revenue into Capital Investment

While altered between tales of transformational revelations that the extractive industry can bring to Afghanistan, and stories of a resource curse that can drive Afghanistan back to conflict and warlordism, the reality is much more settled. The extractive industry alone will never bring Afghanistan to self-sufficiency nor transform it into a modern economy. Investments will take over a decade to mature, but the benefits and positive impacts can be collected early in the process. There are experiences where extractive revenues were transformed to improve living standards, build physical infrastructure and sustainable economies. The test is the capitalization on the extractive revenues. Will Afghanistan re-invest in its population building capacities to sustain its economy? Or will it prioritize military spending? Will the government develop services and alleviate poverty?

Afghanistan will probably see large profits from small- and medium-scale mines. Further developments will remain subject to new discoveries and further explorations and data update. The government of Afghanistan will realize the need for a staged approach, developing upstream and downstream industries, and maximizing infrastructure for the benefit of other sectors. Hydrocarbons will generate revenues in the short-term; and copper, iron and gold on the medium run. The government plans to announce tenders of rare earth and industrial minerals such as lithium and uranium in a medium turn. Yet, with lessons learned from current mining rights, Afghanistan will need to allow its mining sector to mature, and its capacities to develop, particularly in terms of technology transfer and environmental safety. It is equally important to address the thousands of illegal mines by creating incentives to legalize and generate formal revenues; the government will need to be presented as the solution to modernization and profit maximization.