Despite the reduced growth outlook, the sector remains promising

The growth of the mining sector, driven by a sharp rise in commodity prices, spurred Peru’s economy to the fastest sustained growth rate in Latin America during much of the past decade. The sector drew in billions of dollars in investment and drove the emergence of a new middle class with levels of disposable income that had never been achieved in Peru.

In recent years mineral extraction itself has accounted for around 5% of Peru’s GDP, according to official statistics. However, some outlets report that mining accounts for 15% of GDP, with the difference perhaps being explained by the inclusion of metal refining and other non-extractive activities. Regardless of the exact figure, the sector’s impact on the economy is much broader.

According to the think tank the Peruvian Economics Institute, every job created by the mining sector leads to the creation of nine jobs in other Peruvian industries that support it. Mining products also account for almost 60% of exports and around a quarter of foreign investment. As a result of the influence the sector has on the wider economy, it is watched carefully as an indicator of Peru’s economic prospects. This has led to some concern recently. As commodity prices have retreated from their historic highs of the past several years, the value of Peru’s mining exports has fallen.

Slowdown

Compounding the problem, production in terms of volume in certain minerals, such as gold, has fallen due to less capital investment, especially by smaller miners unable to operate in a lower-price environment, and the ageing of existing mines. Many planned projects are no longer feasible. Of the portfolio of $60m of planned private mining investment touted by the Ministry of Energy and Mines (Ministerio de Energía y Minas, MINEM), less than half will ultimately be disbursed, says Héctor Collantes, a mining analyst at Credicorp Capital.

These factors contributed to the slowing of Peru’s GDP growth in 2014 to a projected rate of 3.1%, based on a downgrade the Central Bank issued in mid-October 2014. This is compared to rates of between 5% and 9% for much of the past decade. The Central Bank also lowered its outlook on mining growth for 2015 from an estimate of 9% to 6.5%, as mining is not expected to get an immediate boost either in the form of rising production by volume or from commodity prices. The price of copper, for example, is expected to continue its decline into 2015.

However, in 2016 and beyond, several large-scale copper projects are expected to come on-line that could double Peru’s production of the mineral and add as much as 1-2% to the country’s GDP growth. These projects will help to compensate for falling gold production. Mining is also expected to get a boost from zinc, silver and tin, other metals of which Peru has substantial reserves and for which global demand, especially from China, is expected to grow. These factors have led a number of analysts to conclude that the recent slowdown is temporary and that Peruvian mining and GDP growth could, in the medium term, return to the high levels of the recent past.

Reserves

The mining boom in Peru began in 1993 with the start of commercial production at the Yanacocha Mine, today the country’s biggest producer of gold. Other gold discoveries followed throughout the 1990s, drawing in significant sums of foreign investment. Another wave of investment followed the beginning of commercial operations at the Antamina Mine, Peru’s biggest copper mine, in 2001. Since then exploration and investment have turned Peru into the world’s third-largest copper exporter.

For much of the past 20 years gold and copper have together accounted for the vast majority of Peruvian mining output. In 2012, together, they made up 77% of total mining exports. However, as gold production has waned, more attention has been paid to other mineral resources such as zinc, tin, lead, silver and iron, which are expected to factor more significantly in the sector’s outlook. Overall Peru held 10% of the world’s copper reserves, 4% of gold, 17% of silver, 10% of zinc, 8% of lead and 2% of tin in 2013, according to the US Geological Survey.

Lead, Zinc & Tin 

According to Collantes, Peru is well positioned to take advantage of global market dynamics affecting lead, zinc and tin in the coming years. Demand for these minerals is expected to rise in the medium term as consumption and infrastructure development in China continue increasing. In particular, rising mobile phone sales in China will drive demand for lead – used in batteries – and tin, which has applications in nanotechnology and smartphones. For its part, zinc is used, among other things, as an anti-corrosive agent in steel.

Despite the projections of growing demand, international supply of these minerals is limited by a lack of exploration and certain trade policies. Indonesia, for example, took the decision to export only refined tin, which has decreased the supply of concentrate on international markets. This has supported tin prices, lessening the impact of declining production at Peru’s aging tin mines. The production of zinc and lead had also decreased between 2008 and 2011 but have rebounded in recent years.

The effect of lead, zinc and tin on the mining sector should not be overstated. Together they account for between 15% and 20% of Peru’s mining exports in most years, much less than either copper or gold. However, gains in the value of those exports will serve to buoy growth as gold declines.

Falling Gold Production

The production volume of gold, Peru’s second-most important metal in terms of value, has fallen every year since 2009, with the exception of a slight uptick in 2011. This trend has been exacerbated by the decrease in the price of gold since 2012. Gold production is expected to continue declining as few gold projects are under way. Coupled with the fact that multiple large-scale copper projects are afoot (see analysis), gold’s importance to the mining sector and the economy at large should decrease for the foreseeable future.

Peru’s biggest gold mine, Yanacocha, which is majority controlled by American miner Newmont, has seen declines in production and sales in recent years, with net consolidated gold sales falling from $2.2bn in 2012 to $1.5bn in 2013 and production decreasing from 1.3m ounces in 2012 to 1m ounces in 2013. Yanacocha accounted for 21% of Peru’s gold production in 2013. Barrick Misquichilca and Buenaventura, representing 14% and 5%, respectively, of total gold output, have also seen declines. Of the four biggest producers, only Madre de Dios (10% of national production) saw production increase in 2013.

One important gold mine called Chucapaca is presently being developed in Peru. The project was originally forecast to have a total yield of 6m ounces of gold equivalents. In August 2014 South African company Gold Fields sold its 51% stake in Chucapaca to its minority partner, Buenaventura, giving that company complete ownership of the project. The sale price of $81m surprised many observers, as it priced attributable gold resource ounces at $26.2, a lower rate than had been expected. Gold Fields’ stock price fell slightly on the news. Buenaventura explained after the sale that due to technical challenges and lower gold prices, only 2m ounces of gold equivalents were commercially viable, which means that the mine is unlikely to materially impact the country’s total gold production. “MEGA” COPPER PROJECTS: Copper miners in Peru face some of the same challenges as their counterparts producing gold: lower prices and declining production at certain mines. However, the segment is expected to get a significant boost from several large-scale copper projects – often called megaproyectos in Peru – which are under way and projected to come on-line between 2016 and 2017.

With about $1.4m tonnes of production in 2013, Peru was the world’s third-largest copper producer, trailing only Chile and China. By 2017 Peru is poised to surpass China to become the world’s number two producer. If all the large-scale projects come on-line as scheduled, they will more than double Peru’s annual copper output (see analysis). The projects include several backed by Chinese capital, including Las Bambas, Toromocho, El Galeno and Río Blanco, and others backed by American, Australian, Canadian and British investors, including La Granja and Constancia, as well as the expansion of the Cerro Verde Mine.

For the biggest of these expansion projects, annual copper production is expected to increase to as much as 450,000 tonnes at Las Bambas, 400,000 tonnes at La Granja and 300,000 at both Toromocho and Cerro Verde. In 2014 work on Las Bambas, La Granja and Cerro Verde progressed close to the levels planned. Toromocho has also begun production after experiencing delays due to an environmental violation and concerns over the possibility of high arsenic content in the mine’s potential ore.

Copper Production

These large projects will help offset falling production at Peru’s existing mines, some of which are ageing. Antamina, for example, Peru’s biggest copper mine, has seen its ore grade decrease by half. In the year to October 2014 Antamina’s grades were 0.8%, compared to 1.6% in 2013. Total copper production was down 14% year-on-year, with 246,851 tonnes produced through August 2014. According to Reuters, the decrease in production and ore grades is a consequence of the mine operators’ decision to extract the highest quality ore over the course of several recent years when copper prices were at historic highs. In a statement given to Reuters, Antamina said. “We are sure we will be able to reverse [the lower output] in the medium term.”

In addition to affecting the mine’s balance sheet, the lower production figures have also taken a toll on workers whose incomes are partially derived from profit sharing. As of late October 2014, the Antamina labour union was threatening a strike that would shut down the mine’s operations, as they demanded a bonus to compensate for the decreased earnings resulting from the profit-sharing agreement.

Iron Ore

One of the growth sectors of Peruvian mining is iron ore. To date iron ore has been produced at only one mine in Ica, operated by Shougang Hierro Peru, a subsidiary of a Chinese group. From 2008 to 2013 Shougang’s production in Peru increased from 5.2m fine long tonnes (flt) to 6.7m flt. In the same period, the price of iron ore jumped 40%, from $70 per tonne to $98 per tonne. Now Shougang and other miners are investing significant sums to expand iron ore production in the country. For example, Shougang is currently expanding its mine with a $1.5bn investment. Jinzhao Mining Peru, another Chinese company, plans to invest $3.28bn in exploration for its Pampa de Pongo project in Arequipa. Apurimac Ferrum, a firm backed by Australian capital, plans to invest $2.3bn in exploration for the Hierro Apurmací project in Apurimac. Minera Cuervo, a Canadian miner, also has plans to invest in exploration at a concession in Cusco, but no estimate for the value of the investment was available at the time of print.

Social Challenges

As in many Latin American countries, one of the primary obstacles to mining investment and exploration is resistance from local communities. Social movements have stalled various projects, including, most notably, Minas Conga, a $5bn copper and gold project in Cajamarca State. Río Blanco, a $1.5m copper project owned by Zijin, has also faced delays due to community resistance. Protests in Peru against mining are typically couched in terms of environmental protection and resistance to exploitation of the country’s resources by foreigners. Peru’s biodiversity and fragile jungle ecosystems, as well as its history of colonialism, make both of these issues flashpoints.

However, even though a great deal of the rhetoric surrounding the protest movements has to do with environmental concerns, the key to resolving these conflicts has often been based more on extending the economic benefits of mining projects to local communities than on protecting the environment. Collantes, who emphasised that environmental standards must be respected, told OBG, “We believe that the vision from outside the country that the people are primarily concerned about the environment is not accurate. These communities live among and accept illegal mining operations that have serious environmental consequences. What they want from the major miners is a bigger piece of the pie.” This often means guarantees of employment or public works projects underwritten by mining companies.

An additional point of contention is access to water. Images and anecdotal evidence of miners contaminating vital water supplies have sometimes become powerful rallying points for anti-mining movements.

Local Politics

This was the case in 2011 in Cajamarca in the northern Andes when the state’s president led protests against the Minas Conga project, majority-owned by Newmont, an American company based in Denver. The president of Cajamarca State, Gregorio Santos, a far-left politician of the local Social Affirmation Movement (Movimiento de Afirmación Social, MAS) party, mobilised rural communities to protest against the start of construction of the Congas mine. The protests turned violent and ultimately led to Newmont’s decision to stall the project. It has not been formally restarted since then.

In the intervening years, Santos has been arrested and charged with crimes including conspiracy to commit a crime, bribery and collusion in connection with a kickback scheme in which he was allegedly paid to award millions of dollars of public works projects to a local businessman. The businessman, who has also been charged, turned over incriminating videotaped conversations with Santos and evidence of deposits made to Santos’ bank accounts.

In 2014 Santos was sent to prison to await trial scheduled for August 2015. Nevertheless, in regional elections in October 2014 Santos won a second term as president of Cajamarca after MAS ran a campaign that depicted him as a political martyr who was victimised by mining interests and the national government. Two Peruvian outlets reported that rural residents of Cajamarca had been led to believe that a Santos victory in the election would guarantee his release from prison, which is not true. Santos’ vicepresident will serve as president while he is in jail.

Before the election, Newmont had said that it would wait until 2015, after the local elections had taken place, to give guidance about the future of Minas Conga. Two weeks after the election, Yanacocha, Newmont’s Peruvian partner in the project, released a statement in the form of an open letter to the people of Cajamarca, emphasising their continued interest in investing in the state. Anti-mining candidates also won state presidencies in the states of Apurímac, where Las Bambas is located; Puno; and Moquegua, home to the Chucapaca project.

So far in Cajamarca the MAS anti-mining agitation has not been directed at the other projects under way in the state, such as La Granja and El Galeno. Furthermore, the election of a hostile state government does not spell the end of mining in the region. Carlos Gálvez, CFO of Buenaventura, told the Peruvian newspaper El Comercio soon after the election, “To say that mining is gravely threatened is an overreaction. The mining sector has experienced periods such as that of the military dictatorship and terrorism, and it has continued.”

When President Ollanta Humala was asked to comment on the Minas Conga issue he said he supported the project, but added, in an interview to The Wall Street Journal, “For me the people are more important. Conga is trivial in the history of the country.”

Liberal Reforms

In general, Humala has struck a fairly populist tone in his public comments about mining and has been less outwardly supportive of the industry than the centrist and centre-right Peruvian presidents he has succeeded. Nevertheless, despite the political rhetoric and Humala’s left-wing background, in practice he has responded to economic imperatives and continued the growth-minded policies of his predecessors with regard to mining and other economic activities.

Brian Doffing, general manager of Atlas Copco, told OBG, “Though the mining industry has suffered set backs in recent years, the support of projects such as Tia Maria and Cerro Verde shows a willingness from the government to be engaged and work more closely with the private sector.”

In July 2014 Humala’s government took the step of presenting a package of economic reforms that rolled back environmental regulations, eased the tax burden on corporations and provided tax guarantees to big investors. The package of legislation, which was passed with the support of the centre-right opposition, was designed to stimulate mining and hydrocarbons investment to boost the country’s flagging growth rate. Among the package’s pro-business measures were the dismissal of $7.2bn of tax debt and a guarantee of 15 years of tax stability for any projects with capital investment of at least $500m.

With respect to environmental regulations, the legislation greatly restricted the ability of the Ministry of the Environment (Ministerio del Ambiente, MINAM) to levy fines against mining and hydrocarbons companies for violations of environmental codes. These fines were among the strongest enforcement tools available to the ministry. The legislation also shortened to 45 days the period during which MINAM could comment on new environmental impact studies, which must be submitted by firms before they can begin exploration. These environmental measures have been widely decried by local and international NGOs, especially seeing as Lima played host to the Conference of the Parties, better known as COP20, in December 2014, the last major UN climate change conference before the 2015 Paris summit.

Ratings agencies viewed the economic reforms positively. Moody’s called them credit-positive and cited them in its explanation of its upgrade of Peru’s debt to “A3”. The reforms are also favourable to large mining companies currently developing projects in Peru or considering future ones.

Informality & Illegality

As in many developing and resource-rich countries, informal mining costs the Peruvian state millions of dollars every year, degrades the environment and provides a steady stream of funding to criminal organisations. In Peru the problem is as serious as anywhere. Although no official statistics exist, Walter Sánchez, deputy director of promotion at MINEM, told OBG he estimates that 20% of the country’s gold production comes from informal or criminal mines. This figure, which is in line with other estimates, is based in large part on the discrepancies between the gold production that is reported for tax purposes and the amount leaving the country as tabulated by Customs. In terms of sheer volume, unlicensed mining activity is estimated to have surpassed the drug trade in value. The activity is estimated to be worth $2.5bn annually compared to estimated drug trafficking of $2bn.

The government divides unregistered miners into two categories: informal and illegal. Informal miners are those that may hold legitimate mining concessions, but usually do not have environmental licences or pay taxes, whereas illegal miners are those that trespass on mining concessions held by others or operate in regions where mining is prohibited, such as protected jungle zones, areas of urban expansion or sites of archaeological significance. Both categories contribute disproportionately to the environmental degradation caused by mining activity. Many of the unlicensed miners dump mercury and other toxic chemicals in rivers and have contributed to rapid deforestation in the Amazon.

In the Madre de Dios Region in the southeast, a hotbed of illegal mining, annual rates of deforestation tripled between 2008 and 2012, according to a Bloomberg report. These rates have fallen since then as gold prices have declined. Anecdotal evidence suggests that some of the informal miners, many of whom run sophisticated operations with millions of dollars worth of machinery, operate responsibly, however there is no oversight of their activities.

Government Crackdown

Among Humala’s campaign promises were that he would increase tax revenue from mining and slow the environmental damage caused by the sector. An important part of these policies is cracking down on informality. Humala’s government has attacked the problem in two sometimes-contradictory ways: formalising unlicensed miners and shutting down their operations.

In 2012 the government laid out a multi-year process by which informal and illegal miners could earn legal status and continue operating. The process involves obtaining production contracts from the holders of concessions where illegal miners work, registering with the national tax collection agency (Superintendencia Nacional de Aduanas y de Administración Tributaria, known as SUNAT) and obtaining environmental licences.

As of May 2014, 77,000 mining operators and workers had officially declared their intent to participate in the formalisation programme. These miners had until October 9, 2014 to register with SUNAT. At the time of publication, SUNAT had not yet compiled the applications and published the final number of miners who had registered. Once this has occurred, the participating mining operations will begin the process of obtaining the required environmental licences. It is unclear what portion of the informal mining workforce is represented by the 77,000 miners who expressed their intent to formalise. Estimates of the numbers working in the sector range from 100,000 (according to MINEM) to as many as 550,000, according to Miguel Santillana, principal investigator at the Instituto del Perú, a think tank at the Universidad San Martín de Porres in Lima, who is critical of the government’s formalisation efforts.

The government has tried to incentivise these workers, whatever their numbers, to participate in the official formalisation process by stating that there will be no other path to formalisation offered and that mines that do not participate will be shut down and destroyed. This effort has involved raids by land and by helicopter, and the destruction of seized mining equipment with explosives.

The campaign has led to some debate regarding the government’s motivations. Santillana believes that the authorities are going too far in shutting down mines, rather than facilitating their legitimisation. He warns that the raids could provoke social unrest. However, Sánchez told OBG that the government’s goal is to formalise the mines in order to both capture lost royalty revenues and ensure that environmental standards are upheld.

Infrastructure

An additional challenge faced by the mining sector is a deficit in infrastructure. As a result of Peru’s highly decentralised political structure, public spending is largely carried out by state governments that may lack the experience, sophistication and/or political will to invest adequately in infrastructure. According to a report on mining by EY Peru, “In 2013, on average, local and regional governments have spent only 75% of the money available to be spent on infrastructure.” At the current rates of spending, Peru could have an infrastructure deficit of as much as $88bn – 44% of 2013 GDP – by 2021, according to a study by the Association for the Promotion of National Infrastructure.

“The sector infrastructure is starting to become limited compared to the potential growth of the [mining] industry. It is true that the government is taking steps to bridge the gap, but those steps are still very slow,” Edgardo Rivera, general manager of HL Ingenieros, a Colombian company that provides services to miners, told OBG. These steps include the creation by the national government of public-private partnerships for the construction of roads, airports and port expansions. These projects, which began in 2012 with the announcement of concessions worth $10bn, will help to improve Peru’s infrastructure in the short term but will not address the underlying issues of decentralisation and inadequate spending that are creating the infrastructure deficit.

Another increasingly important obstacle to the overall development of the sector is a severe shortage of qualified engineers, geologists and other related specialists. Aside from a major loss of workers via a brain drain to higher-paying countries, particularly Chile and Australia, a large number of employees nearing retirement could exacerbate the problem.

Outlook

Despite the obstacles posed by populism, informality and gaps in infrastructure, the future of mining in Peru is promising. A government that is receptive to foreign investment and relatively stable institutions create an environment in which mining majors can safely make big investments to exploit Peru’s mineral reserves. Specifically, the development of large copper mines will significantly boost growth in the sector and Peru’s economy at large.

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The Report: Peru 2015

Mining chapter from The Report: Peru 2015

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