Ecuador Mining: Turning the Corner

Ecuador currently has gold reserves amounting to 36.9 million ounces, currently worth close to $60.2 billion.

LBC SPECIAL

Analytica

It’s been a long, troubled slog for President  Rafael Correa’s bid to put Ecuador on the global mining industry map. Populism hasn’t worked in  swaying grassroots – particularly indigenous – resistance to major mining projects anywhere in the  country. Neither has he actually been able to sign  exploration and production contracts, amid a moratorium on new mining projects decreed in  2008 and government indecision on mining  regulations, despite a new mining law from 2009.

But Dynasty Metals, a Canadian company, in August 2010 managed to ship the first 2,400 ounces of gold from its mine near Zaruma. And for large-scale projects, agreement finally appears to be just around the corner: Canadian miner Kinross [on December 5, 2011] announced that it had resolved most of the pending issues with the administration for its Fruta  del Norte gold mine project. This opens the door for major production and may well close the gap in  Andean and Amazon-fringe mining areas between Colombia and Peru.

Ecuador’s current regulatory environment demands higher taxes than compared with many  other major mining countries given that the constitution mandates that “at least 50 percent” of  earnings be taxed in some form. This however includes the 15 percent distribution of profits to workers mandatory for all companies in the country, which has been applied without major issues in other industries including oil. Factoring that out, the taxes – including the soon-to-be 22 percent corporate income tax – become competitive.

In the case of Fruta del Norte, the government expects to collect 52 percent of the income the project generates, including the 22 percent income tax, once the project starts producing in 2014. The two sides compromised on royalties, which will range from 5 percent to 8 percent, depending on the price of gold: 5 percent for the price of gold equal to or less than $1,200 per ounce; 6 percent between $1,201 and $1,600; 7 percent between $1,601 and $2,000; and 8 percent above 2,001.

The contract’s price of gold will be determined by the market price when the contract is finally signed. Should it rise, a 70 percent windfall tax will be charged on the difference to the contracted price. Thus, the contract will be similar to the production sharing agreements with oil companies the administration scrapped in 2010.

Like the latest oil contracts, arbitration will go ahead internationally under the United Nations Commission on International Trade Law, which are tougher for sued parties than the World Bank-based International Center for Settlement of Investment Disputes (ICSID). Ecuador has left the ICSID under Correa, alleging a pro-industry bias by the court.

The Fruta del Norte project, bought from Aurelian Resources in September 2008, is located in hilly tropical rainforest in Ecuador’s southernmost Amazon province, Zamora Chinchipe. It expects to produce 6.3 million ounces of gold and 6.7 million ounces of silver over the mine’s 16-year lifetime.

Overall, Ecuador currently has gold reserves amounting to 36.9 million ounces, currently worth close to $60.22 billion. It also estimates reserves of 72.4 million ounces of silver, 8.1 million tons of copper, 28,471 tons of lead, and 209,649 tons of zinc, among other metals and minerals. To exploit them, the government expects $37 billion in investment over the coming 20 years. Only 44 percent of the country’s 272,046 square kilometers of territory have been explored, so significant additional deposits may yet be discovered.

According to the government, contract negotiations with Chinese-owned Ecuacorriente,International Minerals, and Iamgold are at an advanced stage. Together with Fruta del Norte, these companies’ projects will lead to around $5.1 billion in investments. The government has also managed to set a precedent by charging for royalties in advance. It wants $200 million for the initial projects, likely to cushion the treasury’s liquidity, and Kinross has pledged to pay $65 million. For producers, the current market environment probably makes the expenditure palatable, although there is a risk of future governments demanding additional payments.

Kinross said that several issues remain before the deal is finally signed, including “the completion and approval of the project feasibility study by Kinross; a change in project status from economic evaluation to exploitation in accordance with Ecuadorian law; and … entering into definitive exploitation and investment protection agreements.” Oil Minister Wilson Pastor said these issues should be resolved in coming weeks.

While further delays would be unsurprising, Chilean state copper giant Codelco has announced its intent to explore four properties, and other major companies are interested in entering the market. The government also wants to tender deposits in the Intag valley, according to Pastor, although opposition to mining runs strongly there.

Many Ecuadorian environmentalists decry mining as a threat to the sensitive habitats. The Conaie, the indigenous umbrella organization, and its more radical Amazon Confeniae subsidiary, are particularly opposed. The government is seeking to defuse conflicts by emphasizing redistribution of land through legislation. Vehement protests are however likely in Azuay and Imbabura in the Andes as well as Morona Santiago and Zamora Chinchipe in the Amazon. A taste of this was the 4 a.m. verbal dispute on November 26 between Correa and Salvador Quishpe, the opposition prefect of that province. The issue risks provoking many more public incidents on the 2013 campaign trail.

This commentary originally appeared in Ecuador Weekly Report published by Analytica. Republished with permission.