The Jwaneng Mining Lease: Raising the Rent
September 02, 04 by Chaim Even-Zohar
About a month ago, the 25-year mining lease of the Jwaneng mine expired. Jwaneng is the world’s largest and most profitable mine, producing some $1.4 billion worth of diamonds a year. The mine is operated by Debswana, a 50-50 percent joint venture between the government of Botswana and De Beers. So, effectively, any lease renewal negotiations center on how the total revenue to the government can be increased – if at all. Likewise, De Beers would like Debswana to receive more money, as this would also increase its relative share of revenues. In a back-of-the-envelope cash-flow model that I made it appears that, directly and indirectly, the government is earning some 83%-85% of all profits through taxes, royalties, dividends, etc. That seems like a lot and, ostensibly, there seems little justification for De Beers to settle for less. But things aren’t that simple.
In Botswana, as in most, but not all, resource-rich countries, the mineral rights are vested in the state. Therefore, the state is entitled to the resources’ “economic rent” which basically refers to that part of the value of production that is in excess of the production costs; a fair return on capital of the producer; and a fair profit for the investor’s risks and efforts. An alternative way of looking at economic rent is solely as a reward for the possession of a property. In plain English it means that the government is telling the producer: you are allowed to earn a fair profit, but all the value that is accrued in excess of your costs and profits belong to us. If, theoretically, suddenly the price of diamonds doubled, who would be entitled to a windfall in profits: the privately owned mine or the government of the host country? In Botswana, the government would argue that it belongs to them.
Manufacturers and traders, and everybody else in the diamond pipeline, never face these dilemmas – they buy and sell, and make money (they hope) on the margin. Producer governments face different choices: the diamonds are theirs. Thus it may be worthwhile to keep the diamonds in the ground for exploitation by future generations, it may be worthwhile to reduce production levels to create shortages and get more money for fewer carats – in short, a host of questions come up here. In the case of Botswana, for example, the country is not “hungry” for ever more foreign currency, something which often characterized the behavior of the Russian government.
A successful producer, such as De Beers in Botswana, has considerable leverage. Ore bodies (the diamond bearing kimberlites) in the ground are absolutely worthless until they are discovered, something which requires expensive and skillful prospecting and exploration. Then the full value is only realized if mines and prospecting plants are developed to produce the diamonds. Mining companies with great technical and managerial capacities can operate more efficiently – and this will increase the economic rent to which the government is entitled. The reality in Botswana is such that the chances that the Jwaneng mining lease would be awarded to anyone else but Debswana are virtually zero. So the government has to negotiate a deal with De Beers, knowing full well that it has no option. It must reach an agreement – and it must be with De Beers.
To the outside world, De Beers displays great self-confidence – almost as if this is all business as usual. De Beers’ managing director Gary Ralfe recently noted that “De Beers and the government have always been aware that the lease expired on the 31 July. But I think, as a manifestation of an extraordinary and successful partnership, this has not caused concern. The very fact that we only started substantive discussions four or five weeks ago is a demonstration of that. I can't remember ever concluding any agreement to do with Debswana within the proper timeline. When we renewed the Orapa lease in the mid 1990s, it only took place two years after the expiry of the previous one. I don't think it will be like that this time, but it's to put this into context in a long running and durable partnership between ourselves and government.” When asked what are the issues on the table, Ralfe skilfully avoided a straight answer, saying “because the matter is sub-judice, I am afraid I can't give you any flavour for the details.” That was a few weeks ago.
The President of Botswana, Festus Mogae, is less constrained about sharing his views on the subject. He told reporters in Gaborone that “Botswana is seeking a greater share of income from Jwaneng, the world's biggest diamond mine by value, as it discusses renewing a lease to the mine with De Beers.” To make sure that he was well understood, he restated his intention even more clearly: “We are looking for some improvement in the sharing of benefit," Mogae said. "The resource is ours, which is very important, but the investor is also entitled to a fair return."
It is significant that the President has publicly referred to this issue and that he has made it clear that he is looking for “some improvement in the sharing of benefit”. These are reassuring terms – he didn’t say, we “want substantially more”. He didn’t try to convey a sense of urgency or of tension. That should be viewed as good news. The diamond mining world in the three southern African producer country seems to be in too much turmoil. In Botswana, the marketing arrangements of the diamonds are up for renewal in the next year or so. Ever since the Botswana government hired external consultants to assist it in the negotiations vis-?-vis De Beers, expectations of pending changes were created.
I myself am among those who do believe that there will be changes in Botswana and that what was is not what will be. Jwaneng is extremely important. The mine opened in 1982 and has produced 14.3 million carats out of Botswana’s total production of about 30 million carats. Expressed in today’s prices, this mine has produced some $3.3 billion so far, of which the production costs are but a fraction. So in negotiations, every fraction of a percentage represents real money. So while there is certainly some justification for the uncertainties around Botswana, the changes will be more in the area of domestic value added creation or in the marketing system. It seems that Jwaneng is not held “hostage” to other demands. The Minister of Mines, Boometswe Mokgothu, said earlier this week that he expects talks on Jwaneng to be concluded by December. That is good news. The President has set the tone: the Jwaneng license renewal is not a contentious issue. The president will probably do what he says he will do: and simply raise the rent, somewhat. De Beers is not a tenant that is likely to run away.