Expropriation: A Growing Threat to the Mining Industry?

The threat of expropriation — the seizing of assets belonging to a public or private company by a government — is an ongoing risk to mining firms worldwide.

That fact was driven home in July 2012, when the government of leftist Bolivian president Evo Morales took control of Canadian miner South American Silver’s (TSX:SAS) Malku Khota silver-indium deposit in central Bolivia.

“The situation just escalated very quickly,” the company’s president and CEO, Greg Johnson, told The Globe and Mail. “It suddenly appeared to go to a national political level and the company was not involved and really shocked to see it take the path it did in such a rapid succession.”

Rising anger prompted the nationalization of Malku Khota

South American Silver’s story also emphasizes that an open approach to the local populace sometimes isn’t enough for a company to secure a claim to a property when it’s working in a politically unstable country like Bolivia.

According to Johnson, South American worked hard to secure the approval of 46 indigenous groups living near the site, eventually bringing 43 onboard. But the remaining three, which were conducting artisanal mining on the property, continued to oppose the project.

That prompted protests that led to the government’s involvement, including clashes in which one person was killed and hostages were taken. In response — or perhaps sensing an opportunity to take advantage of rising public anger directed toward South American Silver — Morales announced plans to nationalize the mine on July 10.

The move devastated the company’s share price, which fell from $1.02 on July 6 to just $0.37 by July 11. It’s now trading around $0.43 as investors wait to see how, or if, the company will be compensated.

Malku Khota is a rich target: it contains an indicated NI 43-101 compliant resource of 230.3 million ounces of silver and 1,481 tonnes of indium, along with an inferred 140 million ounces of silver and 935 tonnes of indium. Indium is used in liquid crystal displays and touchscreens. The rising popularity of mobile devices has significantly improved its value and its longer-term prospects.

Bolivia is one of the world’s least friendly mining countries — but it has lots of company

Expropriation is just one more obstacle to foreign investment in Bolivia, which ranked 153rd of 183 nations in the World Bank’s latest ease of doing business index.

South American Silver’s mine is just the latest in a string of nationalizations in the country. Shortly after Morales came to power in 2006, he nationalized Bolivia’s natural gas industry, followed by its largest telecommunications firm in 2008.

In May, just before the Malku Khota situation flared up, he seized the assets of the Spanish company that runs much of Bolivia’s power grid. In June, he turned his sights on Glencore’s (LSE:GLEN) Colquiri tin–zinc mine.

“Bolivia has shown it’s not open for business,” said National Bank Financial analyst Paolo Lustritto.

Bolivia and Venezuela follow the same playbook

Still, Bolivia is far from alone among the serial expropriators. Hugo Chavez, president of Venezuela (number 177 on the ease of doing business index), has reportedly seized 988 companies since 2002, according to Conindustria, a Venezuelan industry chamber.

Last year, Chavez nationalized the country’s gold industry. At the time, the only significant foreign miner operating in Venezuela was Russia-based Rusoro Mining (TSXV:RML), which has two producing mines in the country, along with 10 exploration properties.

There are parallels between Rusoro’s experience and that of South American Silver. Both companies felt they had built strong relationships with the government and local officials. In addition, like Morales, Chavez cited unrest as a reason for his decision. On Venezuelan state TV, he said, “I’m going to approve a law to begin taking the gold areas, and there I count on (the military) because there continues to be anarchy, mafias, smuggling.”

In addition, like South American Silver, the seizure sent Rusoro’s stock tumbling: it dropped 16.7 percent on the day the announcement was made, according to Mining.com.

Rusoro is now seeking compensation for its lost projects and has filed a claim against the Venezuelan government with the World Bank’s International Centre for Settlement of Investment Disputes, a body that Chavez says Venezuela will pull out of.

“We tried to find an amicable solution, but we never heard anything from the government, so then we decided to file the arbitration,” Andre Agapov, Rusoro’s president and CEO, told Reuters. “We lost it all. We don’t understand the situation now. We have no operations in Venezuela.”

First Quantum ran into big trouble in the Congo

The Democratic Republic of the Congo (number 178 on the ease of doing business index) was recently the site of another high-profile expropriation case that angered many in the mining community.

At the center of the storm was First Quantum Minerals (TSX:FM,LSE:FQM), which saw its Frontier and Lonshi copper mines and its Kolwezi tailings project seized by the Congolese government in 2009 and 2010. The story instantly grabbed attention because of the size of the operations: Frontier was First Quantum’s flagship project, and the company claimed to be the country’s largest taxpayer.

Then, to add to the outrage of First Quantum’s shareholders, the government sold a controlling stake in Kolwezi to Eurasian Natural Resources (LSE:ENRC) for $175 million in 2010. The situation prompted First Quantum to file $4 billion of claims against ENRC and the Congolese government at various international courts and tribunals.

Earlier this year, however, the company surprised many when it agreed to a $1.25 billion settlement that grants ENRC the rights to all the First Quantum assets in the Congo that ENRC doesn’t already own. First Quantum clearly felt that it was better to end the matter than carry on the fight — likely for years to come.

“It is not a standard transaction,” First Quantum president Clive Newall was quoted as saying in the Financial Times. “We’re not selling something we clearly own. We believe we still own it, but it is unclear if we do.”

Weaker resource prices may help curb resource nationalism

As with illegal mining, the threat of expropriation is often a risk miners face when they operate in politically unstable countries. If you’re looking to minimize risks like these, it’s important to focus your resource investments on companies that operate in more developed nations where the law is respected.

Still, some mining executives see signs that resource nationalism, including rising mining taxes, more restrictive government regulations and, at the extreme end, outright expropriation, could be slowing. That’s partly because weaker resource prices are letting companies be choosier about where they build new mines.

“Natural resources companies with a pipeline of, say, five projects in five different countries are now likely to build just two or three of those,” stated Financial Times commodities editor Javier Blas. “Thus, executives have the power to cherry pick which combination of country and project offers the best returns.”

Still, even if this trend holds, it won’t protect existing mines from the threat of expropriation. Nor will it provide any guarantee that governments won’t change course down the road, when resource prices inevitably rise again.

Securities Disclosure: I, Chad Fraser, hold no positions in any of the companies mentioned in this article.