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Extractive IndustriesThe Management of Resources as a Driver of Sustainable Development$

Tony Addison and Alan Roe

Print publication date: 2018

Print ISBN-13: 9780198817369

Published to Oxford Scholarship Online: November 2018

DOI: 10.1093/oso/9780198817369.001.0001

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Downstream Activities

Downstream Activities

The Possibilities and the Realities

(p.527) 25 Downstream Activities
Extractive Industries

Olle Östensson

Anton Löf

Oxford University Press

Abstract and Keywords

This chapter discusses the practical possibilities of achieving increased downstream processing in extractive industries and the policies that are commonly used for this purpose. It reviews the reasons why forward vertical integration is not always an optimal choice for extractive industry companies. It finds little support for the argument that differences in market power dictate the geography of downstream processing. The degree of vertical integration appears to be mainly driven by production economics. Market-determined processing margins fluctuate, which raises the risks of investing in downstream processing capacity. Industrial policy for downstream processing is discussed based on experiences in India, Indonesia, Zambia, and Tanzania. Results so far seem to indicate that unintended consequences dominate the outcomes.

Keywords:   extractive industries, downstream processing, production economics, industrial policy, India, Indonesia, Zambia, Tanzania

25.1 Introduction

The possibilities of downstream integration in extractive industries have traditionally been given close attention by policy makers and many governments have made downstream processing an objective of mineral and energy policy. For instance, according to the African Mining Vision: ‘The principal resource endowment opportunities are…downstream value addition: The use of the locational advantage (CIF-FOB) of producing crude resources to establish resource-processing industries (beneficiation) that could then provide the feedstock for manufacturing and industrialisation’ (African Union 2009: 13).1

This chapter will discuss the practical possibilities of achieving increased downstream processing and the policies used. It will argue that governments need to be cautious about elevating downstream processing to a priority objective. It will also attempt to show, by way of examples, how attempts to ‘correct’ market outcomes may carry high costs for the economy.

Section 25.2 will briefly discuss possible alternative explanations for the perceived lack of downstream integration in the extractive industries in lower income countries. Section 25.3 will provide a description of the economics and geography of downstream processing, using examples from three industries: aluminium, copper, and iron ore/steel. Section 25.4 will be devoted to a critical review of policies commonly pursued to promote downstream processing and of practical experiences in a few countries where downstream (p.528) integration has been accorded a high priority. Finally, Section 25.5 will attempt to draw some general conclusions about the kind of policies that could prove successful.

25.2 Explanations for the Lack of Downstream Integration in Extractive Industries

If all locations were equally attractive from other points of view, one would expect downstream processing to take place close to the site of the extraction, simply because processing often involves a reduction in volume, which would tend to reduce transport costs. Since this is clearly not always the case, the reasons for the location of processing activities in other sites have to be explained.

25.2.1 Declining Terms of Trade and Unequal Market Power

Much of the intellectual foundation for the emphasis given to downstream processing and one of the most important possible reasons for the location of processing activities away from primary production was provided more than half a century ago by Hans Singer (1950) and Raúl Prebisch (1950) in the form of the Singer–Prebisch hypothesis. According to this argument, in a world system in which poorer nations specialize in primary products, such as raw minerals and agricultural products that are then shipped to industrialized nations that, in turn, make advanced products to be sold to poorer nations, the major benefits of international trade will go to the wealthy nations, resulting in declining terms of trade for the poorer countries.

The Singer–Prebisch hypothesis attributes the lack of downstream processing in developing countries to the differences in market power between primary producers and producers of processed products. It assumes that developed countries have the power to influence location choices and retain processing capacity in their countries, through trade policy and by other means. Until the 1990s, this view of the world economy did not appear to be in obvious conflict with the observable facts. However, this description no longer appears valid. Price developments for energy and metal commodities since 1960 do not provide unambiguous support for the Singer–Prebisch hypothesis after the year 2000.

There are a number of potential explanations for the absence of downstream processing. Policy measures to support downstream integration would need to be designed on the basis of an understanding of which of these explanations is most relevant to the particular case at hand.

(p.529) 25.2.2 Tariff Escalation

Tariff escalation (higher import duties on semi-processed products than on raw materials, and higher still on finished products, (WTO n.d.a)) is relevant in situations where the domestic market is not sufficiently large to accommodate the output of downstream processing plants and part or all of the production has to be exported. However, tariffs have declined and tariff escalation is less significant, particularly if concessions within regional or bilateral trade agreements, several of which provide for free access to developed country markets, are taken into account. The large expansion of manufacturing exports from China and other emerging economies could hardly have taken place under the tariffs that were in force in the 1970s or 1980s.

We have compared import tariffs for unprocessed and semi-fabricated metal products, for some selected metals (bauxite/aluminium, copper, and iron ore/steel) and countries and regions (China, the European Union, India, Japan, and the United States).2 It appears that tariff escalation is significant, although absolute tariffs are relatively low, with averages for semi-fabricated products being well below 10 per cent.

Some qualifications have to be presented, however. First, simple averages of tariffs do not tell the whole story. Products (within a category such as copper) that are deemed to be strategic may be subject to much higher tariffs, thereby effectively reducing imports. However, in the case of metals, the existence of ‘tariff peaks’ is relatively limited. Table 25.1 shows the range of applied import tariffs for the countries studied. The highest tariffs are still relatively low and would seem unlikely to be prohibitive.

Table 25.1. Import tariff range, selected metals and countries, %

Iron and steel (HS72)

Copper (HS74)

Aluminium (HS76)









European Union








United States




Source: based on tariff data in WTO (n.d.b).

Second, it is important to recall that tariffs are levied on the gross value rather than the value-added. If, say, the tariff on copper concentrates is zero and the tariff on refined copper is 5 per cent while the price of copper concentrates is US$5,000 per metric tonne and that of refined copper US$5,500, the tariff on refined copper is US$275. This corresponds to (p.530) 55 per cent of the price difference between the two products and in all likelihood to a significantly higher proportion of the value-added, since some inputs will be necessary in the refining. The effective rate of protection provided by the seemingly relatively low tariff would thus in reality be very high.

Third, transportation costs have to be taken into account. These can be considerable and can outweigh the effects of tariff protection. If the difference in transport cost between the refined and the unrefined commodity to a given market is high, it may still make sense to produce the refined commodity and pay the higher tariff.

In conclusion, tariff escalation could be a significant obstacle to downstream processing when exporting to some markets. However, in several cases, the higher tariff on the more processed product may be more than outweighed by the difference in transport costs. Moreover, while access to large developing country markets such as China or India may be hampered by high tariffs on processed products, many developing countries now enjoy tariff-free access to developed country markets (and often to the Chinese market) under various bilateral and regional trade agreements.

25.2.3 Economies of Scale

Many production processes in the extractive industries have significant economies of scale. For instance, an oil refinery needs a capacity of 200,000 to 250,000 barrels per day to be profitable (Institute for Energy Research 2005). A new alumina plant would not be economic unless it produced at least 1 million tonnes per year. As these examples show, processing the output from a relatively small mine or oil field locally may not always be competitive. Accordingly, downstream processing may have to wait until production has reached required levels or may necessitate the pooling of output from several mines or oil wells, which may be difficult to realize.

25.2.4 Availability of Inputs

It is not enough to have the basic raw material. Many processes also require specialized inputs. For instance, aluminium smelters need access to low-cost electric power in order to be competitive. Access to low-cost energy is usually the main hurdle. It is maybe illustrative that a legal requirement to process copper concentrate in the Democratic Republic of Congo was delayed after copper producers demonstrated that there was not enough electric power available to smelt and refine the copper mined in the country (Creamer Media 2016a).

(p.531) 25.2.5 Size of Domestic Market

International markets for energy and minerals are highly competitive and it is difficult to compete without relying on a domestic market where locational advantages in the form of lower transport costs yield higher margins. However, the domestic market for processed energy and mineral products in many developing countries is far too small to provide such a cushion. For instance, while a country may produce enough crude oil to supply a refinery of economic size, local demand for products such as petrol or fuel oil has to be large enough so that most of the production does not need to be exported.

25.2.6 Closeness to Market

Industrial users of raw materials expect speedy delivery. Many downstream products such as semi-fabricates of steel and nonferrous metals are produced in a wide range of qualities and are used by a variety of industries; it is necessary to be able to supply the needed quality to the customer at short notice, which means that geographic closeness to the market gives a competitive advantage. Accordingly, facilities for producing items such as semi-manufactured copper products tend to be located close to their customers. Producers located far away are at a distinct disadvantage. It is no coincidence that semi-manufacturing of nonferrous products has migrated from Europe and North America to East Asia at the same rate as has the production of manufactured products, as illustrated by statistics of metals use.3

25.2.7 Business Environment

Raw materials are only one ingredient in the production of processed products. Availability of skilled labour, logistics, and financial services is also important. Moreover, the attractiveness of the investment regime needs to be taken into account. While mines have to be located where there are mineral deposits, processing capacity can, in principle, be located anywhere. Therefore, while the quality of a deposit may compensate for unattractive (from the investor’s point of view) aspects of the host country’s investment regime, these aspects may swing a decision of where to locate processing capacity in favour of a ‘safer’ site out of the country.

(p.532) 25.2.8 Conclusions

Downstream processing often has an inbuilt advantage of lower transport costs when exporting compared to the export of the unprocessed commodity. However, most other factors such as economies of scale, unavailability of inputs, limited size of the domestic market, distance to export markets, and lack of a favourable business climate may outweigh this advantage. Trade barriers such as tariffs appear to play a limited role, particularly when taking into account the preferences now accorded to developing countries under various trade agreements.

25.3 Economics and Geography of Downstream Processing: Some Empirical Data

25.3.1 Extent of Vertical Integration in Selected Mineral Industries

An indication of the viability of efforts to achieve greater downstream processing should be provided by the extent to which the industry is in fact vertically integrated. Vertical integration would seem to hold advantages if it is high. Accordingly, in order to shed some light on this issue, we look at two aspects of downstream processing. First, we consider whether the degree of vertical integration is higher in developed countries, as predicted by the Singer–Prebisch hypothesis, which would support the case for promotion of downstream processing. Second, we look at the size and variations in processing margins, in order to determine if they are very large compared to the price of the unprocessed commodity and if they are stable enough not to pose unacceptable risks to possible public investment, directly or indirectly, in downstream processing.

The share of output at the unprocessed stage that is processed into the following stage in the country of mine production was calculated for three minerals: bauxite/alumina/aluminium, copper, and iron ore/steel, the share being measured both for world totals and for significant producing countries.4

Table 25.2 summarizes the results of the analysis and shows trends over the 2000–14 period. It is interesting to note that vertical integration has decreased for all the first steps of the supply chain: bauxite to alumina, copper ore to smelted copper, and iron ore to steel, while the next step shows either increased or stable vertical integration over the period studied. Partly, this is due to the rise of China as a consumer of raw materials and the country’s investments in downstream processing. The other main reason is the location (p.533) of demand for the processed products, such as steel, which determines where the final step in the processing chain is located. If there are advantages to vertical integration, they may be more important going backward from the final stage than going forward from the first stage.

Table 25.2. Vertical integration, less processed raw material transformed into more processed material within the same country




Copper ore/

smelted copper

Smelted copper/

refined copper

Iron ore/steel






Average over period












Trend over period






Standard deviation over period






Source: authors’ calculations based on data from Raw Materials Data (n.d.) (bauxite, alumina, and aluminium); USGS (2014) (copper ore, smelted copper, and refined copper); World Steel Association (2015), UNCTAD (2015) (iron ore and steel).

25.3.2 Processing Margins

The commercial viability of any processing industry depends on the processing margin: that is, the difference between the prices of the raw material and the processed product. Margins may be inflated by monopoly positions. But in a globalized world with low tariff barriers it is difficult to maintain processing margins containing a large element of monopoly rent. It is difficult to establish the existence of such rents without detailed calculations on the basis of production cost data, which are subject to influences that vary from one plant to another. It is, however, possible to assess if margins are stable or subject to large fluctuations. In that case, it would be reasonable to conclude that investment in downstream processing is associated with large risks. Table 25.3 summarizes data for bauxite/aluminium, copper, and iron ore/steel. For all minerals, the treatment charge, whether explicit or implicit, is seen to be on a decreasing trend as a portion of the price at the following processing stage. Moreover, for both copper and iron ore, the standard deviation is high and increasing, with increased uncertainty and higher risk as a result.

Total processing charges for converting copper concentrate to refined copper (TC/RC)5 have on average been relatively low over an extended period, both (p.534) in absolute dollar terms and also as a proportion of the refined copper price. However, the share of the charges as a proportion of the refined copper price shows violent fluctuations. This implies that the returns from downstream processing of copper are highly uneven.

A comparison of the prices of bauxite, alumina, and aluminium over time shows that the bauxite price as a portion of the alumina price fluctuates more than the alumina price as a portion of the aluminium price. Bauxite prices show some larger amplitude fluctuations, but even those are fairly limited compared to copper and iron ore. Alumina and aluminium prices follow each other fairly well. This would seem to imply that the risk associated with additional processing in the bauxite/alumina/aluminium industry is relatively low.

Both iron ore and rebar6 prices showed large amplitude fluctuations. However, unlike in the case of copper, the variations over time in the implicit ‘processing charge’—that is, the difference between rebar and iron ore prices—and in the iron ore price itself, are of roughly similar magnitude. Accordingly, the additional processing would not appear to increase the price risk.

Table 25.3. Processing margins, cost of turning less processed material into next stage as % of more processed price



TC & RC/LME grade copper price

(Rebar (steel)––iron ore)/rebar

Aug 2010–15

Aug 2010–15



Average over period










Trend over period





Standard deviation over period





Sources: authors’ calculations based on data from London Metal Exchange (n.d.) (copper); S&P Global (n.d.a), Metal Bulletin (n.d.) (bauxite to alumina); London Metal Exchange (n.d.), Metal Bulletin (n.d.) (alumna to aluminium); UNCTAD (2015), S&P Global (n.d.b and n.d.c.) (iron ore to rebars).

25.3.3 Some Conclusions

The degree of vertical integration varies within the extractive industry and between the three metals studied. In all three cases vertical integration appears to be mainly driven by production economics resulting from technology and transport costs and less by corporate strategies or trade policies. For the (p.535) bauxite/alumina/aluminium complex, access to low-cost energy is a major determining factor, along with an advantage for aluminium smelters that are located close to markets. For copper, the transport cost for copper concentrate has meant that copper is often smelted and refined close to the mine, except where economies of scale, access to low-cost energy, and the surge in Chinese demand has generated a trade in concentrate and, to some extent, in smelted blister copper. Finally, in the case of iron ore, developments over the past two decades have been completely dominated by the expansion of steel use in China, which has provided Chinese steel mills with a competitive advantage based on location. It should be noted, however, that even discounting the influence of China, a very high proportion of iron ore production has traditionally been exported because the steel markets of most large iron ore producing countries are too small to accommodate processing of more than a share of the iron ore output. It is notable that the degree of downstream processing is relatively low in high-income countries where producers would be expected to be able to exert some influence over markets: for instance, Australia in bauxite and iron ore, Chile in copper, and Sweden in iron ore. It would certainly be technically feasible for these countries to increase downstream processing. The fact that they have not done so would appear to argue that the attraction of downstream integration is not self-evident.

Based on the evidence of price series, processing margins do not appear to have followed any particular trend in the past two decades. The surge in Chinese processing of all three metals could have been expected to change price behaviour. But this has not happened. Longer price series would have allowed more definite conclusions on this point, but they are unfortunately not available. The time series used are probably in any case sufficiently long to reflect accurately the effects of the Chinese expansion of processing. There is considerable variation in the processing margins over time. In cases where the raw material accounts for a large portion of the total production cost and its price is subject to large fluctuations, downstream processing is exposed to considerable risk. This is the case in particular for processing of bauxite, copper concentrate, and iron ore, but less so for the processing of alumina. The risk of periodically seeing margins squeezed dramatically should give pause to any company or indeed government that might consider investing in processing capacity.

25.4 Review of Policies

25.4.1 Policy Objectives and Means

Government policies aimed at increasing downstream processing are rarely introduced with reference to clearly defined and quantifiable objectives. Nevertheless, it is possible to distinguish three broad categories of objectives: (p.536)

  1. 1.Employment. It is sometimes argued that increased downstream integration will add a significant number of employment opportunities, although most downstream processing is capital intensive.7

  2. 2.Economic diversification and skills development. While the number of jobs created in downstream industries may be relatively small, incentives to create such industries could be justified if they made the economy more diversified, or if the general skill levels were raised.

  3. 3.Appropriation of rent. If there are monopoly rents in processing it would be reasonable for the government to try to correct the situation in order both to raise economic efficiency and to increase government revenue.

As already mentioned, specific policy measures to support downstream integration would need to be designed on the basis of an understanding as to which of the three objectives above might be achieved by using any government intervention that is contemplated.

As concerns employment, a WIDER Working Paper on local content (Östensson 2017) argues that measures aimed at strengthening backward linkages (e.g. via higher levels of local content) may yield significant results in terms of employment generation and that many of these jobs are likely to be associated with portable skills. It is difficult to see how downstream processing could have a comparable impact, since most mineral or energy processing facilities are highly capital intensive and require little of the low-skilled labour in, for example, construction and services that is needed in mining itself or in supplier industries. The higher-skilled jobs in downstream processing are often relatively specialized and skills are thus not easily portable.

The existence, actual or potential, of local markets for extractive industry products would be a positive factor for downstream processing since the development of such markets would reduce dependence on raw material exports and may result in greater economic resilience. However, the mere existence of such markets is not a guarantee that they will benefit fully from the availability of the raw material since the processor may be in a monopoly position with price-setting power.8

The existence of large rents that can be appropriated would appear to be a valid reason for promoting downstream processing. However, as discussed in Section 25.3.2, the rents in downstream processing appear to be limited and (p.537) precarious, with large fluctuations over time. Accordingly, policies based on the perceived existence of such rents and aimed at promoting downstream processing could carry large risks: risks to the financial solidity of the resource company and, in the case of positive tax incentives or government subsidies, a risk of wasting taxpayers’ money.

Governments typically attempt to influence downstream processing decisions in one or more of three ways:

  • consultation with investors aimed at identifying and remedying obstacles to downstream integration

  • economic incentives

  • bans on the export of unprocessed products.

Government measures may be contained in legislation or may form part of agreements negotiated with investors. While agreements are almost universally used in the oil and gas sector to define rights and obligations of government and companies, they are less common and often more restricted in scope for non-fuel minerals, where conditions are instead usually defined in law. Nevertheless, even where taxation is defined in law, many countries use Mineral Development Agreements to define other obligations of investors. These obligations may cover various aspects of the investment, including employment, local content, and downstream processing. Targets may be defined, or a process for achieving unquantified objectives set out. Consultation processes where plans are worked out and agreed are common in the cases of employment and local content, but less so when it comes to downstream processing. Where the legislation and any agreements are silent on downstream processing, it is of course still possible for the government to try to persuade the investing company to integrate forward. Any government has a number of instruments at its disposal that can be used to influence companies’ behaviour in this regard.

Economic incentives to influence companies’ decisions with respect to downstream processing are relatively common, particularly in the form of taxes on the export of unprocessed materials.9

Positive incentives, for instance, in the form of tax credits for downstream processing, have been discussed, but no current examples are known to the authors.

Another positive incentive is duty exemption on imported inputs, which is used both at the primary and downstream processing stage by many countries.

Export bans on unprocessed products are uncommon, but there are a few examples. The most recent example is the ban that was introduced in Indonesia in 2014, which is discussed in Section 25.4.2.

(p.538) 25.4.2 Indonesia’s Unprocessed Mineral Exports Ban

The example of downstream processing policies that has attracted most attention in recent years is the Indonesian export ban on unprocessed minerals. This ban took effect in January 2014. It applies to both metal-based and non-metal-based components of unprocessed minerals and specifies certain minimum levels of processing that are required to avoid the ban. The nominal intention of this intervention is to help preserve the country’s supplies of the affected resources (Nathan Associates 2013). While mineral ore exports such as nickel and bauxite were banned outright, exports of mineral concentrates—including copper, iron ore, manganese, lead, zinc, and ilmenite—are permitted for a period of three years, during which export taxes are levied at rising rates (Bloomberg 2014).

In order to back up the bans, positive incentives have also been provided for companies that invest in processing facilities.10

These measures have had a dramatic impact on Indonesia’s mineral exports. The value of unprocessed exports of bauxite, copper, and nickel fell from US$7 billion in 2013 to just under US$2.9 billion in 2014 (UNCTADstat n.d.). The fact that the rules were introduced at a time of falling prices and widespread excess capacity for the minerals concerned has exacerbated these impacts. Some modifications of the rules have already been negotiated with companies. Meanwhile, a number of projects to build processing plants have been announced and a few have started construction.

It is too early to definitively assess the Indonesian experience since 2014. An estimate made for USAid before the rules came into effect found that the economic losses would be very large. In aggregate, accumulated net welfare losses would amount to somewhere between $34 billion and $33 billion in 2020 (Nathan Associates 2013: 2). In the light of the implementation of the legislation and market developments since early 2014, these initial estimates today appear too optimistic. While it is possible that some of the processing capacity now being built will be profitable, this may be due only to the very generous incentives provided.

25.4.3 Export Taxes on Iron Ore in India

Indian policy with respect to iron ore mining is a good illustration of the difficulties of achieving a balance between the interests of primary producers and processors by using regulations.

In 2011 and 2012, the courts banned mining in the Indian provinces of Goa and Karnataka because of mining outside concession areas and breaches of (p.539) environmental regulations. The ban has since been lifted, but there is still a cap on production (Creamer Media 2012b), resulting in reduced domestic supplies.

Iron ore consumption by the Indian steel industry is dominated by lumps and sinter, with most fines that are not suitable for sintering being exported since they cannot be directly used for iron making in the absence of sufficient capacities for agglomeration through pelletizing (Creamer Media 2012a). Most steel producers are equipped to use iron ore pellets from fines as feedstock but do not have pellet-making facilities at their plants (Creamer Media 2012c). As a consequence, the fines have been left in dumps or, when possible, the material has been exported. In order to assure the domestic steel industry of iron ore supplies, railway freight rates are no less than 3.6 times higher for iron ore for exporters than for ore for domestic use (Creamer Media 2015).

A levy on outward shipments of fines was first imposed in December 2009 at 5 per cent. A 15 per cent export tax on lumps followed in April 2010. A uniform rate of 20 per cent was imposed on both lumps and fines in March 2011 and was increased to 30 per cent in December the same year (Creamer Media 2015). The tax was lowered to 10 per cent for lower grade ores in 2016 (Creamer Media 2016b). Royalties on iron ore were raised from 10 to 15 per cent in August 2014 (Creamer Media 2014b). Pelletizing provided a possible way to exploit lower-grade fines since there was no export tax on pellets. However, a tax of 5 per cent was introduced in January 2014 in response to pressure by the steel industry (Creamer Media 2014a, 2014d). Capacity utilization in pelletizing fell to 50 per cent later the same year (Creamer Media 2014c).

Downstream ActivitiesThe Possibilities and the Realities

Figure 25.1. Iron ore and steel in India 1993–2015, million tonnes

Source: authors’ calculations based on UNCTAD (2013, 2015), TEX Report (2016).

The combined result of these various policy interventions can be seen in Figure 25.1. The peak in export and production in around 2008 to 2009 was partly the result of companies exporting from stockpiles of fines. However, once the most easily accessible stockpiles had been exhausted and prices fell following the financial crisis, this activity came to an end. A couple of years later, the court-ordered mine closures strongly influenced the figures. Nevertheless, production and exports would have been expected to recover once mines could be re-opened. This did not happen, due to the policies pursued. Consequently, and remarkably, from being the world’s third-largest iron ore exporter, India became a net importer of iron ore in 2015.

25.4.4 Processing of Copper in Zambia

Zambia levies an export tax on copper concentrate. The tax is intended to promote the smelting and refining of copper concentrate from mines in the country. The tax is 10 per cent of the sales value, which corresponds to about US$470 per tonne of contained copper at mid-2016 prices. The treatment (p.540) charge: that is, the cost of smelting concentrate in Zambia to produce blister copper (see footnote 5)—is US$70–75 per tonne of concentrate, while the cost of transporting the concentrate from the mine to an overseas smelter is about US$200 per tonne (corresponding to about US$600 per tonne of contained copper) depending on the route taken (Muller 2013).11

Because the cost of transporting concentrate is three times as high as that of transporting blister copper, mining companies would be better off processing the copper even in the absence of the export tax. The smelting charge has to be paid in any case and it does not matter to the miner if it is paid to a smelter in Zambia or overseas. Thus, the export tax does not affect the actions of mining companies. On the other hand, the tax deters investors who for one reason or another are not in a position to smelt concentrates: for example, if a mine produces concentrate that for mineralogical reasons cannot be smelted in existing smelters. Because of the export tax, most such mining projects will not be economically viable in Zambia.

Would this conclusion hold if the smelting charge were to change? As was noted in Section 25.3.2, smelting charges have trended downwards for a long time due to persistent over-capacity at the smelting stage. Several governments (p.541) have introduced legislation similar to the Zambian export taxes, leading to over-investment in smelting capacity and downward pressure on smelting charges. Moreover, smelters that were originally built to process ore from mines that are now closed often continue operating since the original capital investment has been paid back and running costs can be covered. There are several such smelters in the world.

As for processing the refined copper that is now produced in Zambia, a World Bank study (World Bank 2011) does not hold out much hope. The total market for all copper and copper alloy semis in sub-Saharan Africa (excluding South Africa, which is self-sufficient) can be estimated at around 10,000 tonnes per year, which corresponds to a tiny portion of Zambian refined copper output of over 700,000 tonnes per year. Given the location of Zambia, the principal exit shipment ports, and the main shipping routes, the markets outside Africa that could be best served from Zambia are the Middle East and Southeast Asia. The Asian market is, however, well served by substantial large-scale local capacity.

Accordingly, market prospects do not appear to justify further industrial scale copper and copper alloy semi-manufacturing capability in Zambia in spite of regular political pressures to do just that.

25.4.5 Exports or Local Use of Natural Gas in Tanzania

Tanzania has been producing natural gas from its Songo Songo fields on the Indian Ocean since 2004. This gas provides about 50 per cent of Tanzania’s electricity generation, with the remainder used for industrial purposes (AfDB and BMGF 2015). However, more recent discoveries have radically changed the prospects for gas in Tanzania. In the past decade, there has been very large exploration activity in the concessions so far granted by the Tanzanian Petroleum Development Corporation. These have already resulted in vast commercial finds that are only now beginning to be developed.

The gas can be used in three ways: (i) natural gas can be exported to earn foreign exchange revenue; (ii) it can be used to generate energy (electricity) in the domestic economy; and (iii) it can be used to produce a number of products, including fertilizer, compressed natural gas, and petrochemicals.

The choice between the different uses for the natural gas is partly a technical one that will be dictated by project economics. Mainly, however, the choice is a political one. A large portion of the gas in the largest deep water wells will in any case have to be exported, both because the volumes are too large to realistically be absorbed by the national economy and because producing companies will have to export very large volumes to justify their investment in extraction and liquefied natural gas (LNG) plants. A large share of the export revenues will strengthen the government budget. It has been estimated (p.542) that the additional income will amount to US$1.4 billion per year on average over the first ten years of production, corresponding to 1.9 per cent of gross domestic product and 9 per cent of government tax revenue from all sources (AfDB and BMGF 2015: 31). There is, however, potential for the contribution to growth to be significantly larger. The Tanzanian economy is capable of delivering at least some of the goods and services needed for gas exploration and extraction and for LNG production. The government has launched an ambitious local content policy which, if successful, should raise the proportion of nationally sourced goods and services significantly (United Republic of Tanzania 2014).

With respect to the possibility of improving access to electrical power, it should be noted that at present only 24 per cent of the Tanzanian population are connected with electricity services. Using the natural gas for this purpose would mean that the national energy supply company will be able to further reduce its dependence on expensive imported feed stocks of diesel, and also reduce further its use of ageing and unreliable hydro plants. In addition, it would be possible to reduce power tariffs, thereby improving living standards and the competitiveness of domestic industry.

A range of processed products can also be produced from the gas and especially from the large deepwater resources if these are developed. Their economic feasibility differs, however. Certain processes for downstream products have considerable economies of scale and for this reason a large part of the production would have to be exported if production was to be on a commercially viable scale. Moreover, several of the uses would require a considerably lower cost of input than, for instance, would LNG production.12

A domestic fertilizer facility could make a significant potential contribution to Tanzania’s large agricultural sector which at present has a low rate of fertilizer use as well as an expensive subsidy policy to help farmers. A large ammonia/urea plant could be competitive if it could be supplied with gas at US$5–6 per mmBtu: a figure that is more demanding than the US$7–8 supply price needed for a viable LNG export activity. The full capacity output would be significantly higher than the anticipated future demands in East Africa as a whole. So the investment could only be justified if Tanzania had real prospects of also finding large export markets outside the region (Roe 2016).

A competitive methanol plant would consume even more than a fertilizer plant and it would probably need a gas supply price as low as US$4–5. The domestic market is very small, methanol being used mainly as a feedstock into (p.543) chemical industries. Hence a very large export market would also need to be found to justify such a large capital outlay (Roe 2016).

Converting gas to liquid fuels would be an even more challenging investment for the country. A facility to produce naphtha and high quality diesel would only work competitively if it could acquire gas at a price of around US$3–4 mmBtu. Although this type of project would have some attraction in being able to save Tanzania’s large petroleum import bill, the investment needed to achieve this saving would be very large (Roe 2016).

The Tanzanian government has made it clear that it assigns a high priority to downstream processing of natural gas. However, the difficulties of these ambitions are evident. In addition, investors have expressed some concern that the ‘domestic market obligation’ should not be so large that it threatens the viability of projects.

In conclusion, the case of Tanzania’s natural gas illustrates the complex weighing of alternatives that has to take place in order to satisfy several different objectives at the same time.

25.5 Conclusions

This chapter has attempted to provide some basic information and analyses that could inform policy choices concerning downstream processing of both metals and oil and gas, and to show both the risks of policy decisions that are oriented towards meeting one single objective as well as the complexities that need to be taken into account in order to arrive at solutions that are both practical and sustainable.

Section 25.2 reviewed the reasons why forward vertical integration is not always an optimal choice for extractive industry companies. While transport costs often argue in favour of such integration, other technical factors, including economies of scale, availability of inputs, size of domestic market, and distance to markets, may outweigh this natural advantage. There appears to be little support for the argument that differences in market power dictate the geography of downstream processing. Relatively high tariffs on processed products appear to play only a limited role.

The review of vertical integration and processing margins in Section 25.3 showed that the degree of vertical integration varies within the extractive industry. It appears to be mainly driven by production economics resulting from technology and less by corporate strategies. It is notable that the degree of downstream processing is relatively low in high-income countries where producers would be expected to be able to exert some influence over markets.

(p.544) Processing margins tend to fluctuate, in some cases dramatically, which should give pause to all those companies or countries that consider investing in processing capacity.

Section 25.4 discussed government policies for downstream processing. Following a brief description of objectives and instruments, the rest of the section was devoted to a review of four country cases: India, Indonesia, and Zambia on non-fuel minerals, and Tanzania for natural gas.

In Zambia, a simple arithmetic example serves to show that the policy studied—the export tax on copper concentrates—is unnecessary and does not significantly influence processing decisions. It may, however, preclude the exploitation of some mineral deposits, thus needlessly limiting mine production.

In Indonesia, more effort seems to have gone into the formulation of the policy underlying the ban on exports of unprocessed minerals. However, the government has decided to provide very generous incentives to investors in processing capacity, and it is legitimate to ask who pays for the policy: the investor or the Indonesian taxpayer.

The Indian policy concerning iron ore mining and exports illustrates the difficulties of satisfying competing industrial interests who all turn to the government for solutions to their various problems. In trying to help the Indian steel industry to retain international competitiveness, the government succeeded in badly damaging a once successful export industry while leaving the steel industry in an uncertain situation with regard to its raw material supplies.

The Tanzanian example, finally, brings to light an important consideration that is usually absent from the debate about downstream processing, namely the domestic market. In Tanzania the choice may be not between exporting unprocessed or processed products but between satisfying domestic needs—in this case, rural electrification—or maximizing export revenues. This illustrates a basic argument: that downstream processing policies should not be about how to maximize export revenue but about how to meet the needs of the economy.

In conclusion, it is probably reasonable to point out that the presence of raw material resources constitutes only one of the factors that need to be taken into account when taking a decision on the location of a particular type of plant. Incentives or directives to promote downstream processing thus represent only one variation on the familiar theme of picking winners—and one based on a particularly narrow set of criteria. It would probably be more productive in most country cases to instead emphasize industrial policies that focus on removing constraints and bottlenecks that stand in the way of the economy reaching its full potential, including those relating to skills, credit, energy supply, transport infrastructure, and inappropriate regulation.

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(1) A longer version of this chapter, containing more detailed data, has been published as a WIDER Working Paper (Östensson and Löf 2017).

(2) The countries selected are the ones accounting for most of the world imports of the commodities concerned. Detailed results can be found in Östensson and Löf (2017).

(3) Metals use is usually measured as unwrought metal used in semi-fabricated products. Statistics producers, such as the international metal study groups, use this convention.

(4) Östensson and Löf (2017) contains detailed data, including on vertical integration measured at the corporate level.

(5) TC stands for ‘treatment charges’ and refers to the charge for smelting copper concentrate to blister copper. RC stands for ‘refining charges’ and refers to the charge for refining blister copper to copper cathodes. While blister copper is traded, the bulk of international copper metal trade is in the form of copper cathodes.

(6) The price of rebars (also known as reinforcing rods, used with concrete in construction) is used since this is the most basic and lowest priced form of commonly traded steel. Import prices for the Middle East were used since they are broadly based and can be taken as roughly representative of the prices paid by most developing countries for imported steel.

(7) Later processing stages may be more labour intensive, but it is difficult to argue that a country needs to have all the intermediate stages in order to arrive at this later, more labour-demanding stage. For an informative analysis of trade patterns for copper contained in semi-fabricated and finished goods, see Tercero et al. (2016).

(8) As the African Mining Vision expresses it: ‘TNCs, who often prefer to…only make the semi-processed resource available to the local market at a monopoly price (import parity price = the alternative imported price of the resource (CIF) in a particular country), if they have a monopoly or oligopoly position in the country concerned’ (African Union 2009: 14).

(9) See Price and Nance (2009) for a number of examples.

(10) See Bellefleur (2014) for details.

(11) This section is partly based on Chamber of Mines of Zambia and ICMM (2014: Annex I). Copper prices and smelting charges have been updated to, respectively, February 2016 and the average for the 2000–15 period.

(12) The following assessment of the feasibility of different types of downstream processes is based on BG Tanzania (2013).