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Zambia: positive outlook despite increasing downside risks

Our outlook for Zambia’s mining sector in 2018 remains positive as copper prices continue to rise and the country’s electricity supplies improve.

Authored by BMI Research – a unit of the Fitch Group.

Despite this, we highlight growing risks to our copper production forecasts in the coming years following a series of restrictive regulations introduced by the government recently,
which may signal a broader worsening of the country’s regulatory environment ahead.

We expect Zambian copper production growth to accelerate in the coming months as copper prices and domestic power supplies improve.

On March 20 2018, The Zambian Ministry of Mines announced that it is targetting copper production levels of over 1 Mt this year, up from 755 Kt in 2017.

While not as optimistic, we forecast Zambian copper production growth to average a strong 8% this year, which will amount to an output of 815 Kt – up from 2%
growth witnessed last year.

Nevertheless, we note rising downside risks to our forecast stemming from a worsening regulatory environment in the country, prompted by a delicate economic environment.

Bullish copper price outlook and improved power supply to bolster growth…

The primary driver behind rising copper production in Zambia this year will be the positive copper price environment.

Within a generally strong performing industrial metals complex, copper prices have risen over 21% in the past 12 months – the best-performing base metal after nickel.

While we expect copper price gains to be more limited in 2018 compared to the rally witnessed over 2017, steady demand growth will underpin continued tightness in
the copper market and keep a floor under prices.

Accordingly, we recently revised up our copper price forecast to an average of US$7,000/tonne in 2018 from a previous forecast of $6,300 /tonne.

Copper accounts for over 90% of Zambia’s mining industry value as of 2017.

As an added tailwind to Zambia’s mining sector, higher dam-water levels achieved in the country so far this year will likely reduce the possibility of power shortages in the coming months.

As highlighted in previous analysis, unreliable power supply remains one of the key constraints for the operational efficiency of mining companies in Zambia, due to the country’s over-reliance (over 80% of domestic power generation) on hydropower.

Last year, both First Quantum and Glencore were affected by power cuts in the country due to disputes with the government over tariffs.

Given Zambia’s underdeveloped power sector, mining companies account for almost 70% of total domestic electricity usage.

As a result of their overwhelming power consumption, the Zambian government has raised tariffs on miners by up to 30% since 2014.

However, significant rainfall in recent months has led to increased water levels at Zambia’s key Kariba dam, which should support power generation and ease the pressure on miners this year.

The Zambezi River Authority estimates that water levels were close to 481 metres as of February 2018, up from 479 metres last year.

…But weak fiscal position to heighten risks ahead

Despite our positive outlook, we note increasing downside risks to our Zambian copper production forecasts in the coming months following the introduction of new mining policies.

In what is likely an attempt to raise funds, in March 2018, the government announced it would audit local mining companies’ financial statements going back six years, in order to assess potential underpayment of taxes during that time.

Previously in January 2018 it was announced that miners in the country would also be required to transport 30% of their cargo for export by rail, in a bid to revive local rail services.

So far, copper miner First Quantum has been handed a $7.9 billion tax bill as a result of the audit, which poses significant risks to the company since Zambian operations account for approximately 80% of its pre-tax earnings as of 2018.

If other companies were to be affected in the same manner we may revise down our growth forecasts for the Zambian mining industry.

The country’s fragile fiscal position could result in the implementation of further restrictive regulations ahead in an attempt to boost government revenues.

According to BMI’s Africa Country Risk team Zambia’s fiscal deficit will narrow gradually over the coming years but remains high above 5% as of 2018.

Furthermore, the country has so far been unable to secure a much needed $1.3 billion loan from the IMF, due to the s low pace of fiscal reforms.