Clarke
The present contraction and threatened closure of Jamaica's bauxite/alumina industry resulting from the global economic crisis takes me back to an evening almost 15 years ago and a small dinner party I had arranged while I was chairman of JAMPRO. Among those present were the stewards of Government's bauxite/alumina interests, the heads of Government's development banks and an executive of a top Wall Street investment bank.
My purpose was to try to determine whether Government would be prepared to convert its holdings in the alumina sector to equity in a highway connecting Kingston and Montego Bay, with the potential for a dam across the Bog Walk gorge to provide water and electricity.
This was purely exploratory and was by no means a new idea, as I had picked it up from engineering types who had been discussing it for years. My clear impression at the end of the evening was that based on the strategic value accorded to Government's ownership of these alumina assets, the possibility of this transfer of equity was next to nil.
I felt at the time that a significant government-equity stake in the project would be essential to its financial feasibility. Based on information gleaned from engineering and financial experts, I had roughly calculated that the project would cost approximately US$800 million and that the only basis on which it would have been affordable for the Jamaican economy was if annual financing expenses could be held to a minimum. This would be possible only if bilateral and/or multilateral debt at three to five per cent was used and Government put in equity of around US$400 million. This could only have come from the sale of a major government-owned asset, such as Clarendon Alumina Production (CAP), which I had estimated at the time to be worth around US$500 million.
burden on the public purse
The approximately US$100 million of earnings after non-finance expenses, which a privately financed highway project would need to provide an adequate return to private debt and equity, could not have been generated by an affordable toll. The project would then become an unbearable burden on the public purse.
Over ten years later, in 2006, I found myself chairman of one of Government's bauxite/alumina entities. From this position, it came as a major shock when I found that CAP's value was no longer the approximately US$500 million I had earlier, correctly, estimated it to be, but was now less than US$50 million. This was a mind-numbing discovery.
Government's 50 per cent equity in Jamalco through CAP, which gave it decision-making power in the company and entitled it to 625,000 tonnes of alumina per year, had a market value of approximately US$550 million. In addition, between 1990 and 2007, the Government, through CAP invested a further US$440 million in Jamalco with a combination of direct cash payments and bauxite levy foregone. Government had therefore suffered a loss of almost US$1 billion on the capital value it had invested in CAP. How did this happen?
What is known is that sometime in 2000, CAP took on debt of US$125 million, among other things, to provide budget support to the Government. It also incurred a debt of US$65 million to help finance preliminary work on a planned expansion at Jamalco, from which it later withdrew.
CAP also incurred additional debt to invest a further $140 million in mud storage and mine infrastructure expansion at Jamalco. To the extent this investment was needed to replace depleted mud-storage capacity and new mining infrastructure for ongoing operations, it is surprising that special provisions had not been made over the years to prepare for this predictable expenditure; and loan financing should not have been necessary. However, if these new facilities were required to accommodate the planned expansion at Jamalco, in which CAP had decided not to participate and from which it would derive no commercial benefit, CAP should not have been required to contribute.
having an equal voice
As it happens, the expansion project has since been aborted, because the low-cost Trinidadian liquid natural gas on which it had been predicated could not be secured. What is remarkable is that after all these investments were made by CAP, its equity in Jamalco was diluted from the strategically valuable 50 per cent, to a relatively weak 44 per cent. This removed the Government's raison d'être for participation in the company, that of having an equal voice in decisions affecting its future; and the strategic value which had hitherto made the idea of selling its interest to finance important infrastructure projects so unthinkable, was lost.
Two 10-year contracts covering the period 2000-2012, and involving almost the entire quantity of alumina controlled by the Government through its investment in the sector, should have provided very significant earnings for the country. However, as the prime minister recently disclosed, instead of earnings, massive losses have been experienced as a result of an unfortunate arrangement to fix the price on approximately 55 per cent of the contracts without an accompanying hedge against production-cost increases. These losses have been exacerbated by the manner in which the remaining 45 per cent of the contracted volumes, appropriately pegged to the London Metal Exchange price, were handled.
long pricing positions
When the former administration was in office, it unwisely took long pricing positions on the futures market when distant prices were lower than nearby prices. As a result, price-hedging arrangements which were unfavourable to the country were made. This resulted in revenues being almost US$100 million less than might have been earned between 2002-2008. But what is even more unfortunate is that since this administration assumed office and at the same time that it was being justifiably critical of the last government's handling of our alumina sales, it is set to lose a further US$130 million on prices it may be forced to accept for alumina deliveries in 2009 and 2010.
Coinciding with the start of the new, administration, there was a reversal in the pattern of prices in the futures market and distant prices were now higher than nearby prices. In addition, prices were rising in US dollars because of a temporary decline in the value of the dollar against other major currencies. Aluminium prices rose above US$3,500 per tonne for both 2009 and 2010. This situation called for long price-hedging arrangements; but the Government apparently fell asleep and allowed these favourable pricing opportunities to pass. There was a long period of strong prices, peaking in July 2008 and stretching from the first quarter of that year to the end of August, just before the collapse of Lehman Brothers. Lehman's demise is widely seen as the event which precipitated the international financial crisis.
At a stretch, one could have forgiven delaying price-hedging decisions up to the point of Lehman's failure. But immediately thereafter, the Government should have moved quickly to hedge prices for at least the years 2009 and 2010, the period which most experts think the global economic crisis might last. Why this was not done, I do not know. What I do know is that because of this failure to act, we will be forced to deliver alumina for those two years based on metal prices as low as US$3,000 instead of over US$3,000. This converts to alumina prices some US$200 per tonne below that which would have been possible, were the Government more alert to its opportunities. The cumulative loss could be as much as US$130 million for the two-year period.
trading losses
The losses to the country through the management of our alumina assets cannot be justified on any count and the Government's ownership position in the sector should have been discontinued a long time ago. The truth is, regardless of who owns the alumina plants, substantial benefits accrue to the country through the value of the local production-cost inputs, including the bauxite levy, workers' compensation and locally contracted services. This amounts to approximately US$90 to US$100 per tonne, or US$360 to US$400 million per year. However, for the past several years, our 'strategic' ownership position in alumina plants has caused us to give up a substantial portion of these earnings through trading losses and interest on debt incurred, essentially by CAP.
What is most amazing though, is that an asset as valuable as the approximately 725,000 metric tons of alumina owned by the Government with an annual potential revenue of US$250 million (J$21 billion) at 2008 average prices, could have been handled in the cavalier manner that it has, with no transparency whatsoever.
The prime minister has now expressed an interest in selling CAP, but because of prolonged losses, the company is now likely to have a substantial net negative value. And, selling it could result in the Government being left with a net liability of as much as US$250 million, as it would be forced to assume all of CAP's debt. Nonetheless, Government needs to end the haemorrhage of ongoing trading losses, although the timing of the sale of the company could not be worse, with the industry's asset prices now on the floor.
sale was long over due
This decision to sell CAP should have come a whole lot sooner and the proceeds used to finance valuable infrastructure projects to spur economic development. However, the most important lesson which the Government should take from this sad experience is that governments should always avoid owning commercial enterprises unless there are clear and demonstrable national strategic advantages in doing so. And in those cases where ownership is justified, it should always be with full transparency, and management which is conducted strictly along commercial lines. Government should also have the wisdom and the discipline to let go of these assets as soon as the strategic reason for their ownership has passed. If these principles had been observed, this birthright of ours might not have been lost, and at so great a cost.
Claude Clarke is a former minister in the People's National Party government and manufacturer.
A bauxite mining pit in Jamaica. File
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