ECONOMIOC ANALYSIS OF THE COPPER MINING INDUSDRY OF IRAN
Kazem Oraee, PhD
Professor, Stirling University, Stirling, UK, E-mail:
Arash Goodarzi, MSc
Research Fellow, Ministry of Labor and Social Affairs, Tehran, Iran, E-mail:
Nikzad Oraee-Mirzamani, LL.B., M.Sc., D.I.C.
Research Student, Imperial College London, London, UK, Email:
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Abstract
Mining of copper ore and the related industries play an important role in Iran’s economy. Copper ore production in Iran accounts for 75% of the total production in the Middle East. All activities related to copper, that is, exploration, production, refinement etc are owned and managed by state owned companies. Decisions have been made to privatize all these activities. To assess the success of this privatization process, different components of the industry must be subject to economic analysis. In this paper, the cost estimation of all operations has been carried out. The total potential and attainable revenues have also been estimated using historical data available from the industry. Risk is a major factor in all mining activities and the copper industry of Iran has been subject to risk factors arising from many internal and external variables. These variables have been recognized and their effects evaluated. The effect of risk on the economic feasibility of the operations in the industry has also been analyzed.
Keywords: copper; economic analysis; Iran
Introduction
Iran is a developing country with a transitional economy, bases on to export raw materials. It is widely accepted that the existing public enterprises and large state-owned market players are no longer the most efficient way of running the economy and that a wide-ranging reform is necessary across Iran’s economy. Most of the developing countries have begun privatization in their public enterprises. Iran has also engaged in a large privatization program since 2005 and so far has privatized several state economic enterprises and some joint ventures, which in the current context are companies owned jointly by the private and public sector.
A convincing body of evidence was advanced which suggested that private enterprises could not only perform all the operations and functions that public enterprises were responsible for but could also perform these activities with greater efficiency. As a result, privatization has become a major phenomenon in many countries in the world. Iran has examined as a country in the process of switching from growing state enterprises to privatizing too. Although theory, accountability, efficiency and financing are all reasons for creating state enterprise, financing is the most prevalent driver of privatization.
It is widely believed that if current governmental organizations are privatized they will need to become more efficient. At present many are not profitable. This is widely thought to be due to large-scale unnecessary recruitment in order to reduce domestic unemployment rates. True privatization will inevitably lead to many unpopular job cuts. Furthermore, many of these companies receive subsidies and grants from the government.
The history of National Iranian Copper Industries Company
Iran has large copper resources and numerous copper porphyries occur in an arc belt extending from northwest Iran, southeast into Pakistan. These deposits are estimated to contain 2 billion tons of copper, comprising around 3.5% of the world’s known copper resources, from which some 20 million tons of pure copper can be obtained. The world’s copper reserves amount to 57 billion tons. In addition, Iran has the 17th largest copper reserves in the world.
Kerman Sarcheshmeh Mines Company was established in 1972 following the nationalization of Iranian Mines. The company became the partner of the US Anaconda Company a year later. Finally, the Kerman Sarcheshmeh Mines Company changed its name to National Iranian Copper Industries Company (N.I.C.I.CO) in 1976. The activities of N.I.C.I.CO include exploration, exploitation and the processing and distribution of raw materials in order to produce the final copper products.
Economic analysis
Economic analysis is a systematic approach to determining the optimum use of scarce resources, which involves comparing alternative ways for achieving a specific objective under given conditions and constraints. It is necessary for making decisions concerning investment activities in every business. Financial resources are limited and therefore any investor must choose the best investment opportunity from those available to him. Before stakeholders spend capital it has become essential to ensure that the proposed outcomes are well researched and cost effective.
Economic analysis takes into account the opportunity costs of resources employed and attempts to measure in monetary terms the private and social costs and benefits of a project to the community or economy.
A popular strategy for firms is profit maximization or at times the minimization of losses. There are many tactics for achieving this goal. In Iran investing on mining projects in the stock exchange is thought to be a positive step since approximately one third of the economy is dependent on the activities in the mining sector. Therefore for the purposes of N.I.C.I.Co raising capital through the sale of its shares in the stock exchange is thought to be a positive step since it is a large corporation and is bound to provide attractive investment opportunities.
Investment opportunities will have different rankings according to their level of predicted profitability. Even if the investor faces one investment opportunity, it must be compared to other profit-generating activities. Thus the concept of the opportunity cost has to form an integral part of every economic analysis.
Generally, balance sheet, profit and loss accounts and other financial statements published by public companies present raw, and in some cases meaningless numbers without much analysis. The balance sheet and profit and loss account of N.I.C.I.Co are presented in table 1 and table 2 for the recent triennial fiscal years.
Sale analysis
Sale analysis is the process of breaking a complex topic such as sale into smaller parts to gain a better understanding of it. A sale analysis is an investigation of a market that is used to forecast the next sales, according to past experiences and prediction of future conditions. Sale analysis is vital when perfect competition prevails in a market, whereas it is not so important in cases of a monopoly producer. The market for the production of copper in Iran is a pure monopoly market. Furthermore a company enjoying monopoly power is not subjected to competitive pressure from the market. Many clients have had to endure long delays before being able to buy products from N.I.C.I.Co in Iran. According to Sale (Import & Export) analysis for the previous two fiscal years, the company has allocated sixty percent (60%) of its sale to the domestic market and the rest have been exported. Cathode copper, wire rod and the concentration of copper are the most valuable products. They comprise some eighty five percent (85%) of the company’s total sales value. The sale of cathode copper accounts for approximately forty five percent (45%) of the total revenue (Tab 3, 4).
The prediction of price
Pricing and breakeven analysis will determine the impact of a price change on the business. Copper is a finite resource, but, unlike oil, it is not dissipated and therefore can be recycled. Recycling is a major source of copper production in the modern world. As consumption in India and China increases, copper supplies are becoming scarcer. The price of copper has quintupled from the 60-year low in 1999, rising from 1,320 USD per ton in June 1999 to 8,780 USD per ton in May 2006. Prices subsequently dropped to 5,290 USD per ton in February 2007 before rising again to 7,710 USD per ton in April 2007. By early February 2009, however, weakening global demand and a steep fall in commodity prices lead to a drastic fall in prices to 2,540 USD per ton. Some reports however forecast an increasing demand in the near future as the global economic growth resumes. A rise in raw material prices, especially in the metals have been occurred in recent months and the prices rose above 8,300 USD per metric ton in the tenth month of 2010.
However notwithstanding the reviving economies, constraints in the production of copper are likely to contribute to the shortfalls and thus the copper price is likely be driven by the rules of demand and supply instead of mere investor speculation. In 2011 the price is estimated to peak at more than 7,500 USD per metric tons on its way to averaging 6,500 USD.
Figure 1. The average price of cathode copper from 2001 to 2010
Cost estimation
Costs as well as revenues must be calculated. Costs are the monetary value of expenditures for supplies, services, labor, products, equipment and other items purchased for use by a company or other accounting entity. Cost is the total money and resources associated with an activity. A cost is the value of money that has been used up to produce something.
The global recession and collapse of copper prices has forced the closure of many high cost mines and adversely impacted on project development.
The rapid pace of change in the copper industry makes it even more important for producers and industry observers to truly understand the drivers on cost and profitability, as well as the implications for future copper mining.
In N.I.C.I.CO, overheads comprise the largest group of costs which amount to around 40% of the total costs. Overhead costs include the ongoing operational costs. It is usually used to group costs that are necessary to the continued functioning of the business, but which do not directly generate profits. Overhead expenses are all costs on the income statement except for direct labor and direct materials. They include energy, depreciation, transport, rent, repairs, supplies and other such costs (Table 5, 6).
Calculation
The values that a project will have in the future, and indeed its value in the past, are different from its value in the present. Therefore in order to assess the profitability of a potential investment opportunity, one must compare the present value of a project with the value derived from other investments. Calculating the Net Present Value (NPV) is a useful method for economical evaluation; it is computed as the sum of discounted values of all future returns less initial investment. It is a standard method for using the time value of money to appraise long-term projects. The discount rate that makes the algebraic sum of future returns and initial investment equal to zero is called the Inter Rate Ratio (IRR).
The cash flow table is formed according to the balance sheet and the profit and loss account (Table 7). The total assets in 2008 were assumed as cash our flow for year 0 and the summation of net profit and depreciation in 2009 were assumed as cash in for years 1, 2, 3, 4, 5, 6, 7, 8, and 9.
In sensitivity studies, different values of PVIF (Present Value Index Factor) are examined and NPV is calculated in each case.
Net present value is computed for PVIF=15%, 20%, 25% and 27.8%. The NPV is positive for 15%, 20% and 25% and IRR is 27.8% where the amount of NPV becomes nil.
Where inflation and risk are not accounted for, Net Growth is 10% and is therefore an acceptable rate. If however inflation is taken to be 20% in average (as it has been in Iran during the past 25 years) then PVIF = 10 + 20 = 30%. In addition if the level of risk is taken into account, say of around 10%, then PVIF = 30%. Therefore a project where the IRR is 27.8% will be uneconomical.
Privatization in Practice
A special governmental body has been created tasked with ensuring the correct implementation of the First Chapter of the 4th Economic, Social and Cultural Development Plan of Iran (2005-2009). It is called the Iranian Privatization Organization and is tasked with divesting the shares of N.I.C.I.CO. Forty percent of the shares were offered to the public on two occasions, 20% each time.
In 2007 the first 20% of the company was sold for 1.1 billion USD. The investors were mostly other state-owned companies including pension funds and the state broadcasting industry. All shares were sold in less than 7 minutes. In almost every recent case of privatization in Iran, other state-owned entities and companies have been seen to be the main investors. These include state banks, government-linked investment and pension funds. None of the companies which have recently raised capital through public stock offerings have been proven profitable. Nevertheless in every public offering case these shares were sold in a matter of minutes. Therefore it seems that even where investment opportunities in Iran are not deemed profitable, state-owned companies with low profit margins can still sell their shares rather easily.
Conclusions
It is a long-standing rule of economics that when the provision of commodities is concerned, in most cases the private sector will have a greater incentive to produce the goods in the most efficient method possible. Should the production and the sale of a commodity be profitable in the private sector then other market players will be encouraged to enter that market and begin to compete with the incumbent seller. This will increase competition and in turn will drive the firms to produce at a lower cost to the final consumer.
In Iran copper is currently produced by N.I.C.I.CO which enjoys monopoly power in the market for copper producers. The absence of adequate competition in this market has lead to shortages of supply and an inflated price, which inevitably affects the overall inflation rate in the economy.