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Has Chile seen the mining industrial sector become a niche to create linkages and boost economic development? - Part II
The first section of this article suggests that resource-blessed countries share some common characteristics. Particularly in the creation of linkages between the core extractive industry and different higher value sectors in the economy. Taking into consideration the structure of the mining value chain, production linkages can be associated to the goods and service suppliers. In light of this, we need to understand: what are the possibilities for upgrading the production linkages of the copper mining industry in Chile?
Two main outputs can be identified as enablers to create production linkages: capital from mining firms’ operational costs and projects portfolio, and mine copper production. Capital is argued to facilitate upstream and side-stream linkages, while the second to downstream linkages. The following paragraphs will debate each of the cases using values estimated for the 2014 mining sector performance in order to estimate the size of opportunities, while different sources will serve as reference to characterize the local mining suppliers.
Linkages towards suppliers
According to Consejo Minero, in 2014 the average operational cost of extraction and processing (excluding direct wages) accounted for MUSD 25,733 or 50.5% of the mining firms’ cash flow (Consejo Minero, 2014). Furthermore, according to estimations by Innovum-FCh and COCHILCO, 60% of operational costs of the mining companies (excluding energy and fuels) are associated with purchase of goods and services to suppliers (Innovum, 2014). Similarly, a report elaborated by the Boston Consulting Group (BCG, 2007) for the Consejo de Innovación, estimates that the average annual projected share of operational cost for the mining firms in the 2008-2010 period would be directed 24% to goods and supplies, and 38% to services. As a rule of thumb then, it is fair to assume that of the total demand to mining supplier firms, 40% is towards goods while 60% to services. Therefore, an overall estimate of the size of the market for the local mining suppliers had a potential of MUSD 15,000 associated to operational cost of mining firms members of Consejo Minero in 2014. Even when this figure cannot be taken into account as a definite value, it does deliver a perspective of the size of Chilean mining suppliers’ market.
According to Consejo Minero, the estimated value of copper mining projects in execution phase in Chile during 2014 adds together near to MUSD 20,000. Furthermore, they suggest that the growing Chilean mining sector has up to MUS$ 45,000 worth in projects that are in different evaluation phases. The largest share of the investment is by multinational firms operating in Chile. The largest project in execution stage (MUSD 4,199) corresponds to the Australians’ BHP Billiton and Rio Tinto and the Japanese JECO joint operation Minera Escondida’s OGP1 Project (Consejo Minero, 2014). This project is not a greenfield deposit, but the construction of a new mineral processing facility. Typically, the costs distribution for industrial projects under EPCM (engineering, purchase and construction management) contracts can be estimated as 10% for engineering and 90% divided equally in equipment, materials and construction (COCHILCO, 2007). It is suggested that 60% of the cost associated to equipment is towards specific mining and processing equipment (BCG, 2007). Again, this delivers a perspective of the size of mining projects growing market in Chile.
Chilean mining suppliers characterization
In order to have a better characterization of the growing mining suppliers sector, Fundacion Chile released two public surveys (Innovum, 2012) (Innovum, 2014). Four categories of firms were defined: i) contractors; ii) equipment and goods; iii) engineering and consulting services; iv) support services. From the total 5,998 mining supplier firms identified in 2012 (Innovum, 2014) 30% of them are involved in equipment and goods, while 60% in services (combining contractors and support services). One must be careful not to underestimate services that at first might not be perceived as relevant. To put this in context, transportation of labor signified to CODELCO a higher annual cost than heavy machinery rental, accounting for MUS$ 22 (COCHILCO, 2007). In term of size of the suppliers, it is possible to estimate that none of the four categories of supplier have over 12% of firms with sales over MUS$ 4 a year. In the case of engineering and consulting suppliers, even when the number of firms is around three times smaller than the rest of the categories, the share of firms with sales over MUS$ 4 is not significantly lower than other categories.
To the already mentioned Fundacion Chile surveys, it is possible to incorporate DICTUC (2007) results. Even when the latter followed a different methodology, it is argued that the comparison should serve the purpose of this analysis. When the three surveys are combined, it is evident that the total number of mining supplier firms have increase almost linearly during the 2007-2012 period. More interestingly, the major increase occurred particularly in smaller size firms, which increased from 826 to 2,639 in only 5 years. It could be inferred that suppliers firms were created to fulfill the increasing demand, as copper production increased, but with only a few firms achieving higher levels of total sales.
Although the engineering and consulting mining firms represent the smaller number of firms and total sales (assumed as represent the lower project and operational cost for mining firms), it has by far the largest share of human capital. This category of supplier has 62% of their labor with complete superior education (e.g. engineers, geologist). The data suggests that outsourcing of mining firms towards suppliers have been mostly intended to low skilled labor-intensive activities, rather than technology-challenging or highly skilled labor activities.
Almost the totality of the mining and mineral processing equipment are imported. Thus, during the operational cycle of the mines and processing plants it would be normal to expect further importation of spare parts and equipment replacement, in addition to normal operational input supplies. In the DICTUC (2006) survey, the main business activity of the supplier firms was included in the statistics and separated in three categories: services, industrial, and commercial. If only the suppliers that have over 50% of their sales to mining firms are taken into account, 29% are commercial-related (importers and re-sellers) and 42% services-related; leaving only 29% are actual manufacturers (DICTUC, 2007). One problem with the survey is that it does not specify what type of goods are manufactured locally, the degree of specialization to mining, technological upgrade or the market size.
In 2006, mining firms directly imported 12% of their total goods purchases (Consejo Minero, 2007). However it must be taken into consideration that this does not implies that the local suppliers, which supplied the remaining 88%, are the actual producers of the goods, but rather re-sellers. During this period, the imports of goods by mining supplier firms almost triplicated the mining firms direct imports. It is not explicit however what is the specific role of the supplier firm. In fact BCG (2007) suggests that 50-70% of total mining-related goods are imported. Particularly, 14% of mining firm’s operational cost represents the market of general services and maintenance suppliers. Many of the tasks involved within these services require specific equipment, which is also generally imported. The mining equipment market (such as mining trucks, shovels, processing equipment) is dominated by only a few multinational brands. As shown in the table below, based on the MCH survey for mining equipment in 37 mining firms and 22 service suppliers operating in Chile (EDITEC, 2009), it is evident than only a few MNCs have control over the principal equipment in the different stages of the mining value chain. This summary only accounts for the total number of equipment provided by each brand, but not the total value.
A report by the U.S. Department of Commerce aimed to highlight the on-going increase in the Chilean mining market and the opportunities to increase the U.S. supplier’s market share, which by 2012 already controlled with a 40% share (U.S. Commercial Service, 2013).
Linkages towards downstream higher value industries
The size of the downstream linkage is associated with the share of the copper production that is refined and used in the local manufacturing sector. Using available data from COCHILCO for the 2000-2013 period, it becomes evident that this linkage has failed to achieve it full potential. Less than 50% of the copper production is refined locally, and with an almost inexistent higher value industrial sector (average 1.3% of the total locally refined copper sold to local manufacturers). As the case of the upstream linkage, no increase of the share of the market opportunity has shown to increase in time, even with the increase of the local copper production. Therefore, the second mechanism of development has failed to achieve it potential in Chile.
What can we conclude on the potential linkages?
The importance to use reliable magnitude of values is to establish size of opportunities and missed-opportunities. The goods and service supplier sector showed an increase in numbers and size, as the increasing copper production required so. Over 5,000 suppliers are able to account for over 90% of the mining sector requirements. This is identified as a successful side-stream linkage. However if specialized mining and mineral processing equipment is separated from this group and taken into account as an upstream linkage the impact is quite different. I suggest that only around 7% of the potential size of this sector, of a total estimated of MUS$ 4,000, is produced locally. Furthermore, this value has not seen to vary even while new supplier firms are created and production of mining firm increases. In other words, upstream linkages and therefore the first mechanism for growth have failed to occur in the Chile, or its impact has only be marginal.
As mentioned, the successful side-stream linkage does not necessarily entitle a development mechanism. The findings suggest that the larger proportion of goods suppliers is imported and therefore not granting a large share of earnings locally. In the case of services suppliers, the evidence suggests also an import-dependency to equipment and with low human capital. Services focus on labor intensive and low-skilled activities. One sector however shows to be different, which is the engineering and consulting services (following the categorization suggested by Innovum surveys). Although its size is difficult to quantify, it undoubtedly offers services across the mining value chain and during the different stages of projects development. However this category only represent the 10% of total mining suppliers in Chile, and multinational firms with local offices represent an important share of the market.
Continue to Part III
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