Competitiveness and Trends for the Mining Sector in Argentina in 2019

Competitiveness and trends for the Mining sector in Argentina in 2019

Mining

Abril 2019

____ kpmg.com.ar Competitiveness and trends for the Mining sector in Argentina in 2019

Introduction

Over time, Mining has remained as one of the sectors carrying sheerer weight in the national productive framework, since it is developed within a territory rich in natural resources and because, despite the present stagnation –closely linked to the investing behavior and the international prices– it is key to achieve the sustainable development of the other economic activities, mainly, in the manufacturing and construction industries. As indicated in the 2018 report about the sector (KPMG, 2018)1, the Mining industry, understood as the business involving all activities aimed at the extraction of metallic minerals, stones for construction and hydrocarbons, provides 3% of Argentina’s GDP and 6% of total national exports (that is, about USD 4.0 billion). These figures drop by 1% and 1.3%, respectively, when hydrocarbons and fuels are not considered in the total estimate, and only the production of metallic minerals and stones for construction is included. In addition, the results of the Input-Output Matrix prepared by the National Institute of Statistics and Census (INDEC)2 shows that while Mining is one of the largest generators of indirect employment – around three indirect positions per direct position created by the sector–, most of its gross production value is demanded as supplies of other economic activities, which underlines the importance of this sector for the local economic growth.

Mining, as most of the economic activities based on extraction and/or production of commodities, depends heavily on international prices. Thus, when the price of minerals goes up or climbs, capitals flow directly to the sector, either as investments in the regions where the business shows the best internal conditions for development, or as an increased speculative demand inherent to these markets, and in which the financial disbursements would be driven by higher yields compared to other assets, such as bonds, bills and other debt securities. Actually, two specific situations that took place in 2018 are worth mentioning, which determined the downward trend of the price of most of the mining commodities over most of the year: i) firstly, the economic slowdown in China (from an annual average growth rate of 14% to less than 7% over the last ten years), one of the countries providing the greatest boost to the international demand for

1 “Some relevant issues for the mining sector in 2018”. KPMG Argentina, January 2018.

2 “Input-Output Matrix Argentina 1997”. Ministerio de Economía, Secretaría de Política Económica, Instituto Nacional de Estadísticas y Censos (INDEC).

commodities. This meant a big impact on these markets, which contributed to the stagnation of the price of minerals, such as gold, copper or silver during the year; ii) secondly, the appreciation of the US dollar as a result of the increase in the benchmark interest rate by the US Federal Reserve (US FED) in September 2018 and the ensuing backward step in the speculative demand for commodities. These two situations together with the fall in global demand contributed to the unsteady, even downward, trend in the price of these assets during the first half of the year. Although the US FED has recently announced that it does not expect to raise interest rates during 2019, should this be the case, such decision may impact the US dollar exchange rate and promote a new depreciation of the emerging and developing countries’ currencies as a result of the outflow of capitals from these countries and an increase in assets denominated in US currency. This situation will also bring about an erosion of commodities as speculative instruments and the ensuing drop in their prices, mainly, minerals, such as gold and silver.

Figure No. 1 Changes in main minerals prices. 2008-2018

Gold Silver (USD/ounce) (USD/ounce) 2.000 40 1.250,4 35 1.500 30 25 14,8 1.000 20 15 500 10 5

0 0

2008 2011 2014 2017 2018M03 2018M06 2018M09 2018M12

Nota: i) dado que el litio es un mineral que no cotiza en el mercado de valores, no se poseen datos oficiales sobre la evolución de su precio, como sí sucede con el resto de los minerales expuestos en la figura; ii) por falta de recurrencia mensual, los precios para el litio son presentados con periodicidad anual; iii) la cifra del precio del litio para el año 2018 es una estimación construida a partir de la consulta con referentes del sector. Fuente: elaboración propia en base a Banco Mundial y Metalary.com, 2019.

Copper Lithium (USD/Tons) (USD/Tons LCE)

10.000 12.000 10.000 8.000 6.075,3 10.000 8.000 6.000 9.100 6.000 4.000 4.000 2.000 2.000

0 0

2008 2018 2008 2011 2014 2017 2018M03 2018M06 2018M09 2018M12 2009 2010 2011 2012 2013 2014 2015 2016 2017

Note: i) As lithium is a mineral not listed on the stock market, there is no official data about the changes in its price, unlike the rest of minerals disclosed in the figure; ii) as there is no monthly information for lithium, its prices are disclosed on an annual basis; iii) the price amount of lithium for year 2018 has been estimated based on information provided by different players of the sector. Source: Prepared by KPMG based on data of the World Bank and Metalary.com, 2019.

Actually, as noted in Figure No. 1, while the price of gold increased by 44% in the ten-year period from 2008 to 2017, accounting for USD/ounce 1,257; during year 2018, it showed a downward trend from the average quoted price of USD/ounce 1,330 in January to USD/ounce 1,250 in December, which meant a 6% fall in the price of such mineral over the year. Something similar occurred to silver and copper, metallic minerals that showed a 14% drop in their prices between the first and last month of 2018. Unlike the abovementioned trends, lithium maintained its growing trend. Boosted by the growing share in the lithium-ion batteries, which currently account for 50% of the use of this mineral, the price of lithium carbonate has been showing a rapid growth over the last two years. In 2017, the average price amounted to USD/Tn. 9,100 and in 2018, it was estimated in the amount of 10,000. Thus, it became the “trendy” mineral, while it opens up a real development opportunity for the countries of the region, such as Argentina, Chile and Bolivia, which, together with Australia, have the greatest reserves of this mineral at a global level. Additionally, it should be noted that the Foreign Direct Investment (FDI) is a key factor in Mining both at a local and international level, as the development thereof requires enormous investments and long-term periods for capital amortization, but also, because the high volatility of prices and regulatory changes, mainly in environmental matters, imply a risk that can only be managed by mature companies, highly integrated, with the possibility of getting huge budgets, and usually, of international standing.

In this regard, the net FDI flows to Argentina displayed a cyclical behavior over the last ten years, from a remarkable increase in the period 2011-2012, in the amount of 16.8 billion to a subsequent downward plunge in reply to the exchange restrictions imposed (limiting cross-border transfers, restricting remittance of earnings abroad and the purchase of foreign currency); a situation that started to be improved in year 2016 when the referred exchange restriction was removed. During the same period, net FDI flows to the mining activity followed a pattern similar to the aggregate amount, considering that the sector depends heavily on these investments for the development thereof. In fact, as shown in Figure No. 2, net foreign investment in Mining amounted to USD 4.7 billion in year 2012 (or 28% of total FDI) and fell below USD 1.0 billion in 2014 (5%) and 2015 (1%), or USD 100 million in 2016 (23%), basically as a result of the earnings reinvestment process and the settlement of debts with related companies carried out after the removal of the restrictions mentioned above. Additionally, upon analyzing the FDI destined to our country in the period 2007-2016, it is worth mentioning that: i) although Mining has been the sector that has driven most of the foreign investment in that period (12% or an aggregate amount of USD 12.7 billion), ii) when figures are compared among the mining countries of the region (Peru, Chile, Colombia, Brazil and Mexico), Argentina’s allocation of FDI to Mining ranks below the rest of the countries. Under a scenario in which the production activities weighed in favor of capital flows and fund placement, the poor performance of investments in this sector, during the period analyzed, necessarily implies the existence of important internal obstacles that prevented local production activities from having access to the global FDI. Even though there is no official data about this variable for the last two years (2017 and 2018), as the figures disclosed by the Argentine Central Bank (BCRA) include periods up to 2016 only, there are some indications that help estimate that the FDI allocated to this sector followed the same pattern, which is currently intensified by the high interest rates boosted by the US FED and a context of knockdown prices. All these factors weigh on investment decisions and drive the reallocation of scarce resources towards other type of instruments or financial assets, thus reducing the availability of funds earmarked for real economy and the development opportunities for the sector.

Figure No. 2 Foreign Direct Investment flows to Mining in Argentina. 2007-2016

FDI flows to Mining Aggregate FDI 2007-2016 First 15 sectors (In billions of USD and % of the aggregate (in millions of USD) amount) Mining 12.733 IED Minería 28% 5,0 30% Finance intermediation Deposit collectors 4,5 Share IED 23% 25% Wholesale trade 4,0 Minería Food industry 3,5 19%

20% Chemicals % 3,0 15% 16% Car industry Beberages manuf. In Bn. USD Bn. In 2,5 13% 15% Telecom. 2,0 Mining support 10% 1,5 7% Oil and Gas 5% Retail trade 1,0 4% 5% Pharmaceutical prod. 0,5 1% Common metal manuf.

0,0 0% Radio and TV

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 0 5000 10000 15000

Source: Prepared by KPMG based on data of the Argentine Central Bank (BCRA), Foreign Statistics and Exchange Sector.

With so many limitations at an external level, mainly those relating to the changes in prices and the influence of interest rates on investment flows, the structural competitiveness, understood as the set of factors, institutions and policies that determine the production capacities of a country3, becomes a key element to encourage investments. In this context, the changes experienced by Mining in the local environment during 2019 and over the next years will strongly depend on competitiveness and the business environment of our country. Therefore, this document seeks to show some of the issues that are affecting the competitiveness of local Mining and how they impact on the investments flow towards that sector, in addition to the analysis of the key performance variables to understand their reality or the impact they may have on lithium, as critical subsector for Argentina. To this end, this paper will deal with: i) Mining competitiveness and improvement opportunities, ii) lithium as an example to drive competitiveness and, finally, iii) some considerations for the sector.

I.- Local Mining competitiveness and some complicating factors

In general, the competitiveness landscape of an economy can be relatively measured by a set of economic, institutional and political variables that affect productivity and, therefore, the investments return. The higher the level of these variables compared to the rest of the countries, the better the conditions created for investment and, therefore, for the development of production activities. This definition is intended to exceed the idea, whereby it is ascertained that the significance of a factor (e.g. natural resources) is a sufficient condition for the sustainable development of a production activity (in this case, primary or extractive). The initial existence of a factor provides certain comparative advantages, which, a priori, determine the production possibilities or opportunities of an economy. However, for an economic activity to be sustainable,

3 This is the definition provided by the World Economic Forum (WEF), organization that measures the countries competitiveness since 1979 by means of its Global Competitiveness Index (GCI).

the given (or natural) conditions should be added to other above the ordinary elements that may have a positive impact, for instance, clear and coherent regulations, political and economic stability, a taxation system with no disincentive effects, the implementation of tax benefits and access to financing, established institutions and a developed infrastructure to ease transactions and reduce the costs of companies, among others. All these elements help improve productivity of the economic sectors in order to attract investments, operate with efficiency and be competitive.

Figure No. 3 GDP or gross value added (GVA) of Mining in Argentina. 2008-2018

Mining GVA (In millions of pesos of 2004 and a year-on-year % variation)

6,0 VAB Minería 25%

VAB (Var.% i.a) 20% 5,0 4,4 4,5 4,1 15% 4,0 10%

3,0 5%

GVA 3% % Var. % 0% 2,0 -5% 1,0 -8% -10% -9%

0,0 -15%

2017 2008 2009 2010 2011 2012 2013 2014 2015 2016 III Trim2016 III Trim2017 III Trim2018

Note: As there is no data available for the last quarter of 2018, the chart includes the comparison of the third quarters of years 2016, 2017 and 2018. This comparison shows that, in real terms on a year-on-year basis, the third quarter of 2018 showed a GVA drop by 9% compared to the same quarter of 2017, akin to the drop observed in 2016. Source: prepared by KPMG based on data published by the Argentine Ministry of Treasury and INDEC.

From the local viewpoint, the lack of cohesion between these elements has been one of the main determining factors of the poor performance of the economy, in general, and of the primary sectors, including Mining, in particular. Actually, the impairment noted in the international prices as a result of the drop in the demand of countries highly engaged in these markets, as is the case of China, and the increase in risk-free interest rates boosted by the USA monetary authorities (US FED), provided additional internal elements unrelated to the market that helped discourage investments, thus affecting Argentine Mining earnings during 2018.

Accordingly, as shown in Figure No. 3, the gross value added (GVA) of the Mining sector4 stated in prices in constant currency have displayed cyclical variations over the last ten years, thus evidencing the low growth achieved during the period at issue (average, annual, ~2% in 2008- 2017). Along the track followed by the GVA of this sector during the first ten years analyzed

4 Extraction of metallic minerals and exploitation of mines and quarries not previously classified out of INDEC measurements.

(i.e. from 2008 to 2017), but mainly on the quarter-by-quarter comparison, the different internal and external events that shaped the sector –while acting, in some occasions, as opposing forces– can be noted. Thus, the acceleration and increase in international prices of most of the commodities –a process that continued up to year 2012 and that externally drove the global investment towards the primary activity– faded out locally, upon the political and institutional uncertainties, the macroeconomic problems (such as cost and price inflation), tariffs and several local restrictions on the purchase of foreign currency or the remittance of earnings abroad, among others. At present, the end of this cycle and the subsequent price plunge (a situation that took place when the main markets for these goods started to slow down their growth) were, together with a high interest rate environment, the biggest determining factors for the recent performance of Mining at a global level.

However, locally, the different measures implemented to boost the development of Mining and other sectors, basically involving tradable commodities in a context of knockdown prices, such as the removal of the restrictions on exchange transactions and export tariffs in 2015, or the implementation in 2017 of the Federal Mining Agreement (AFM) –which was observed by the Argentine Association of Mining Companies (Cámara Argentina de Empresarios Mineros/ CAEM) mainly in connection with the assessment of royalties and other matters not considered relating to the competitiveness of the sector5–, did not have the expected impact and were unable to halt the trend of the last years; a situation specifically existing in 2018, when the export duties were reinstated and expanded (mainly affecting the metallic mining) and which suspended the ambitious investment program involving the public-private participation (PPP). This was a plan intended to foster the development of necessary infrastructure, which was suspended as a result of the increase in the costs of the international credit as from September 2018 as well as the local increase in country risk (that climbed to 700 basis points in December 2018). This situation fully impacts the non metallic Mining sector, particularly in the production of stones for construction and delivery of concrete.

Although since 2016 a lot has been done to improve the internal conditions and drive investment flows, the political, social and economic reality have meant major obstacles that have slowed down the rate of changes, which gave rise to throwbacks adversely affecting the operating costs of companies and, therefore, investments.

Before analyzing the main elements that affected the local competitiveness of tradable sectors, mainly Mining, it is important to consider which the fundamental pillars are on which structural competitiveness relies and how this index has changed in the case of Argentina. To this end, the Global Competitiveness Index (GCI) of the World Economic Forum (WEF) is applied. The GCI measures the structural competitiveness of countries by weighting a set of more than one hundred (quantitative and qualitative) variables organized into 12 pillars that account for aspects that determine productivity and the existing conditions for business and production development. Based on the findings from the WEF analysis, Argentina ranked 92nd among 137 economies for period 20176, which meant an improvement of 12 points away from the findings for year 2016 and 14 from the findings for year 2015.

5 “El gobierno firma un nuevo Acuerdo Federal Minero”, TELAM, junio de 2017.

6 Although the last available GCI report dates from 2018 (2018-2019), and considering that such version changed the pillars and compilation methodology, we decided to use the prior version (i.e. for 2017-2018) to make the comparisons with the prior reports.

Although progress was made in almost all aspects assessed, those achieved on the Institutions pillar were the most important, basically due to the shift implied in the change of government in December 2015 elections, and a political profile quite far from that prevailing up to such year. The Technological readiness pillar has also shown progress based on the measures adopted by the current government to boost the import of capital assets and technology. The Financial Market Development and Goods Market Efficiency pillars have also improved, since, the removal of the restrictions on exchange transactions, the limitations on cross-border transfers and the export duties affecting, mainly, the agribusiness and Mining sectors acted as great incentives to the development of production, at least, at the beginning of the current administration. As noted in Figure No. 4, progress in competitiveness was not impressive, as other mining countries, such as Australia or Canada, are better grounded and have material advantages to drive more investments towards the development of their Mining sectors, as well as other countries of the region, such as Chile and Peru, which display better scores in almost all pillars compared to our country.

Figure No. 4 Competitiveness and Pillars. Comparison with other countries. Year 2017

Competitiveness Pillars (GCI, 2017). Competitiveness Pillars (GCI, 2017). (score, 1 - 7) (score, 1 - 7)

Institutions 8 Institutions Innovation Infraestructure 6 Innovation Infraestructure 6 4 Business Macroeconom Business 4 Macroeconomy Development y Development 2 2 Health and Health and Market Size 0 Primary Market Size 0 Primary Education Education

Access to Higher Access to Higher Tech. Education Tech. Education Finance Market Goods Market Finance Goods Market Development Efficiency Market Efficiency Labor Market Development Labor Market Efficiency Efficiency

Argentina Australia Canadá Argentina Chile Perú

Source: prepared by KPMG based on The Global Competitiveness Report 2017-2018, World Economic Forum (WEF), 2017.

Regarding 2018, the analysis conducted by the WEF shows a new throwback in the local competitiveness compared to 20177 findings. In general terms, different events affected such findings. Firstly, the economic activity shrank more than 2% compared to 2017, since during 2018, the worst drought over the last 50 years affected not only the local primary production but also the industry, the exports and the inflow of foreign currency. Secondly, in addition to the international

7 The calculation methodology used to assess the competitiveness of the economies was amended in the 2018 GCI. Therefore, in that report, the 2017 positions achieved by the countries were revised in order to make a comparison on a valid base. In such edition, it is noted that Argentina lost two positions with respect to the 2017 assessment, and ranked 81st.

turmoil caused by the US FED decision of increasing the interest rates (which meant an increase in lending, a downward pressure on prices of commodities and a financial drain, mainly in emerging and developing economies), the government’s need for consolidating the public finances, decreasing the inflation level and obtaining financing, together with the widespread speculation impacting the US dollar and the interest rates, resulted in an agreement with the International Monetary Fund (IMF) to obtain a SBA loan (Stand-by-Agreement). Such loan was intended to operate as a mattress for the exchange market but, actually, meant that the Government was unable to reach the fiscal goal set (i.e. a 0% primary fiscal deficit of GDP by the end of 2019) and the related reorganization of the national budget. This scenario required a restriction on current expenses (wages and salaries and hiring of personnel) and on capital (public works), as well as an increase in revenues (fewer current transfers and new taxes, such as the reinstatement of export duties). At first sight, these findings evidence that competitiveness in Argentina still requires hard work. This reality also implies a set of improvement opportunities, which in the short to mid-term may be implemented if some elements and variables are redefined or improved, which are key to the development of the Mining industry.

Among the elements and variables that specialists commonly consider as affecting performance of any activity, but mainly Mining, are labor productivity, unit labor costs (driven by wages and salaries), tax burden, transportation-logistics costs and the quality of infrastructure and, finally, regulation.

The labor productivity of the Mining sector, that is, the estimated quantity of product generated by a direct employee during a given period of time (one year, for instance) has shown, over the last decade, a behavior not far from that of the gross added value of the sector displayed in Figure No. 2. In fact, the changes displayed by this performance variable in Figure No. 5 account for the impairment process suffered by the local Mining industry over the last ten years. In a context featured by the drop in the international prices of minerals and an upward trend in costs stated in US dollars–mainly wages and salaries, which, locally, showed an average increase of 120% in US dollars from 2008 to 2017–the productivity performance, which evidenced a decreasing trend since year 2010, was impacted not only by the external conditions but also by other internal elements of continuing existence. The most significant, among others, are disputes between employers and labor unions, strikes and halts that delay production and regular development of the activity, and to a great extent, lack of skilled human resources, mainly in the technical areas. However, the considerable devaluation of the Argentine peso in relation to the US dollar during 2018 and the ensuing erosion of wages and salaries stated in US dollars improved the ratio of this variable to the productivity of the sector (since, most of production is destined to the foreign market), which was translated, as shown in the second chart, into a decrease in the unit labor cost (ULC).

The ULC represents the cost of labor incurred by the sector per unit of output produced (in this case, the amount of wages and salaries in USD required to obtain one dollar of output). Thus, an increase in this measure indicates that the sector or the economy becomes more expensive or is less efficient (less competitive), while a decrease in this measure implies the opposite (more competitive). In the case of the Argentine Mining sector, after years of displaying an upward trend in ULC (a 70% increase in US dollars from 2008 to 2017), in 2018, an inflection point was crossed when the ULC fell by 9% in US dollars. However, such decrease was viewed as a short-term competitive improvement, as it was explained by the Argentine peso devaluation and not by the necessary reforms required by the sector, which would enhance long-term efficiency and productivity and entail a dramatic change in the Mining industry competitiveness.

Figure No. 5 Productivity, Wages and Salaries and Unit Labor Costs in Mining 2008-2018

Labor productivity at constant prices and Unit labor cost (ULC) wages and salaries in USD (Productivity (Cost in USD per US dollar produced by index 2008=100 and wages and salaries in employee) thousands of USD) 140 Productividad Salarios 3,5 0,25 Minería Total

130 3,0 0,20 2,5 120 0,15 2,0 110 1,5 0,10 100 1,0

Productivity (100=2008) Productivity 0,05

90 0,5 Cost in USD per dollar of product of dollar per USD in Cost

80 0,0 0,00

2017 2008 2009 2010 2011 2012 2013 2014 2015 2016 2018

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Wages and salaries in thousands of USD of thousands in salaries and Wages

Note: i) Labor productivity was estimated by dividing the GVA at 2004 prices corresponding to the Metallic Minerals and Exploitation of Mines and Quarries not previously classified by the registered private employment of the sector; ii) the ULC was estimated as the ratio between the salary for registered employees and the monthly productivity obtained in i), both measures stated in US dollars. Source: prepared by KPMG based on Argentine Ministry of Treasury (MECON), INDEC, Argentine Ministry of Production and Labor, Observatorio de Empleo y Dinámica Empresarial [Employment and Corporate Dynamics Observatory/ OEDE)], 2019.

Another high impact element in the performance of any activity and amounts of investment is the tax burden. The tax structure applied by the Government is usually a more than material item in the companies’ costs when the tax burden is high –that is, the revenue-taxation ratio–, particularly, when such remittances from the private sector to the public sector are not translated into tax benefits to boost production and investment, or they are not earmarked for infrastructure to improve connectivity, transportation and general conditions for the development of the activity. All this would mean lower operating costs, economies of scale in production, and, as a result, better levels of productivity and competitiveness. In the Argentine Mining sector, the tax burden is really high and it is expected to increase in 2019, after the reinstatement of the export withholdings regime, repealed in December 2015.

As noted in Figure No. 6, in 2017, the estimated contributions of Mining to the tax authorities exceeded the aggregate amount of $15 billion, including the federal and provincial taxes, as royalties, income tax, turnover tax, social security contributions and withholdings, value-added tax, provincial rates, fees and other. This amount accounted for 20% of Mining revenues; an amount that started to decrease in 2013. At least, this situation lessened the burden. Although there is no accurate information for 2018 based on the unavailability of information in the sources inquired (mainly the Argentine Tax Authorities –AFIP), it is estimated that the contribution of the Mining sector to the national budget was substantially higher than that for year 2017, since the related Argentine peso devaluation–in such year–helped increase earnings from exports, with the related effect on a higher income tax payable.

Figure No. 6 Taxation on the Mining sector 2010-2019

Tax burden on the mining sector (In millions of pesos and % of revenues) 25.000 35% 29% 29% 27% 27% 30% 20.000 22% 23% 25% 20% 15.000 19% 20%

15% 10.000

10% 5.000 5%

0 0%

2010 2018 2011 2012 2013 2014 2015 2016 2017 2019

Aporte al SP Presión Tributaria

Note: i) Contributions for years 2018 and 2019 were estimated based on data included in the report of “Mining Variables”, October, 2018 (CAEM-ABECEB); i) to that end, in order to clearly evidence the tax burden on the sector, the estimate for 2019 was considered without including the export duties (23.3%) as an approximation for 2018; and ii) the projected amount including the export duties as an approximation for 2019 (28.8%). Source: prepared by KPMG based on “Report of Mining Variables” issued by CAEM-ABECEB, October, 2018.

Moreover, it is expected that after the reinstatement of export duties, which, in the case of Mining, accounts for an additional contribution to the Tax Authorities of $ 4 for each dollar exported until 2020, the contribution of most of the primary sectors to the Tax Authorities will Increase significantly during 2019. In fact, private8 estimates confirm that the inclusion of export duties could increase the tax burden on Mining to approximately 29% in 2019, since tariffs would account for around 5.5 percentage points in addition to the estimated amount not including these duties.

Even though it is worth mentioning that these estimates were made by assuming the full implementation of projects in progress, the inclusion of these new taxes, the elimination of which had acted as an important incentive to Mining investment and production, mainly in relation to lithium, might pose a risk to the continuity of certain exploitation activities, affecting the business and, ultimately, tax collection.

Logistics and transportation costs and those related to the quality of the existing infrastructure to facilitate trade constitute another obstacle for the improvement in the competitiveness of the Argentine economy, particularly Mining. In this regard, the World Bank has developed an index intended to measure the logistics performance of the countries by surveying and weighing data related to the quality of logistics services, the ease of arranging competitively priced shipments, the efficiency of the customs office, timeliness of shipments, the ability to track and trace consignments and, finally, the quality of trade and transport related infrastructure. In general terms, the Logistics Performance Index (LPI) is a well-known indicator published biennially by the World Bank that measures the degree of efficiency with which the supply chains of the

8 “Reporte de variable mineras”. CAEM-ABECEB, October 2018.

countries connect companies with local and international opportunities. Thus, high ratings shown by this index mean a better quality in logistics and transport, which allows reducing time and commercial costs faced by companies, as well as being more competitive in this regard.

In this sense, logistics has become key to ensure the continuity of Mining exploitation, since the activity is not currently limited to the operation but must cover many other aspects related to management up and down the chain, being transport management essential to the adequate movement of finished products, supplies and raw materials from and to other locations, particularly taking into account that the requirements to be met by the sector in terms of sustainability, safety and environmental care restrict the business to locations far from urban centers and points. This scenario results in an increase in operating costs borne by mining companies and, therefore, the need to optimize them. Upon improving logistics costs, decisions on the means of transport used are important, and so is scheduling the route to be covered, always in line with standard criteria in terms of delivery times, transport costs and safety, among others. In this regard, transport logistics and infrastructure are also significant, and they do not depend entirely on companies developing mining activities, but mainly on governments, which ultimately decide to provide for proper regulatory frameworks and efficiently or inefficiently allocate resources and investment to facilitate the business.

Taking into account the previous comments and how logistics and transport affect Mining, Figure No. 7 shows the variations in the LPI for Argentina and the main mining countries of the region, as well as a comparison of the index items and its performance in 2007 (first data available) and 2018 (last data available).

Figure No. 7 World Bank Logistics Performance Index 2007-2018

Logistics Performance Index. Selected Breakdown of Logistics Performance countries Index: Argentina (1: low; 5: high) (1: low; 5: high) Perú Argentina Chile 3,40 Efficiency of customs 2018 2007 clearance 3,30

3,20 Infraestructure Quality

3,10 3,05 Logistic Competence 2,99 3,10 2,96 3,00 Logistic Performance 2,89 2,98 2,89 Index (LPI) 2,98 2,90 Shipments at 2,80 competitive prices

2,70 Shipment tracking

2,60 Punctuality of shipments

2,50

2007 2010 2012 2014 2016 2018 1,0 3,0 5,0

Source: Prepared by KPMG based on data of the World Bank, 2019.

As can be seen, the behavior of the LPI for Argentina has shown a downward trend in almost all the period under analysis. In relation to the rest of the countries, Argentina ranked in the 62nd position out of a total of 167 countries evaluated in 2018, while others such as Chile or Mexico ranked among the first 40. Likewise, the poor performance in terms of logistics is basically explained by the deficiencies detected in investments in infrastructure related to trade, quality of customs operation and price competitiveness. At this point, it is also important to note the impact that the suspension of the public-private participation (PPP) investment program could have on the development of works, due to the global increase in credit and the local difficulties posed by country risk, as well as its effects on the various projects agreed intended to gradually solve the chronic infrastructure deficit that Argentina has been facing for years; particularly taking into account the relevance of this plan in a scenario marked by the reduction in capital expenditure implemented by the State as a basic measure for the fulfillment of its fiscal target for 2019. In summary, the poor performance of the index compared to other Mining countries in the region (even worse if compared to the good levels achieved by other off-region countries such as Australia and Canada) limits the competitiveness of the Argentine Mining sector, and this could reduce the share of the activity in the global FDI in a context characterized by the increase in the performance of financial instruments and assets and the resulting decrease in investments allocated to production.

The last aspect that prevents the promotion of competitiveness in the sector is regulation, which, in turn, has to do with other aspects, such as tax pressure, employment conditions and productivity. In this sense, it is important to achieve substantial improvements in the legal and regulatory field seeking to include in the regulatory framework of the activity the necessary characteristics to attract capital and ensure adequate development without major obstacles. In addition to the tax structure and the pressure exerted by the Tax Authorities on the sector, related to regulation, best represented today by the re-implementation of tariffs on exports, the general legal framework currently applied to Mining is the mining Activity Law (No. 24196) of 1993, an old and anachronistic wording demanding fundamental changes in many aspects and that the government seeks to change in the short term to encourage Mining investment in an international context that is not very favorable to the activity. The so-called Federal Mining Agreement (AFM), signed by the majority of the mining provinces (17) and by the national government in June 2017, goes in the same direction as, in addition to seeking the consistency of the legal framework governing the development of activity throughout the national territory, key to determine the business predictability, it seeks to represent all mining provinces taking into account their geological differences and financial ability, as well as the needs inherent to local development and technological advances in environmental matters. In effect, the AFM has a dual objective. First, since the provinces are the legal owners of mineral resources within their territories, it seeks to settle a historical debt in relation to their share in profits from the extraction of minerals, by introducing a change in the method by which royalties are recognized -setting them at a maximum of 3% of the gross production value (GPV)-, and implementing a contribution of 1.5% of the GPV to be paid by operating companies, aimed at creating a development fund for infrastructure works. Secondly, the AFM seeks to standardize the procedures for the activity and to improve the conditions under which it is developed by analyzing and balancing business objectives with social- environmental objectives, and establishing i) the extension of the concession of exploitations until the extracted mineral is exhausted; ii) the stability of tax conditions for a period of 30 years; and, finally, iii) the increase in sanctions imposed on companies not complying with environmental guidelines. Based on this dual objective, the AFM seeks to become the legal framework shaping the activity during the next 20 years, as well as a firm indicator of confidence for the sector and foreign capital.

However, the AFM needs to be considered by the National Congress in order to become a law, but it must wait for the right political conditions in order to move forward. In this scenario, the Mining Department, accountable to the Argentine Ministry of Production and Labor9, has asserted that although the AFM is no longer a priority in the local political agenda, the agreement is currently applied to aspects such as Mining best practices, digital registration, environmental care, mine closing, Glacier Protection Law (No. 26418) and other socioeconomic items affecting the communities where the mining activity takes place. In addition, according to the same source, the AFM seeks to include sustainable development in education, create local employment, ensure a space for small scale Mining and for SMEs in the sector, as well as encourage the use of renewable energy in exploitations. However, the private sector -particularly, the Argentine Association of Mining Companies (CAEM)- has highlighted that the aforementioned agreement does not comply with one of its main guidelines, i.e. to encourage investment and a greater capital flow, since the amendments made in terms of royalties and new taxes have increased the tax burden on the sector and, therefore, caused the opposite effect10.

Despite the fact that today the full development of Mining is prevented due to mainly economic issues (rising inflation, dollar exchange rate and high interest rates, among others), the regulatory framework update is key to make the sector more dynamic, raise its competitiveness and attract a greater flow of investments. Experts agree on the fact that around 60% of the local subsoil has not been explored yet and that, despite the country's mining wealth, the chronic lack of adequate policies oriented to Mining has hindered its sustainable development. Likewise, the persistence of these issues added to the fact that several provinces have not signed the agreement, basically due to the legal barrier preventing them from developing Mining in their territories (such as San Luis, Tucumán or Chubut), have become impossible obstacles to projects which hinder a potential investment on Mining.

II.- The present situation of lithium from the perspective of competitiveness

Lithium is currently a mineral with great potential for local development. Although the performance and evolution of the production value of local Mining is related to the performance of other traditional minerals such as gold, silver or aluminum, in the last years, lithium has substantially increased its contribution to the activity, from 1% of the GVA of Mining in 2011 to an estimated 9% in 2017.

In fact, if the trend in the production of this mineral is maintained in the future, i.e. a scenario of high prices and increases in investment levels, an even more important growth in the production of this

9 “El Acuerdo Federal Minero está frenado en el Congreso”. La Opinión Austral, November 19, 2018. https://laopinionaustral.com.ar/el-acuerdo-federal-minero-esta-frenado-en-el-senado/

10At the same time, the CMEA had proposed certain changes that were not taken into account in the final version of the agreement now awaiting approval and regulation. For example, in terms of royalties, the CMEA promoted a progressive scheme to support the development of investments using a mobile system based on the generation of profits from each mining project and not on sales (see: https://www.cronista.com/3dias/La- mineria-que-viene-Nacion-y-provincias-definen-una-nueva-hoja-de-ruta-20180406-0005.html).

mineral would not be surprising, let alone taking into account the less promising context shown by other traditional minerals in our country, such as gold, silver or copper.

In this new reality, lithium has become an attraction for global investments since the extraction of the mineral is driven by an upward trend in the price in international markets as well as by the incremental weight of lithium-ion batteries (exceeding 50% of the demand today), as a result of the pressure exerted by other productive sectors such as automotive and technology. In this sense, Argentina, together with Chile and Bolivia, is part of the so-called "lithium triangle", a geographic space located at the frontier of these countries and where most of the world reserves of this mineral would be found. As a result of this situation, Argentina is one of the points of greatest attraction for investment destined to the exploration and exploitation of this mineral, which is expected to maintain an upward trend in terms of production and, mainly, export. The current local production, at around 40,000 tons/LCE (lithium carbonate equivalent) is carried out by two companies: the local subsidiary of the US Livent Corporation, member of the FMC group (Minera del Altiplano SA), which works in the salt flat Hombre Muerto in Catamarca, and the local Sales de Jujuy operating in the salt flat Olaroz in the province of Jujuy. In addition, to date, there are several projects undergoing feasibility or even earlier stages, these two companies may be joined by Minera Exar (including Lithium Americas and SQM), which is building exploitation premises in the salt flat Cauchari-Olaroz in Jujuy; and Rincon Limited, which has strong intentions to invest in the salt flat Rincón in Salta.

Figure No. 8 Changes in exports of lithium in Argentina 2018-2022 Projection (In million dollars and in % of mining and fuel exports)

Exports of lithium (in millions of USD and as a % of mining and fuel exports)

Lithium Lithium (as % of mining and fuel exports) 2.500 10% 9,0% 9% 2.000 7,6% 8% 7% 1.500 6,5% 6% 5% 4,0% 1.000 4% 3% In millions of dollars of millionsIn 1,8%

500 2% fuel and mining of a % As 1,1% 1,0% 0,8% 1%

0 0%

2016 2008 2009 2010 2011 2012 2013 2014 2015 2017 2018 2019 2020 2021 2022

Source: Prepared by KPMG based on data from the Argentine Ministry of Treasury (MECON), INDEC and Argentine Ministry of Energy and Mining (“El Litio, una oportunidad”, Subsecretaría de Desarrollo Minero, Dirección Nacional de Promoción Minera, 2018).

The 40,000 tons of current production account for around 17% of world production, which in 2017 reached 234,000 tons/LCE. By 2019, specialists estimate that the local production of this mineral could reach the range of 60,000-90,00011 tons, with an upward trend that would enable a multiplication of the output of this sub-sector by several times, to exceed 300,000 tons in 2022. Regarding exports, if it is assumed that the growth rate of foreign sales of the mineral in the first seven months of 2017 and 2018 is extended to the whole year, estimated foreign sales of lithium would have exceeded the amount of USD 250 million (in 2018), or would have gone from 6% to 9% of total exports of minerals and fuels, which in 2018 reached an estimated amount of USD 4 billion (see Figure No. 8). In line with the projection of local production for 2022, it is estimated that lithium exports will follow the same path, reaching figures above USD 2,000 million that year.

However, it is important to note that these projections were made prior to the occurrence of certain local and international events that currently have an impact on Mining and could have an effect on the production of lithium during 2019 and incoming years. In particular, it should be noted that the reinstatement and generalization of the export tariff scheme that had been repealed in December 2015 will have a recessive effect that will not be easily offset against the current exchange rate policy (which seems to be more intended to solve the high inflation of prices and costs than to maintain a high exchange rate to ensure the profitability of tradable sectors). Likewise, the evolution of prices remains a determining factor. In this regard, although the price of lithium has kept an upward trend in the last years, the recent increase observed in benchmark interest rates, a decision taken by the US FED, could have a negative impact on its future evolution, taking into account that such a decision re-assigns global investment flows, causing capital transfers from the commodity markets to other assets and financial instruments. Finally, it is important to weigh the competitiveness factors already mentioned and that could also play to the detriment of lithium, mainly in terms of regulation, infrastructure and logistics costs.

III.- Final considerations

Mining, like other local productive activities, has evidenced a limited development in recent years in response to a series of internal and external events preventing it to fully exploit the opportunities offered to the activity in Argentina. Added to the downward trend in the prices of minerals, due to a substantial drop in international demand, certain local events, both political and economic, have had an impact on this activity, mainly in 2018.

In the external area, it is important to understand that the change induced by the US FED in the monetary policy and the consequential increase in interest rates in the short to medium term will bias the investment flows towards financial instruments and assets, thus retracting demand and prices of commodities in most international markets. This situation could lead to a significant deceleration in global funds allocated to productive investment, thus increasing the selectivity of FDI and the competition of mining countries to obtain investments in their territories. With so many

11The projection made by the Argentine Ministry of Energy and Mining (currently accountable to the Ministry of Treasury) as to the maximum production capacity of lithium for 2019 in “El Litio: una oportunidad” (2018), was estimated at around 62,000 tons / LCE. However, more recent estimates would place the aforementioned estimate at 90,000 tons.

limitations externally, the competitiveness of the countries becomes key to the local development of Mining. In this sense, in Argentina, the Mining sector and most of the productive activities require structural reforms that may in the medium term bring substantial and permanent improvements in productivity levels, provided that the country has recorded low qualifications in relation to its competitors, both in terms of structural competitiveness (WEF) and in relation to the analysis of performance variables.

Thus, it is important to note that, in addition to the low production levels observed in recent years considering production per employee (labor productivity), the sector urgently needs a radical change in tax matters, in such a way that the tax pressure may be relieved. In 2019, taking into account the weight of tariffs on exports, tax may reach 29% of revenues.

It is true that the Argentine economy is undergoing a transition period in economic matters, mainly in relation to the effects that fiscal targets have on public investment and current expenditure, which would not allow the government to take measures in the short term intended to correct this impact and mitigate the consequential delay in the development of infrastructure works (mainly in transport and logistics), necessary to improve the conditions in which these activities are carried out.

Finally, a regulatory reform to update and define the regulatory framework of the activity for the incoming years is important. Although this has been the intention of the government when signing the Federal Mining Agreement (2017), the fact is that the agreement has not yet been able to become a law, because it has not been discussed and approved by the National Congress. It should also be pointed out that it is unknown whether all the mining provinces will give their consent to the agreement because, first, certain legal impediments would limit mineral extraction in some of them and, secondly, as these provinces argue, the benefits offered by the AFM in terms of promoting investment and the development of the sector would not be entirely clear.

Taking these factors into account, it is clear that the opportunities for the sector in Argentina are as important as the actions to be taken in relation to competitiveness. It is also worth noting that the political factor will have a significant weight during 2019, since the elections scheduled for the end of that year bring uncertainty to the combined expectations of the majority of the productive sectors. This implies that Argentina must wait until the confirmation of trends to gain a better relative position and address the issues of each sector, and promote improvements in competitiveness. For the time being, efforts should continue to be focused on the development of lithium since this mineral is now a cornerstone that enables local Mining to keep its international presence, add weight to global performance and, above all, envision a better future.

References

CAEM, “La minería en Argentina. Incrementar competitividad para aprovechar su potencial”. CAEM-ABECEB, January 2017.

CAEM, “Reporte de variables mineras”, October 2018. CAEM-ABECEB, October 2018.

CAEM, “Litio. Situación actual y potencial en Argentina”. Cámara Argentina de Empresarios Mineros (CAEM), 2019.

INDEC, “Input-Output Matrix Argentina 1997”. Argentine Department of Economy, Ministerio de Economía, Secretaría de Política Económica, Instituto Nacional de Estadísticas y Censos (INDEC).

KPMG, “Some relevant issues for the Mining sector in 2018”. KPMG Argentina, January 2018.

MINEM, “El Litio: una oportunidad”, Argentine Department of Energy and Mining, Subsecretaría de Desarrollo Minero, Dirección Nacional de Promoción Minera, 2018

MINEM, “El Litio: una oportunidad. Estado de situación. Perspectivas. Mercado”, Argentine Department of Energy and Mining, Subsecretaría de Desarrollo Minero, Dirección Nacional de Promoción Minera, 2017

MINEM, “Competitividad y atractividad de inversiones de la minería argentina”. Argentine Department of Energy and Mining, Subsecretaría de Desarrollo Minero, Dirección de Economía Minera, Dirección Nacional de Promoción Minera, December 2017.

WEF, “The global competitiveness report. 2017-2018”, World Economic Forum, 2017.

WEF, “The global competitiveness report. 2018”, World Economic Forum, 2018.

Authors Mario Belardinelli Mining lead partner KPMG Argentina

Matías Cano Economist Clients and Markets KPMG Argentina

Diego Calvetti Energy and Natural Resources Lead Partner, KPMG Argentina

kpmg.com.ar

@KPMGArgentina

KPMG Argentina

KPMG Argentina KPMG AR Talentos

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