From a Special Correspondent*

Papua New Guinea suffers chronically from the way in which state equity participation is negotiated in major resource extraction projects.

A combination of the worst possible behaviour from international resource companies, which is as bad in PNG as it is in any country in the world, abetted by the incompetence of the National Government in negotiating equity participation, means that PNG ends up seeing its resources shipped offshore with the lowest possible returns to the Nation.

Take Nautilus as an example.  When Nautilus agrees to allow Government to purchase 30% of the equity they are not offering 30% of Nautilus Minerals Inc., they are offering 30% equity in the Solwara 1 project.  This is a critical distinction.  Solwara 1 is a project.  It is not a company. Nautilus Minerals, Inc., is the company that realises the cash flow. Solwara 1 is a project that will not make money (just as Lihir never declared a profit for thirteen years while the parent company made billions).

In the press release Nautilus Minerals, issued on January 17 it says:

The mining lease has been granted for an initial 20 year term and the PNG Government has retained an option to take up to a 30% stake in the Solwara 1 Project as a joint venture partner. If the option is exercised the government will contribute funds to the project in proportion to its interest, including its share of the exploration and development costs incurred to date.

This clearly means Government is investing in the project, and not the company. It also means Government is committing itself to contributing “funds to the project in proportion to its interest” (to quote the press release).  That means 30% of the costs.  Costs.  Not profits. Further, Government is committing to paying its share of “exploration and development costs incurred to date” - in other words, we have to absorb 30% of the costs ALREADY incurred, and these costs can be massively inflated with very little effort.  There is nothing that talks about a return to Government – no promise of profit.  To the contrary, there is nothing but liability for Government in this agreement.  The basic concern is that Government is investing in the project, and not in the company.  The cash flow is through the company, not the project.  That is where the money is made, and Government has neither equity nor prospect of equity in the company.

It is very simple. Just ask Nautilus to give us equity in Nautilus Minerals Inc. and see what they say. Solwara 1 is not a publicly listed company.  It is what is commonly referred to as an illiquid stock. The stock of Solwara 1 is not valued off the public equity but, instead, off a speculative estimate on Solwara 1, which affects the Nautilus share price, something in which Government does not have the prospect of an equity stake.  Solwara 1 is not publicly traded.

It is no accident that within a week of the signing of the agreement Nautilus Minerals Inc., issued a press release (January 25th) talking up the potential returns of the project.  This is standard operating procedure – it increases he stock price of the publicly traded company – Nautilus Minerals – based on the underlying asset – Solwara 1 – and provides huge cash flow to the company as shares increase in value, but none of this is realised by Government which has a position – or is contemplating such – in Solwara 1 and not Nautilus Minerals, Inc.

That the project will not make money is patently obvious.  It has happened over and over again not only in the Pacific, but around the world.  This is a scam.  Not only is the project not the publicly traded entity, it has to purchase materials, equipment, goods, supplies, and a range of other items from companies which are usually fully-owned subsidiaries of the parent company. All of these subsidiary companies can easily inflate their prices and transport costs, thereby ensuring the PROJECT does not make money, but ensuring that the profits flow to the PARENT COMPANY since it owns the subsidiaries. Overall extraction costs can be inflated easily, and these costs are absorbed by the project.  Again, this is standard operating practice, and National Government does not appear to have the slightest clue this is going on.

Further, since Government will inevitably be forced to borrow money to finance the equity position, it will be liable for something between 15 and 18% finance charges for the borrowing, in addition to whatever liabilities the company incurs.  And this payment is being made for an equity position in a project that will almost certainly, on paper, lose money.

This has nothing to do with the advisability of going forward with the project or not, the potential environmental consequences, and so on. It is simply that the way in which they are going forward is foolish and actually opens Government to all the costs of Solwara 1 that Nautilus Minerals chooses to lodge there. The Government is buying liabilities, not profits.

This has happened over and over in PNG, and is now happening in the LNG Project as well.  So the question of management of resources by national government is not only one of corruption, as in the Special Agriculture Business Leases, which are now proliferating, but one of incompetence and, I suspect, disinterest resulting in absolutely terrible deals for all the people of PNG from National Government on down.

*First published on the PNG Mine Watch blog