VZCZCXRO3608
RR RUEHBZ RUEHDU RUEHJO RUEHMR RUEHRN
DE RUEHLS #0080/01 0361005
ZNR UUUUU ZZH
R 051005Z FEB 09
FM AMEMBASSY LUSAKA
TO RUEHC/SECSTATE WASHDC 6699
INFO RUCNSAD/SOUTHERN AF DEVELOPMENT COMMUNITY COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC

UNCLAS SECTION 01 OF 03 LUSAKA 000080 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EMIN ECON EFIN ZA
SUBJECT: MINING SECTOR MALAISE WORSENS 
 
¶1.  (SBU) Summary.  Zambia's mining sector has been hit hard 
by the fall in commodity prices induced by the global 
economic recession.  Responding to pressure from the private 
sector, the Zambian Government (GRZ) has announced its 
intention to withdraw its windfall tax on mining revenue as 
well as make several other small concessions to the mining 
industry.  The gesture is mostly symbolic, however, as the 
windfall taxes do not apply at current price levels, with 
copper prices currently hovering around USD 1.50/lb. 
Although appreciative of this development, mining companies 
remain deeply concerned about the viability of their 
operations in Zambia, given high production and 
transportation costs, inadequate local smelting capacity, and 
the still onerous tax regime.  Although troubled by rising 
unemployment, Mines Minister Maxwell Mwale expressed 
confidence that the sector will absorb these shocks and 
maintain profitability.  He affirmed that the Ministry has no 
intention of nationalizing the closed mines.  End Summary. 
 
Government Withdraws Windfall Tax 
 
¶2.  (SBU) On January 30, Finance Minister Situmbeko 
Musokotwane announced to parliament that the GRZ intends to 
withdraw its windfall tax on mining revenues.  The windfall 
tax had been part of a new minerals tax regime that included 
higher corporate tax and mineral royalty rates.  The taxes 
had been the source of much contention since their unilateral 
introduction in early 2008, with mining companies claiming 
that the new taxes abrogated their (still treated as secret) 
development agreements with the GRZ.  The GRZ's response 
(supported by the World Bank and several bilateral donors) 
had been -- and continues to be -- that the terms of the 
development agreements, which the GRZ had signed to lure 
investment during privatization, had been too generous and 
did not significantly compensate Zambia for its natural 
resources.  According to an industry analyst, the Zambian 
Chamber of Mines had been lobbying for months against the 
windfall tax and had seized the opportunity of lower prices, 
mining closures and downsizing, and a sympathetic Finance 
Minister to push for its revocation.  The Director of the 
Chamber of Mines Nathan Chishimba claimed to emboff that the 
combination of the windfall tax on revenue (vice profits) 
plus variable profit, corporate, and royalty taxes had the 
potential to cost a mining company USD 1.05 for every USD 1 
of revenue, had it been implemented. 
 
¶3.  (U) The windfall tax withdrawal will cost the government 
nothing at present, given that the taxes do not take affect 
until copper prices rise above USD 2.50/lb.  The concession, 
however, marks a symbolic relaxation of the GRZ's mining 
reforms and a recognition of the need to conciliate with its 
mining companies.  During his presentation to parliament, 
Finance Minister Musokotwane also announced that the GRZ 
would allow companies to depreciate their capital investments 
by 100 percent in the first year (rather than by 25 percent 
per year over a four year period) in order to encourage 
mining sector investment.  To reduce operating costs in the 
ailing mainstay of the Zambian economy, Musokotwane said the 
GRZ would cut import taxes on heavy fuel oil (from 30 to 15 
percent), allow mining companies to add hedging income to 
(and presumably deduct hedging losses from) their taxable 
income, and defer value added tax on copper concentrate 
imports from the Democratic Republic of Congo, effective 
February 1st. 
 
¶4.  (SBU) Although the private sector welcomed the moves, 
mining companies remain deeply concerned about their economic 
prospects, particularly given high production and 
transportation costs.  The managing director of Kansanshi 
Mining (a company owned by First Quantum Minerals of Canada), 
told emboff that the new tax structure is still more 
"onerous" than the terms that the GRZ had offered to most 
mining companies in their individual development agreements. 
He also pointed to the 15 percent export levy on copper 
concentrates, making the export of unprocessed copper a 
"money-losing proposition" at current copper price levels. 
Additionally, he noted that existing and near-term smelting 
capacity in Zambia is less than half of that which is needed. 
 Consequently, mines that produce concentrate in excess of 
that which the Zambian smelters can treat will either produce 
less or shut down altogether, he projected. 
 
Mining Closures and Cutbacks 
 
¶5.  (SBU) Mines Minister Maxwell Mwale appears to share 
little of Musokotwane's concern about the impact of the 
global economic crisis on Zambia's mining sector.  In a 
meeting with the Ambassador on February 2, Mwale acknowledged 
that mining companies had been hurt by declining commodity 
prices and that this had sent shockwaves to other segments of 
the Zambian economy.  Mwale, however, said that he believed 
 
LUSAKA 00000080  002 OF 003 
 
 
mining companies could operate profitably at current world 
price levels.  He also maintained that Zambia had spare 
smelting capacity.  Mwale pointed to petroleum prospecting in 
Northwestern, Eastern, and Southern Provinces as well as 
impending uranium production.  He speculated that this would 
be particularly feasible for Equinox's Lumwana Copper Mine, 
which he said intends to extract uranium mineralization in 
order to produce uranium oxide ("yellowcake").  (Note:  In 
early January, Lumwana announced the postponement of its 
uranium treatment plant, due to difficulties securing project 
financing.  Lumwana, however, will continue to stockpile 
uranium-bearing material for potential processing at a later 
date.  End note.) 
 
¶6. (SBU) Mwale opined that many of Zambia's mining companies 
had priced their investments according to historically high 
prices, rather than industry averages, and had been operating 
inefficiently.  He projected that this was particularly true 
for Luanshya Copper Mines (LCM), a joint venture between 
Swiss-based International Mineral Resources and Ben Stein 
Group Resources of Israel, which closed its operations in 
December 2008.  According to Mwale, LCM had been outsourcing 
much of its operations, which become economically untenable 
after the fall in metals prices.  Mwale opined that LCM's 
transfer pricing arrangement for smelting services from its 
affiliate, Chambishi Metals, had been to LCM's disadvantage. 
 
¶7.  (U) Mwale expressed regret about the unemployment 
resulting from LCM's closure, pointing to the ripple effect 
on mining service providers.  He estimated that LCM's closure 
may result in as many as 6,300 lay offs, consisting of 1,300 
LCM employees and perhaps 5,000 contractual laborers, service 
providers, and suppliers.  Closure of the Chambishi Metals 
smelter and down-sizing at both Kansanshi Mining and Mopani 
Copper Mines could bring the total number of job losses to 
about 8,000, Mwale suggested. 
 
GRZ Response 
 
¶8.  (SBU) Countering local media reports that the GRZ would 
take over failing mines, Mwale said that it was the GRZ's 
role to create an enabling environment for private sector-led 
growth.  Mwale affirmed that the GRZ does not intend to 
nationalize LCM, although an almost entirely government-owned 
holding company, Zambia Consolidated Copper Mines (ZCCM-IH), 
may operate it until the GRZ finds a suitable investor. 
Mwale said that he had received expressions of interest from 
Russian, Chinese, South African, and Middle Eastern 
companies, but that the GRZ did not want to transfer 
ownership o the mine until it had resolved questions related 
to LCM's outstanding liabilities to "domestic sharholders," 
presumably referring to ZCCM-IH's 15 prcent stake in LCM, 
which it bought for USD 1.5 illion in 2005.  Ambassador 
urged Mwale to condut an open solicitation for investors 
rather than ust deal with those who come calling.  He said 
sch an open solicitation should include an honest asessment 
of LCM's assets and liabilities.  (Comment:  Mwale seemed 
interested in such an approach.  End Comment.) 
 
¶9.  (SBU) In a separate meeting, Chamber of Mines Director 
Chishimba claimed there was little investment interest in the 
mine due to enduring investor skittishness since the GRZ's 
unilateral imposition of the new tax regime in 2008, even 
though the windfall tax was subsequently revoked. 
 
¶10.  (SBU) The Ambassador briefed Mwale of Zambia's 
qualification for a Millennium Challenge Account Compact, 
which could entail a major infusion of funding to reduce 
poverty through economic growth.  The Ambassador emphasized 
the importance of making continual strides on 
anti-corruption, in order to maintain Compact eligibility, 
and suggested that the GRZ's eventual participation in the 
Extractive Industries Transparency Initiative (EITI) would be 
a useful signal of the GRZ's commitment to integrity and the 
rule of law.  Mwale noted that the GRZ has an EITI committee 
in place, chaired by the Secretary to the Treasury, and is 
seeking government and stakeholder approval for its draft 
work plan.  Chishimba said the Chamber of Mines actively 
supports the EITI but senses the GRZ is only focused on 
industry obligations for EITI, not its own. 
 
Comment 
 
¶11.  (SBU) The true viability of Zambia's mining sector 
probably lies somewhere between the Mines Ministry's optimism 
and the private sector's despondency.  Mining executives 
continue to resent the GRZ's unilateral abrogation of 
development agreements that offered long-term concessions to 
attract international investors.  Although the elimination of 
the windfall tax may hearten investors, the Zambian 
Government may have forfeited much of its credibility over 
 
LUSAKA 00000080  003 OF 003 
 
 
the past year, and the Zambian market may have lost much of 
its appeal for mining investors, at least at current 
commodity prices.  Although this may not fend off all foreign 
investment to the mining sector, it may attract a lower-tier 
of mining companies that have a larger appetite for risk.  It 
may also dampen Zambian economic prospects and delay the 
mining sector's expansion beyond the global economic recovery. 
 
BOOTH