Brazil—Not a Country for Beginners

Mining powerhouse sets its sights on becoming a better destination for investment

Brazil’s continental scale, its resource base, and its economic and political clout are fast rendering the nation a regional and international powerhouse. With 8.5 million km2 of land mass and 7,500 km of coastline, Brazil dwarfs all of its South American neighbors.

Differences in size and scale aside, Brazil shares a long history of economic and political instability with its Latin America neighbors. However, since the comprehensive economic reform program of 1994—known widely as the Real Plan—Brazil has demonstrated more consistency, both in the functioning of its democracy, and in its many years of continuous economic growth. Today, Brazil stands alongside China, Russia and India under the BRIC acronym as one of the world’s leading destinations for foreign direct investment (FDI). With an annual gross domestic product (GDP) growth rate of 7.4% in 2010, coupled with vast geological potential, Brazil’s attractions are obvious. Nevertheless, it is important to note that Brazil sits sandwiched between Mozambique and Tanzania as the world’s 127th economy out of 183 for ease of doing business according to the World Bank’s 2011 survey.

Brazil still has huge strides to make in terms of translating nearly two decades of economic and political stability into a solid and stable business environment that works efficiently and coherently for the international investor. Brazil must be analyzed cautiously and patiently by those new to investing in emerging markets. “Brazil is not a country for beginners,” said Franklin Feder, president, Alcoa, which has a 50-year history in Brazil. “The Brazilian people are very gracious, kind and hospitable; however, they are often too kind and hospitable. You really have to know what you are doing in Brazil in order to get things done here.”

Brazil’s Economic and Political Transformations
Brazil’s reliance on coffee production led to a sustained period of import substitution industrialization (ISI) following World War II, continuing until the mid-1960s. In an effort to transform the Brazilian economy from one of inflation and debt to that of a diversified capitalist market economy, the military leadership introduced widespread economic reforms in 1964.

The economic reforms simplified the foreign exchange regime, introduced incentives for investment and promoted exports—the result was a sustained period of growth, averaging around 11%, for Brazil’s economy between 1968 and 1973. Despite the oil shock of 1973, the Brazilian government continued to back its high growth policies, putting major strain on the country’s macro-economic position. Brazil’s current account deficit grew from $1.7 billion in 1973, to $12.8 billion in 1980; foreign debt increased from $6.4 billion to $54 billion over the course of the same time period. Debt led growth throughout the 1980s and early 1990s caused inflation, which remained at around 100% throughout the early 1980s, and grew to 1,000% in the mid-1980s before reaching 5,000% in 1993.

Brazil’s politics, meanwhile, have been equally erratic. In common with much of Latin America, Brazil bounced between military dictatorships and populist democracies. The election of Fernando Henrique Cardoso in 1995 marked a clear turning point in Brazil’s political and economic history. Cardoso’s “Plano Real,” enacted the year prior to his election, was the first successful political action plan to sustainably combat Brazil’s persistent economic challenges of managing external debt and inflation. The core tenets of the Plano Real were to introduce a new currency (the Real) at a relatively high peg to the U.S. dollar, raise interest rates to curb spending, to encourage investment as well as saving, and to curb government spending.

The Plano Real worked wonders. Brazil soon became the darling of the international investment community, stabilized inflation, and entered a sustained period of economic growth. Brazil’s economy has averaged GDP growth of 5% per year since the turn of the 21st century. It would appear the country’s economic and political instabilities are finally finished.

Following Fernando Henrique Cardoso’s successful two terms as president between 1995 and 2003, long-term leftist presidential candidate Luiz Inacio Lula Da Silva was elected as Brazil’s president in 2003. He sustained economic growth and political stability throughout his tenure. By electing Lula’s chosen successor, Dilma Roussef, in 2010, the Brazilian electorate demonstrated its approval of Lula’s ideological direction and stewardship of the national economy. Roussef also received the thumbs up from the mining community. Professor Joao Marini of the Agency for Technological Development of the Brazilian Mineral Industry (ADIMB) spoke for many when he said, “When Dilma wins the election, expect conditions for the mining sector to improve.”

The Country of the Future?
Brazil’s relatively well-developed and diversified economy was one of the first to enter and then recover from the recent global financial crisis. After a short period of negative economic growth at minus 0.2% in 2009, the Brazilian economy was already forecast a sustained period of strong growth by early 2010. Brazil’s vast resource wealth, leadership as a global agricultural producer, industrial strength, emerging services industries and international status—boosted by Brazil’s hosting of the 2014 World Cup and 2016 Olympic Games—are all indicative of the increasingly strong position the country will occupy in the global economy.

The Brazilian economy represents more value, in dollar terms, than all of the other South American economies combined. The Brazilian central bank expected GDP growth of 7.3% for 2010, followed by an average 5.5% per year growth from 2011 until 2013. Goldman Sachs predicts the Brazilian economy will become one of the five largest in the world by 2050.

Concerns remain, however, with regard to Brazil’s government policies and the ease (or difficulty) of doing business in the country. A bloated public sector and social policies widely regarded as being over generous have put Brazil’s macro-economic sustainability at risk and heralded criticism from the international investment community. Brazil’s transportation and energy infrastructure, as well as the country’s labor force, would all benefit from significant increases in investment from both the private and public sectors in order to raise overall competitiveness. Nevertheless, from a mining perspective, Brazil’s vast resource base combined with today’s commodity prices render the country a very interesting proposition for any potential investor.

Brazilian Mining Today
Mining in 2008 made up almost 2% of Brazil’s GDP, accounting for $23.95 billion. Growth in the sector is phenomenal, and mining is expected to reach an estimated $46.44 billion by 2014. “Between 2000 and 2008, the size of the industry has grown five times,” said Marcelo Tunes, director of mining affairs, Brazilian Mining Institute (IBRAM).

Demand for minerals has pushed up the value of Brazil’s mineral production, increasing in U.S. dollar terms by 250% between 2000 and 2008. There was a drop of production in 2009, caused by the global economic crisis, but estimates for 2010 reckon that Brazilian mineral production will surpass $35 billion and continue rising 10% to 15% per year.

In 2012, the country is expected to reach the same levels of production and sales as registered before the financial crisis. IBRAM forecasts a total of $54 billion investment for the period 2010-2014. Iron ore is the principal mineral in which the investments will be made, and will account for around 67% of the total.

Mining directly employed 161,000 Brazilians in 2008. Studies carried out by the Geological Survey of Brazil (CPRM) show the mining industry indirectly created about 2 million jobs in 2008, a number which is increasing. New players are coming into the market, including junior mining and exploration companies, and service providers.

Geological Potential
Brazil is the fifth largest country in the world by landmass and hosts the world’s sixth largest mining production. “The Brazilian mining sector has enormous geological potential. Most of the country has not been explored,” said Miguel Antonio Cedraz Nery, general director, National Department of Mineral Production (DNPM).

In 2009, Brazil received only 3% of the world’s total exploration budget in mining. So far only 30% of its territory has been systematically explored using geological mapping. Although its total area is close to seven times that of Peru, Brazil has invested only half of the amount that Peru has in geological surveys.

The Geological Survey of Brazil has indicated that there is a high probability of finding first class poly-metallic deposits—similar to those found in Carajas in the north of the country—especially in the Amazon region. “Brazil is a huge country, similar from a geological point of view to Canada or Australia. The likelihood of finding major tier one assets remains very high,” said Professor Marini.

The Amazon region has the potential for major undiscovered mineral resources in addition to the large reserves of (by volume): iron ore, manganese, bauxite, gold and tin. There are, however, concerns about damaging the Amazon rainforest. Much of Brazil’s future mineral production will depend on finding new approaches and technologies that permit responsible and sustainable mining that will not harm the environment. If this can be achieved, then according to Marcelo Tunes: “Brazil has the potential to double or triple its current mining production.”

Mineral Production
Brazil produces 70 mineral commodities: 21 metals, 45 industrial minerals and four fuels. The South American giant is the second largest producer of iron ore worldwide, with 19% of total global output. After oil, iron ore is the second largest Brazilian export commodity, with China, Japan, Germany, France and Korea the leading importers.

Brazil is the world’s principal producer of niobium, the seventh largest producer of tin and the thirteenth largest gold producer in the world, producing approximately 55 metric tons (mt) of gold in 2008 according to IBRAM. Recent high gold prices have led to new investments in expansion and exploration so that Brazil’s gold production will increase significantly.

In 2008, China became Brazil’s largest trading partner, surpassing the United States. China’s demand for raw materials should continue to be one of the main drivers for the mining sector in 2011 and beyond. Iron ore accounts for 82.6% of all of Brazil’s metal exports, followed by gold. The country’s main imports are spread fairly evenly among coal (29.6%), potassium (29.09%) and copper (20.9%). Investment projects delayed by the financial crisis have since been restarted, particularly by the industry’s leading companies, including Vale, BHP Billiton, Rio Tinto and Barrick. Brazil is keen to attract foreign investment yet complicated regulations, lack of infrastructure, and a limited pool of qualified professionals have slowed the arrival of foreign capital. Investors are further discouraged by the lack of precise geological data for most areas. The Heritage Foundation’s Index of Economic Freedom 2009, which measures the overall environment for setting up a business in 183 countries, downgraded Brazil from “moderately free” to “mostly unfree.”

The state remains present in many areas of the economy. Businesses are subject to archaic legislation, high credit costs and frequent regulatory changes. Brazil requires large investments in energy and logistical infrastructure. This presents opportunities for investment in the construction and improvement of roads, railroads, pipelines, port and terminals, and waterways as well as in the power infrastructure.

Brazil spends only about 2% of its GDP on infrastructure—a third of what China and Chile spend, and half of what India spends in relation to its GDP. A study by the Brazilian Association of Infrastructure shows that Brazil needs annual investments of $90 billion in logistics and infrastructure to end bottlenecks in the economy. Should this investment not be forthcoming, the country will be unable to maintain its rate of economic growth. Hopes are high that the new president will address these issues. “The recent election of Dilma Rousseff, who was responsible for the mining sector in the previous government, will bring efficient initiatives for the mining industry’s development,” Tunes said.

Brazil’s Mining Market Structure
The Brazilian mining market is dominated by approximately 15 mining companies of both international and domestic origin. Iron ore is by far the most prevalent mineral exported to the international market from Brazil. Vale’s pre-eminence in the Brazilian mining sector is expressed by the company’s dominance over the iron ore market; representing 80% of total Brazilian production, with CSN, Anglo American, MMX and Samarco making up the shortfall.

Brazil’s other leading mineral commodities are also dominated by a relatively small group of mining firms. Mineracao Rio Do Norte, Alcoa and Vale dominate the production of bauxite and alumina. Niobium production is overwhelmingly dominated by CBMM, while manganese production is almost entirely controlled by Vale. Votorantim is Brazil’s only producer of zinc, while the company is also responsible for around half of Brazilian nickel production alongside Anglo American Brazil. Brazil’s relatively under-developed copper production is dominated by just two companies: Vale and Yamana. Gold production is perhaps the most evenly divided of Brazil’s mineral resources, with Anglo Gold Ashanti, Yamana Gold and Kinross representing the major part of supply alongside smaller producers such as Eldorado Gold and Jaguar, as well as garimpos settlements in Brazil’s more remote regions.

Brazil’s garimpos are artisan miners, producing outside of the auspices of Brazilian regulations and often regarded as illegal operators. There are major concerns about the environmental impact of practices employed by the garimpos, such as the use and subsequent dispersal of mercury into soils and waterways.

Brazil has a long tradition of fostering domestic engineering and services firms, such as Camargo Correa and GeoSol, in engineering and drilling services respectively. International players such as Master Drilling, SRK Consulting, AMEC, Coffey Mining and Ausenco are also present. An interesting recent phenomenon has been the formation of joint ventures and takeovers between established international firms and domestic players, such as the recent merger of Minerconsult and SNC Lavalin, and the agreement between CNEC and Worley Parsons. The combination of international experience and technical expertise, and the local knowledge of Brazilian firms, is widely acknowledged as being extremely effective. The growth forecasts for Brazil’s mining industry outlined above are set to further increase international interest from services and engineering companies.

The equipment supply market is more mature than the services sector, with major international players such as Metso established in the country for more than 50 years. From Volvo, Komatsu and Cat, to FLSmidth and Cummins, the vast majority of suppliers can be found in Brazil, many with significant manufacturing capacity on the ground. Agents such as Tracbel and Sotreq for Volvo and Caterpillar respectively have world class service offerings to complement their leading technologies, while suppliers of domestic origin such as Technometal and Rossetti are continuing to grow their market share in Brazil’s rapidly expanding equipment supply market place. Although still widely regarded as an emerging market, Brazil boasts an extremely high level of technical standards with regards to the manufacturing and supply of equipment, with numerous international companies such as Siemens and Scania locating parts of their international research and development hubs in the country, alongside groundbreaking local firms such as GEOID, CEMI and Brasfond.

Brazil’s Regulatory Framework
Brazil’s regulatory regime is particularly complex, with jurisdiction for particular tenets of the approvals process divided between municipal, state and federal levels of government. At a federal level, the three key government agencies responsible for Brazil’s mining industry are the Ministry of Mines and Energy, DNPM and CPRM.

Mining in Brazil is governed by the Mining Code (1967). Law number 9314 of the mining code signed in January 1997 states that all mineral exploration licenses are granted by the DNPM, with development concessions issued by the Ministry of Mines and Energy. Under Brazil’s 1988 federal constitution, it is stated that all mineral resources are assets of the federal government and that rights to mine such resources are issued in alignment with the Mining Code. All companies formed according to Brazilian law, with headquarters and senior management in Brazil, are eligible to apply for licenses for the exploration and production of Brazilian commodities.

As set out in the 1988 constitution, environmental sustainability is of great importance to the way industrial activity is conducted in Brazil. Environmental regulations in Brazil vary between state authorities, thus having the potential to create confusion and duplication throughout the applications procedure. Essentially, the environmental applications process involves adherence to three separate levels of control. Initially, an environmental impact assessment (EIA) must be completed. Following completion of an EIA, an environmental license (LA) is required to ensure environmental impacts of a particular project are in accordance with the respective environmental regulations of the state in question.

The final regulatory process is the Plan of Recovery of Degraded Materials (PRAD). The PRAD ensures appropriate steps will be taken to ensure an environmentally sustainable approach toward mine decommissioning and the removal of tailings. Brazil’s two key environmental regulatory authorities are IBAMA and the Ministry of the Environment.

Throughout 2009 and 2010 there has been ongoing debate regarding a wholesale modernization of Brazil’s mining regulatory framework, with a view to making Brazil’s mining sector more attractive and easier to manage for international investors. Proosals for a complete overhaul have been submitted to congress.

“The Brazilian Government has some priorities in terms of regulatory change,” said Claudio Scliar, secretary for Geology, Mining and Mineral Processing. “First, we are undertaking a 20-year national plan of geology and mining and mineral processing. This national plan already exists in other economic sectors, however it is lacking in the field of mining. Second, the government wants to transform the DNPM into an agency that oversees the regulation of the mining sector. The government will also create a National Council of Mineral Policy that will update the outdated Mining Code. Finally, the government is discussing mineral royalties, which need some changes by the ministry. Brazil overall needs a new policy for the mining sector.”

The overall consensus is Brazil’s new regulatory regime will simplify applications and licensing processes, thus helping to render Brazil a more interesting investment proposition for international firms.

Some key proposals are as follows: A new National Mining Policy Council will be established, headed by the minister of Mines and Energy, reporting directly to the president on matters of policy and strategic direction for the mining industry overall. The government aims to replace the DNPM with a new National Mining Agency. The new agency will incorporate DNPM’s present structure, although there will be a clear focus upon recruiting more technical staff. Areas of major mineral interest will be designated and promoted for investment as opposed to the current more arbitrary approach. On top of this, current mining licenses will be replaced by mining contracts with more specific terms, valid for variable periods of up to 35 years. With a view to incentivizing a more concerted move downstream for the mining industry, the royalties’ regime will be charged at differential rates, progressively lower for firms that adopt more comprehensive ore processing within their overall production strategy.

Under the new regulatory regime, a number of proposed measures also aim to mitigate the negative impacts and bottlenecks created by speculation in the mining market. Prospective concessions will be awarded under a public bidding process in contrast to the closed shop/first come first served process currently in place. Furthermore, exploration permits will be limited to a maximum, non-renewable period of five years. Permit holders that have not conducted surveys within this period will forfeit their rights to the respective prospects. As opposed to the relatively low, flat rate presently charged for concessions, the annual rate will run on a progressive scale increasing each year the concession is on license.

In a move to further improve Brazil’s record on social and environmental performance, a series of adjustments will be made to the regulatory regime, such as holding public hearings for major projects to engage communities, as well as placing discretionary limits on the sizes of particular areas that are allocated to one single company. Finally, a mandatory transitional period will be incorporated within the proposed changes in order to ensure that all companies are provided with a suitable amount of time to adjust to the new regime.

Brazil’s Geological Survey
The CPRM has overall responsibility for the geological mapping of Brazil’s entire land surface, as well as for compiling a database of prospective regions for potential mineral development. “Essentially, CPRM generates the basic geological information on the 13 million m2 of Brazilian territory for those interested in investing and developing prospects in Brazil, not limited only to the mining sector,” said CPRM President Agamenon Dantas.

Despite being allocated its largest budget ever for 2010, the CPRM’s work is generally perceived as being inadequate. There is debate as to who has the precise responsibility for detailed mapping of Brazil’s entire land mass and offshore resources. The private sector regards this duty as incumbent upon CPRM, whereas CPRM regards more detailed mapping and exploration activities as the reserve of the private sector. The present status of this debate is viewed by the mining industry as something of an obstacle to increasing international interest and subsequent investment in Brazil’s largely unknown geological profile.

The crux of the debate is whether CPRM should prioritize mapping the entire Brazilian land mass, excluding the Amazon at a scale of 100,000:1, or, whether CPRM should focus on narrower, more exciting areas for the mining industry with a view to attracting private investment into the industry. “It is of course the dream for all entrepreneurs for CPRM to carry out detailed mapping of all areas of potential geological interest, but the reality is CPRM’s job is to detect areas potentially interesting for mining and other industries,” said Dantas. “It is then up to the private mining sector to undertake more detailed mapping themselves. After all, CPRM does not work only for mining; we have social goals such as locating water sources beyond pure economic development in mind.”

Professor Marini disagrees with that approach. “Brazil doesn’t have good mapping and geological information for potential investors. Many Brazilian companies are going to work abroad. For example, Vale is investing in Africa, Mongolia and in Peru.”

“There is an obvious lack of mapping in Brazil and I believe this is a lack the government should be required to fulfill, in much the same way as happens in Australia, in Canada or in France,” said Ricardo Francesconi, director of geological exploration services firm Geoservice.

The ongoing debate surrounding Brazil’s geological mapping is far from being resolved. What is clear, however, is Brazil’s geology is very much unknown relative to other mining nations. This presents an excellent opportunity for firms with a focus upon exploration to find huge assets in frontier regions such as the Amazon and Northern Minas Gerais State.

The Tax and Royalties Regime
Taxation policy between Brazil’s myriad of federal, state and municipal authorities is a matter of complexity. In its most simple terms, taxation varies for mining companies depending upon the region of Brazil they mine in, and the mineral they are mining. Ultimately, all mining companies in Brazil are subject to corporate tax of between 10% and 15%, as well as to the royalties regime—otherwise known as the Compensation for Exploiting Mineral Resources (CFEM). Under the terms of the CFEM, mining companies are liable to pay a maximum of 3% on net sales of mineral assets. Precise percentage ranges vary depending upon which mineral is being extracted and sold. For example, the rate for bauxite and manganese is 3%, iron ore is 2%, and gold is 1%. Royalties are shared between federal, state and municipal authorities, with each receiving 12%, 23% and 65% respectively.

There is speculation that plans are afoot to increase VAT or taxes on exported mineral commodities so as to encourage mining companies to develop downstream capacity as opposed to exporting raw materials to markets such as China and Japan. Given the importance placed upon such industrial policy by Lula, there is tangible concern throughout the industry that newly elected Dilma Roussef will begin pursuing such policies more vigorously following her inauguration in January 2011.

Brazil’s 2030 Plan for the Mining Industry
Alongside the Brazilian government’s new proposals for regulating the mining industry, a 20-year strategic plan, covering the period 2010 until 2030, has also been tabled to provide a strategic planning tool for the mining industry, putting forward proposals for programs and structuring measures for developing them, according to Fernando Lins, director, Department of Mineral Processing within the Secretariat for Geology, Mining and Mineral Processing.

There is clear impetus in the 2030 plan to provide the Brazilian mining industry with the necessary demand side data to ensure that mineral commodity production in the country is targeted toward meeting domestic demand in a sustainable way. The plan is also directed toward maintaining Brazil’s position as one of the leading global suppliers of key resources such as iron ore, manganese and bauxite. In line with recent international trends, the Brazilian mining market is shaping itself toward becoming a global leader in the supply of other bulk commodities, such as potash and phosphate, particularly in view of the country’s status as a leading international player in the agricultural industry. Vale’s rapid move into phosphate and potash production best underlines this trend.

The 2030 plan has a clear focus on aligning mineral production with Brazil’s domestic market potential, sustainably supplying key input materials such as processed aluminum, steel, phosphates and copper to its dynamic domestic market.

On top of the key agenda of targeting Brazilian mineral production far more specifically toward domestic demand, the 2030 plans second fundamental tenet is to move industrial capacity further downstream. As mentioned earlier, the government’s downstream agenda has created differences in opinion with major players such as Vale. On the one hand, Brazil’s growing labor force and resource base sets the ideal foundation for added value industrial development; however, much industrial development may be nonviable considering the wage differential and infrastructure advantages steel mills and aluminium smelters can leverage in competing economies such as China and South Korea.

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