Mining in Latin America

Rafael Vergara

Over the past two years, the outstanding prices of base metals and commodity minerals in general have played a role in increasing mining activity in Latin America.

Of the US$7.5 billion allocated to non-ferrous exploration the world over in 2006 (US$2.6 billion more than 2005) and of the approximately US$10 billion of 2007 (US$2.5 billion more than 2006), approximately US$4.2 billion or 24 per cent of the world's total investment was spent in the region - which in the aggregate means about US$3 billion more than in 2005. Canada comes in second, at 19 per cent, and mainland Asia, Europe and the Middle East hold third place with 17 per cent (source: Metals Economics Group). If we add investment in production, the region is now attracting more than 30 per cent of world investment, compared to just 12 per cent in the 1990s. Greenfield projects are under way, others that were put on hold have now been reactivated, and expansions that were frozen are now being implemented. This rise in activity has taken place despite the numerous mergers and acquisitions among international mining companies (including that between CVRD and Inco) - which reduced the exploration and development budgets of those companies - and despite the increasing interest of international mining companies in less explored areas, such as the former Soviet Union, China and Mongolia, and some countries of the Middle East and Africa. Moreover, it happened despite the expropriations carried out by the governments of Venezuela and Bolivia in the past two years. 

Latin America is still an important base for the world supply of metals and a substantial global mineral reserve. Regional production includes 48 per cent of all copper, 29 per cent of all silver, 39 per cent of all molybdenum, 22 per cent of all iron, 21 per cent of all zinc and 20 per cent of all gold.

Mining continues to be significant to the economies in the region, especially in Mexico, Peru and Chile, and is gaining more importance everyday in Brazil, as well as in Argentina. In Chile, for example, the mining sector represented 23 per cent of GDP in 2006. Investment in mining continues to come largely from outside of the region, especially from Canada, the United States, the United Kingdom and Australia, and not only from large companies but - more so than ever - from junior companies, particularly in exploration. Lastly, some investments from China - including purchase of mines and companies - and, again, old players from Japan are being seen in the regional scenario. In addition, regional private mining companies - like Grupo Mexico and Peñoles in Mexico, Buenaventura in Peru, and Luksic in Chile - have also grown. While production is largely privately held, regional government-owned metal mining companies, like CVRD in Brazil and Codelco in Chile, have also become stronger.

This current development in the region stemmed from the abandonment, starting in the 1980s, of the protectionist, statist and foreign investment-averse model. In that decade, several regional governments understood that mineral resources could not remain static and had to be exploited quickly, and that private enterprise, including foreign companies, was critical to that process. This occurred in an environment of world economic change where the government was not perceived as a good administrator and the market was deemed the best allocator of resources. In addition, the wealth of geological resources and the increasing political stability in some Latin American countries contributed to create the necessary setting for regulatory changes. These changes allowed mining to develop, both by strengthening legal title to mineral resources and by encouraging foreign investment, backed by sufficient government assurances.

Yet a growing concern for the environment came hand-in-hand with this vast mining development, requiring mining in the region to be grounded on the concept of ‘sustainable development'. In the past few years, the environmental factor has become significantly more crucial. In some countries, stricter requirements have been placed on mining projects. Authorities are supervising more closely and at times with greater discretion. Sometimes there are delays and bureaucracy to get the environmental approvals and permits. On the other side, the collective awareness of the environment and its components requires more and better responses from the industry, such as respect for biodiversity and phytostabilisation of tailings dams. In some places, the use of mining industry supplies, such as water, requires not only a legal title but also an assurance that the local environment will not be altered by its extraction.

Legal title to a mining deposit and to key supplies (such as water), availability of the required economic resources, or even the procurement of the environmental permits, is no longer sufficient. Instead, the need is arising to have a ‘social licence', an approval by human communities having some geographic, ancestral, cultural or other relationship with the place where the project is located. This licence is required because it is mandated by law or by the citizen-participation mechanisms provided in environmental impact assessment systems, or because reaching an agreement with those communities for use of the relevant lands (as in Latin America a mining concession does not carry title to the surface) and for the use of water is, in actual fact, necessary. These agreements result in direct payments to the communities, creation of funds with specific social purposes and investments in infrastructure, education or health, and may also include the project's commitment to
use local goods or services or to train and employ local workforce, all of which, of course, raises project costs. In that sense, in the past two years the price boom of minerals - and accordingly the bigger revenues of mining companies - have increased the expectations of communities and of governments (for example, the Peruvian president has requested "voluntary and extraordinary contributions" to avoid further discussions on possible new taxes). The companies have answered by focusing additional direct contributions on certain specific social areas of the communities where they are located, under a shared administration or trust, with a long-term view to strengthen their relationship with the local people and environment.

The foregoing is a manifestation of ‘corporate social responsibility', a concept that has taken special importance in the region and that many intend to standardise in the globally-debated ISO 26000 (a final discussion is foreseen for September 2008). The stated objective of this concept is that enterprises appropriately balance economic performance, social development and respect for the environment, or ‘the three Ps': profit, people and planet. The true value of an enterprise, it is said, is defined by the way in which it combines those three basic factors, which should translate, among other things, into good labour relations, job safety and health, the promotion of training and education, and contributions to the relevant community to improve its quality of life. These are particularly sensitive issues in Latin America.

Sustainable development initially, and corporate social responsibility today, are the answers developed by the mining industry to questions about its contribution to host nations and to imputations in connection with environmental and communal issues. In a ranking (in May 2006) of the better and worse performing countries on these matters, the International Council on Mining & Metals included three Latin American countries among the best, out of a total of 14. But it also included two among the worse. In addition, in certain countries, such as Chile and Peru, one of the stated reasons to promote and approve a royalty on mining production was the little contribution made by mining companies to the development of host countries. The public perception of mining's contribution to national wellbeing tends to be very similar. Companies have become aware of this and, together with their trade associations, have implemented programmes and taken actions to foster an understanding of the contributions that mining makes to the various communities in our region. This is possibly the greatest present and future challenge to Latin American mining.

One increasingly relevant aspect in the region is the complex energy situation. The dramatic reduction or, even worse, the total interruption of gas flows between interconnected countries of Latin America, the lack of power generation infrastructure in some countries and the weak or defective legal structure of the energy sector in others have created a concerning situation for the regional mining industry, which sometimes has arrived to the courts, in addition to raising the related production costs because of the abrupt rise in input prices, such as oil and gas. Some mining companies are facing this situation by looking for alternative sources of energy, including possible investment, such as in geothermal opportunities, or building their own power generation plants (including LNG facilities), mainly to secure their needs but also to supply third parties, as the revenues appear to be interesting. On the other hand, as natural gas reserves are concentrated in some countries strategically positioned in the region, energy regional integration is under discussion and could be a challenge for the legal profession.

Additional factors affecting the industry's costs and bottom line are the escalation of labour-related burdens and pressures - including rules to rigidify the labour relationship put in place in some countries - a lower quality in new deposits, as well as growing difficulties in the exploitation of existing mines, and the increasing restrictions or problems to get water resources. These factors, together with the unlikely emergence of major production technology breakthroughs in the foreseeable future, make it difficult to anticipate a reduction in production costs. On the positive side, however, there is an increasing need for geologists, mining engineers and subcontractors, and other specialised people. Additionally, the region continues to have unexplored territories with high-grade deposits that should not entail major exploitation difficulties.

Although somewhat overlooked, another likely cost-increasing factor may be the registration, evaluation, authorisation and chemicals restriction (REACH) regulation, approved in December of 2006. Through REACH, the EU is attempting to impose new standards and requirements on the sale and use of chemicals for the production of goods exported to Europe. This could have a serious impact on the costs of Latin American mining.
Other increasingly important matters that also represent a challenge to Latin American lawyers, particularly regarding their legal implementation, include:
• the reclamation and closure of mining facilities and related environmental costs and liabilities: standards and rules have been issued on this subject in some countries, but in the most of the region there are no clear solutions or safe harbours, such as the ability to deduct closure expenses before the business is ended and the financial mechanism to insure the reclamation and closure costs;
• Kyoto Protocol: the great majority of Latin American countries signed the Protocol, but thus far we understand that no mining projects have procured co-financing under that Protocol and its clean development mechanism. Some, however, are under review in their search for such co-financing;
• international free-trade agreements and bilateral investment treaties (BITs): as part of the globalisation process, Latin American countries have signed several free trade agreements and BITs. While mining investments have not been affected yet, there is some concern that environmental standards and liabilities imposed by these treaties may eventually become non-tariff barriers to international trade and, particularly, to cross-border mining investments. Development opportunities are also present in these treaties, however, due to the reduction of tariffs and protection of foreign investment;
• bilateral mining treaties: some Latin American countries have signed mining treaties with neighboring nations to take advantage of mineral resources located within their borders. This opens an outlook for further development of mining activities in and between these nations, an example in this regard is the Pascua Lama Project, on the border between Chile and Argentina, which is partly based on the legal framework provided by a bilateral mining treaty between those countries; and
• amendments to mining law: in 2006 some amendments were introduced to the mining law in Mexico, whereby a single concession for exploration and exploitation replaced the original two (one for exploration and one for exploitation). This kind of concession already exists in Bolivia and there are some voices calling for the same amendments in other countries of the region.

In terms of the practice of law, implementing mining projects in Latin America has become more complex in the past few years. Exploration options and joint venture agreements are becoming ever more sophisticated. Often mining properties owned by different individuals must be brought together to make a project attractive. Owners of mining concessions require a greater share in project profits through mechanisms such as net smelter return or net profit interest.

In some countries, the attempt has been made to implement a venture capital market to finance exploration, in an attempt to imitate the Toronto Stock Exchange. For the same reasons, various codes and sets of rules are being implemented, as the first step towards creating a venture capital market, based on the CIM Standards of Canada, the JORC Code of Australia and the SAMREC Code of South Africa. In addition, rules on ‘qualified persons' are being studied and implemented. It is generally believed, however, that the existence of a good set of rules to regulate these markets will not be sufficient in the absence of incentives for the common investor to invest in these exploration projects. Regional governments are not viewed as being motivated to offer tax or other incentives to encourage this. Furthermore, generally, institutional investors and pension fund managers cannot yet, or in fact do not, participate in this segment, which reduces the possibility of success of these new financial markets. Notwithstanding, Peru's good experience with its growing venture capital market gives hope to the region.

In connection with the financing of mining production, project finance continues to be used as traditionally structured, through direct or syndicated loans from national or international banks, multilateral agencies or export credit agencies, or a combination of such sources. Lately, mining companies have started to use other vehicles, such as stock or bond issuances in the domestic or foreign markets, or mining infrastructure leases. The latter has been successful particularly in expansions of mining projects currently in production, at conveniently low costs.

The outlook for Latin American mining is auspicious, among other reasons, because of the strong demand for minerals by the Chinese, Indians and other Asian economies, increasing at annual rates of approximately 10 per cent. At this time, there is an investment portfolio in the region of US$40 billion for the next five years, especially in Argentina, Brazil, Chile, Mexico and Peru.

Political stability in the prospective host country will be a mandatory condition precedent for new mining investments. While there may be an understandable tendency to place all Latin American countries in the same bag when it comes to assessing the regional political situation, particularly because of certain renowned populist and pseudo-statist administrations, a clear distinction must be made among the various countries in the region. Each has a different political situation that must be analysed and assessed separately. Many - precisely where there is an abundance of mining - are stable democracies. Transitions from one administration to the other are orderly, economies are stable, prudent growth, and inflation remains at around 5 per cent annually.

There are multiple challenges to be tackled, as mentioned above, particularly environmental matters, community relations, general recognition of the contribution made by mining to each country, key supplies and inputs (energy and water) at reasonable prices, management of environmental liabilities, and closure of mining operations. If these are overcome with effort and intelligence, they may eventually signify substantial business opportunities.

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