The long-term sales contracts

Omar Davies, Contributor

The present administration has used every opportunity to seek political mileage from the long-term sale agreement for alumina from production at the Jamalco plant at Halse Hall, Clarendon. This issue has been trotted out by both the prime minister and minister of finance on various occasions as alleged evidence of mismanagement on the part of the previous administration, in general, and on my part, in particular. It is no coincidence that the issue is resurrected at periods when data on the social and economic fronts demonstrate the incompetence of the administration's handling of Jamaica's present challenges.

For example, even whilst the administration is claiming that the economy is 'going in the right direction', the official statistics demonstrate 12 consecutive quarters of economic decline, and the national debt has increased by 50 per cent over the same period. The Survey of Living Conditions shows that poverty levels have moved from below 10 per cent in 2007 to 16.5 per cent in 2009. Simply translated, between 2007 and 2009, an additional 180,000 Jamaicans are now living below the poverty line.

Suppliers and contractors are owed in excess of $80 billion and the total due to individuals and institutions for refunds for tax on interest, taken at source, is now in excess of $20 billion. The Government has now established itself as a chronic bad debtor.

The present administration's discussion on the Clarendon Alumina Production Limited (CAP) alumina sales agreement has been deliberately self-serving, with no attempt made to present the matter in an analytic way. Against that background, in this piece, I lay out the facts so that the public can have a full grasp of this transaction.

THE BACKGROUND

It is useful to begin with a brief discussion of the background to CAP. The company was established in the mid-1980s by the Jamaica Labour Party administration led by then Prime Minister Edward Seaga, following Alcoa's decision to close the Halse Hall plant due to the downturn in the world alumina market. Mr Seaga, with full backing from the Opposition People's National Party (PNP), recognised that if the plant remained closed for any extended period, there stood a good chance that when the global industry recovered, Alcoa might choose not to reopen it. Consequently, he took the brave decision to re-open the plant under government of Jamaica (GOJ) control, but managed by Alcoa. When the industry recovered, a new agreement on the operation of the plant was struck with the GOJ and Alcoa as equal partners. CAP was the vehicle through which Jamaica's 50 per cent ownership was held.

One difficulty, which has plagued the operations of CAP throughout its 25-year existence, is that the company was never properly capitalised. Consequently, there has been need to use debt financing for all aspects of CAP's obligations, e.g. funding its share of the costs of maintenance and plant expansion.

long-term sales Agreements

The long-term arrangements under a predetermined price formula is not new to Jamaica. Over the period 1986 to 1999, Jamaica entered into such a contract to a value of US$365 million. Some of the resources received from these pre-payments were used to finance CAP's share of the cost of capital improvements and expansion of the Halse Hall plant.

Bruce Golding and Audley Shaw have sought to characterise the 2000 CAP long-term sales transaction as a unilateral and whimsical decision made by me. This assertion is patently false, notwithstanding that both gentlemen are, or should be, fully aware of the facts.

The facts are that the 2000 long-term sales transaction was conceived and developed by the most competent set of professionals available in Jamaica, supported by eminently qualified overseas advisors. In terms of the team from Jamaica, the two lead negotiators had between them 55 years of experience in the bauxite, alumina industry. I might say, in passing, that the current absence of any sense of direction for the industry, is linked to the fact that no competent replacements for these experts have been found by this administration. In addition to our local expertise, the GOJ engaged the internationally known firm of JP Morgan as financial advisers, as well as professionals from two international rating agencies, Moody's and Fitch.

The assembled team identified three critical production-cost factors to be taken into consideration - oil, caustic soda and capital expenditure. In terms of oil, many experts, including the internationally respected magazine, The Economist, projected that oil would average US$5 per barrel over the life of the contract. Even if oil prices increased to levels, six to seven times this projection, the agreement would have remained profitable.

Based on the analysis of the team, the long-term sale agreement involved a dual-pricing mechanism as a risk-management measure: a fixed price of US$180 per tonne for half of the alumina involved in the transaction, and a variable price of 12.25 per cent of the London Metal Exchange (LME) price for aluminium for the other half.

As regards the fixed price component, the cost projections for oil, caustic soda and capital expenditure were stress tested by the experts advising the Government on the transaction, and found to be adequately covered. This component of the agreement was a hedge against aluminium falling below US$1,500 per tonne, as had occurred several times during the previous decade.

As regards the variable price component, it is instructive to note the comment of the financial advisers: "The vast majority of the world's third party alumina is traded as a percentage of the LME price for alumina. This mechanism provides a defined industry reference for pricing Jamalco's alumina."

Subsequent developments

After the transaction was concluded, there were several adverse developments which drastically changed what was thought to be an excellent deal for Jamaica. The three most significant developments were: (a) the upward movements in the prices of oil and caustic soda; (b) the need to 'front-load' investments in infrastructure, and (c) the negative impact of hurricanes over the period 2004 to 2008.

Oil and caustic soda: The cost of oil needed to run the Halse Hall plant increased 300 per cent between 2004 and 2008; from US$22 million in 2004 to US$85 million in 2008, while the cost of caustic soda, per tonne of alumina produced, moved from US$11 in 2004 to US$37, in 2009. These price movements were not anticipated by any expert, yet they radically changed the cost of producing each tonne of alumina.

Investment in infrastructure: The tripling of the capacity of the Halse Hall plant between 1985 and 2006 put pressure on the bauxite reserves then being mined in Clarendon and southern Manchester. Consequently, new reserves had to be exploited and the complementary infrastructure constructed in a shorter time period than had been initially estimated. The estimate of the required investment was doubled between early 2006 and mid-2007, with CAP's share moving from US$100 million to US$200 million.

Hurricanes: The devastation caused by hurricanes is well known to Jamaicans, but few recognise the impact on the operations of Jamalco. Between 2004 and 2008, there were Hurricanes Ivan, Dennis, Emily, Dean and Gustav. The cost to Jamalco of the devastation of these hurricanes over the four-year period was in excess of US$60 million.

In summary, there were extenuating circumstances in terms of the unforeseen upward movements in the prices of critical inputs, as well as the impact of natural disasters. A sensible, responsible government should have called back to the negotiating table the purchaser of the commodity, the company Glencore, and Alcoa, the country's partner at the Halse Hall plant. The renegotiating of contracts, in the face of unexpected developments, has been successfully achieved on various occasions during the history of Jamaica's bauxite/alumina industry. The current administration failed to act, possibly because there was a rapid change of portfolio ministers during this critical period.

However, perhaps the most important point to note is that Jamalco was the only alumina plant to remain open throughout the recession. This was only possible because of the reinvestment facilitated by the long-term sales contract.

A Similar Deal

What is ironic about the current administration's repeated attempts to castigate me about the long-term sale agreement, is that a similar situation has arisen on their watch. They took the decision, no doubt based on what seemed to be reasonable assumptions about future currency movements, to enter into a swap transaction that has turned out to be exceedingly costly for Jamaica. This is the euro/US$ swap with Citibank in respect of a loan of 204 million euros which the previous administration had obtained from BANDES, the Venezuelan Development Bank, to finance the operations of the National Road Operating and Constructing Company. The current government sought no independent expert advice when entering into that complex and risky swap transaction. The losses resulting from the swap have been estimated at over US$50 million, and continue to grow.

swap arrangement

During the financial and economic crisis in 2008, the euro appreciated significantly against the US$, moving from around US$1.20 to over US$1.53. The administration, fearing further appreciation of the euro, entered into a swap arrangement to convert the debt of 204 million euros to one of US$311 million (at an exchange rate of US$1.524). Furthermore, this new debt was at a higher interest rate than that for the original BANDES loan: 8.29 per cent, compared to 7.25 per cent. Almost as soon as the swap was completed, the US dollar began to appreciate against the euro. As such, the Government had swapped from the euro to an appreciating dollar at a higher interest rate, thus significantly increasing the cost of servicing the loan.

Faced with the growing losses on the deal, the Government decided to return to Parliament seeking permission to buy back the loan, given that several factors had changed, counter to their expectations.

What is unknown to the public, and even to many of my colleagues, is that prior to returning to Parliament, the prime minister called me, seeking the Opposition's co-operation in having the proposal approved expeditiously. However, the associated Ministry Paper, tabled by Mr Golding, had been badly prepared. On reading it, I alerted the prime minister to the fact that not only was it confusing but it also provided unnecessary details on the proposed transaction to the market. I advised the PM to withdraw the paper and present a revised document of the standard required by the international market.

He not only took my advice and withdrew the Ministry Paper, but requested that my colleague, Peter Bunting, and I work with the technicians from the Ministry of Finance and the Public Service (MOFPS) and their local private-sector advisers to revise the document. In the national interest, we agreed, and for two days Bunting and I worked with the officials of the MOFPS in revising the Ministry Paper which was re-tabled by the prime minister and passed by Parliament.

I have related this last episode simply to demonstrate that, despite the cut and thrust of the political environment, it is absolutely essential for senior political representatives to recognise that when the country's interests are at stake, the scoring of petty political points is unacceptable.

national effort

In our meetings to deal with the debt swap, the prime minister appeared genuinely to appreciate the need for a national effort in resolving a costly problem. It is instructive that no member of his political directorate joined the meetings, involving him, the officials, Peter Bunting and me. It is difficult to reconcile that posture of co-operation, in the national interest, with his minister of finance articulating the most vulgar, tribalistic utterances at the party's annual conference.

I hope that this piece has presented to the public the full background to the long-term sale agreement. Furthermore, I have outlined what has occurred with regard to the loss-making euro-US dollar currency swap, in order to show that governments are inevitably faced with the challenge of making decisions in the present, which are dependent on factors, over which they have no control.

In such circumstances, there is a need for leadership in the national interest, characterised by mature and civilised behaviour, not vulgar tracing and 'trash talking'. Perhaps this is asking too much of the PM and his lieutenants.

Omar Davies is Opposition spokesman on finance and planning. Feedback may be sent to columns@gleanerjm.com