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Political Risk Analysis
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May 2012
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TABLE OF CONTENTS
I. II. EXECUTIVE SUMMARY (Dommert)......….……………………………………....4 INTRODUCTION...…………………………………………………………………7 A. PROJECT BACKGROUND (Brockman)…………………………..…………………..7 B. SIERRA LEONE (Chu)…………………….………………….…………………......8 C. IHS POLITICAL RISK RATINGS AND RANKING INDEX (Mittal) ……….......……....10 !" III. IV.
Choice of IHS Model …………………..………………………...……......12

!!" Model Improvements …………………………………………...………....13 RISK MAP (Mittal, Gupta)………………………….……………………………...14 RISK ASSESSMENT, EVALUATION, & MANAGEMENT.………..…………17 A. POLITICAL RISK (Brockman) ……………………………………………...……..17 i. Introduction ……………………………………………………...….……17 ii. War and External Threats …………………………………...……………..20 !!!" Civil and Labor Unrest ……………………………………………...…......23 !#" Internal Violence ………………………………………………..……...…27 #" Regime Instability ………………………………………………..…...…..29 B. SOCIO-ECONOMIC RISKS ………………….………………………………...…...33 i. Economic Instability (Gupta) ………………………………………….…..33 ii. Energy Vulnerability (Gupta) …………………………………………..….37 iii. Environmental Activism (Mittal)………………………………………...…42 iv. Ethno-Linguistic Factionalism (Mittal)…………………………….……….45 C. COMMERCIAL PETROLEUM RISKS …………...…………………………...………53 i. Constraints on Foreign Oil Company Investment (Chu)……...…………...…53 ii. External Transfer and Inconvertibility Risks (Dommert)…….…………….…61 iii. Threat of Adverse Changes in Contracts/Fiscal Terms (Chu)…………...……67 V. RISK MANAGEMENT INSURANCE…..………..………………………………74 A. PROJECT RISK THRESHOLDS AND BREAK EVEN PREMIUM (Mittal)……………....74 B. TRADE INSURANCE (Gupta)……………....………………………………………80 VI. CONCLUSION (Dommert)...…………..…………………………………………...82 1

APPENDIX A................................……………………………………………………...…..84

Additional Responsibilities: Delphi questionnaire management – Dommert Final compilation – Brockman, Chu

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PROJECT METHODOLOGY

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I. EXECUTIVE SUMMARY
The Penn Resource Risk Associates (PRRA) have prepared the below political risk analysis in conjunction with the Densus Group LLC for medium to large petroleum companies interested in investing in Sierra Leone, West Africa. In September 2009, Anadarko, a U.S. oil company, announced that they had made an oil find off the coast of Sierra Leone. Petroleum exploration and production will likely become a major contributor to domestic revenue mobilization and development of financing opportunities for Sierra Leone. PPRA has chosen to conduct its political risk assessment using the IHS Energy Group’s Political Risk Ratings and Ranking because the rating methodology is specifically designed to address the issues relevant to the petro industry and therefore can inform a focused risk report specific to the client companies. PPRA has modeled the risk environment using both country risks and industry-specific risks to produce a risk map. It has assessed and evaluated each risk, and it presents a risk management plan where appropriate. Its grouped analyses of the risks are as follows: • Political risks represent the largest risks to the company’s investment now. Therefore, for each of these risks – risk of war and external threats, risk of civil and labor unrest, and risk of internal violence, and risk of regime instability – PPRA prescribes two mitigation measures. 1. Designate standard operating procedures for protecting staff and assets in the event of a crisis.

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2. Purchase political risk insurance for each contingency, provided that the cost of that insurance falls below the company’s absorption threshold for that risk. • Two socioeconomic risks laid out in the IHS model present the next largest potential threat to company investments. These risks - economic instability and energy vulnerability –require mitigation measures to manage the high-probability events. 1. Hire locals to contribute expertise on the patterns of economic and energy availability nadirs and the appropriate coping tactics in the local context. Local partners with social, political, and commercial clout can also help the company establish relationships with local institutions that can support and protect the company’s investments from event consequences. • Two commercial risks – the risk of constraints on foreign oil company investments and the risk of adverse changes in contracts and fiscal terms – represent the smallest risks to the company. 1. Transfer these risks to a financial firm, contingent upon the cost of that transfer remaining below the risk absorption cost to the company. • IHS Model The consolidated results of the IHS model, including the risk scores for each of the risk sub-categories are as follows: Short Term Retain risks of ethno-linguistic factionalism and repatriation and inconvertibility.

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Risk Rating Rating Political Risks Socio-Economic Risks Commercial Petroleum Risks Political Risk RRI Rating Long Term Risk Rating Rating Score (out of 5) Political Risks 1.7812 Socio-Economic Risks 2.0625 Commercial Petroleum Risks 1.325 Political Risk RRI Rating 60% 20% 20% Weight 1.06875 0.4125 0.265 1.74625 Score (out of 5) 1.6125 2.0625 1.325 60% 20% 20% Weight 0.9675 0.4125 0.265 1.645

The break even insurance premiums, calculated after analyzing the IHS model, conducting present worth analysis and calculating project risk thresholds are: $ 9,170,898 for short term and $9,202,500 for long term. These values amount to approximately 9% of the initial investment.

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II. INTRODUCTION
A. Project Background The Penn Resource Risk Associates (PRRA) have prepared the below political risk analysis in conjunction with the Densus Group LLC for medium to large petroleum companies interested in investing in Sierra Leone, West Africa. The names of these companies have been withheld for confidentiality purposes but will be hereafter referred to as the International Petroleum Investor Group (IPIG). Such a company has the following corporate profile: • The capacity to make investments in early stage petroleum exploitation in excess of $100 million dollars with $20 million dollar annual capital infusions in early years of the project. • Experience and willingness to work in West Africa, the Middle East, and other areas of high risk petroleum exploitation • • A proven track record in successful development of offshore oil finds An appetite to invest in high risk environments and to actively manage identified risks This report examines the political risks associated with the first five years of a hypothetical investment in a $100 million offshore oil exploitation project in Sierra Leone in recently discovered oil fields there.1 This report is designed to help companies considering investing in similar projects to evaluate the risks and costs of insuring against those risks before making an initial investment. Using the framework designed by the IHS Company, a global $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$ %$Kennedy, Will. "Anadarko Says Jupiter-1 Well off Sierra Leone Finds Oil, Gas." Bloomberg. N.p., 21
Feb. 2012. Web. 1 May 2012. .

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information company with expertise in the political risk in extractive industries, PRRA provides analysis on risks related to pure political risks, socioeconomic risks, and commercial petroleum risks. Within this framework, each risk subcategory is evaluated with an assessment on the impact of the risk on IPIG and suggested risk management practices. The report includes both a risk map of the severity and likelihood of different risks as well as a thorough statistical analysis of the amount of capital at risk and proper insurance thresholds that make investment sensible. Below, a brief background on Sierra Leone has been prepared, before the report turns to the risks surrounding the industry.

B. Sierra Leone Sierra Leone is a West African country with its capital in Freetown, bordered by Liberia, Guinea, and the Atlantic Ocean. It covers an area of 71,740 km2, and its population, as of 2012, stands at 5,485, 998.
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It is a member of the Mano River Union (MRU) – other members

including Cote d’Ivoire, Guinea, and Liberia – as well as a member of the Economic Community of West African States (ECOWAS).3 From 1792 to 1961, Sierra Leone was one of Britain’s West African colonies. Sierra Leone is officially a constitutional democracy with an executive president and a parliament. Since its independence in 1961, the two dominant political parties in Sierra Leone have been the Sierra Leone People's Party (SLPP) and the All People's Congress (APC) – in the 50 years since Sierra Leone’s independence, the SLPP has ruled for a total of 16 years, while the APC has ruled for 29 years; together, the SLPP and the APC account for about

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Choice of the IHS model: The IHS Energy Group’s Political Risk Ratings and Ranking index provides a more focused risk assessment than most other rating systems. Since the rating methodology is specifically designed to address the issues relevant to the petro industry, it is a more micro-level assessment than the comparable but more general and imprecise BERI, and the Economist riskrating models. For example, the distribution of weights between the various risks is done keeping in mind their impact on the petro-chemical industry- weight given to commercial petroleum risk is relatively lower because of the recent liberalization of petroleum legislation and loosening of fiscal regimes whereas the weight given to political risks is high because of the high frequency of regime change and internal violence. It is more suitable than PRS because it goes one stage further by analyzing within the FDI category with respect to industry specific indicator in the host country’s environment.

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Model improvements: Error and Uncertainty Analysis The model has been significantly improved to account for the variance in the responses of the Delphi respondents as well as the variance in the responses of the team members. Rather than merely taking the mean (and median) of the results of the Delphi Survey to calculate the IHS risk ratings and risk probabilities, we have tried to carry out an error/uncertainty analysis. Thus, not only does the model reflect the risk ratings (and risk probabilities) but also reflects how certain (or uncertain) the ratings are. This incontrovertibly enriches our data precision and increases accuracy. To do the error/uncertainty analysis, we have calculated: • • • The standard deviation of the Delphi responses The 95% confidence interval for the Delphi responses The standard deviation and the 95% confidence interval of the combined responses of the Delphi respondents and the team members Changes to the Political Risks Index Additionally, the section within the political risks index on war and external warfare has been adapted to take into account the major effect that the upcoming election will have on civil unrest in the short and long term. Probabilities and accompanying statistics such as the standard deviation were calculated separately and combined to calculate final risk probabilities. Lastly, because irregular and democratic transitions occur largely independent of each other, we once again diverge from the IHS model here and consider each risk individually, splitting the weighting for the risk map between the two.

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III. RISK MAP
The relevant risks for oil investments in Sierra Leone, based on each risk’s severity and probability, have been summarized through the risk map below:

The IHS model specifies three general categories of risks: Political risks, SocioEconomic risks, and Commercial Petroleum risks. The factors contributing to each risk profile have been plotted with the each risk’s severity on the x-axis, with each risk events probability on the y-axis. The area or relative size of each circle in the risk map is indicative of the weight of

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the specific factor as specified by the IHS model. Following is the description of the three risk indices:

Indicators

Weights

Description

War & External Threats Political Risk Index (Overall Weight = 0.6) Civil & Labor Unrest Internal Violence

Specifies potential risks such as border disputes and armed conflict 0.1 due to international disputes. Includes internal issues such as 0.25 protests, strikes and demonstrations Any form of kidnapping, bombings 0.35 and crime Assessment of the change in leadership through cyclic elections, or 0.3 sudden military coups/assassinations Structural soundness, performance 0.25 and future trajectory of economy Dependence on imported oil and 0.2 vulnerability to price shocks Opposition to oil exploration and industrial activity due to potential 0.3 harm to environment Potential threat to industry due to 0.25 civil and ethnic tensions Restrictions to investment due to war, embargos or structural government 0.35 policies Potential currency risks and inability 0.25 to recover capital gains on investment Premature contract termination or 0.4 sudden changes in contract terms

Regime Instability Economic Instability Socio - Economic Risk Index (Overall Weight = 0.2) Energy Vulnerability

Environmental Activism Ethno-linguistic Factionalism Commercial Petroleum Risk Index (Overall Weight = 0.2)

Investment Constraints Repatriation Constraints Adverse Contract Changes

The grey portion of the graph represents the sections of risk that IPIG should be concerned about since it represents a medium or greater severity of risk and probability of risk. Based on the resulting risk map produced, it can be seen that the commercial risk index poses, the lowest risk to IPIG as a whole with both low risk severity and probability of each risk. The socio-economic factors in the other hand have a more dispersed risk profile. Ethno linguistic has 15

a extremely high risk severity given the status of past ethnic conflicts in Sierra Leone, but a lower probability of taking place in the future given the years of post-civil war peace. Structural risks represented by energy vulnerability and economic stability have a lower risk severity, but have a high probability since these are problems that IPIG will have to dynamically deal with. The political risk index as can be seen, is something IPIG will have to be vary of constantly while investing in Sierra Leone. This represents a constant risk that will face to their investment due to the nature of Sierra Leone’s political climate. In the sections below, the assignment of the severity and probability values for each risk will be further elaborated. $

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IV. RISK ASSESSMENT, EVALUATION, AND MANAGEMENT$
A. Political Risk This section will evaluate risks to IPIG stemming from traditional political risks: war and external threats, civil unrest, internal violence, and regime instability. As evident from risk map presented above, the greatest risk in this category is regime instability. This could manifest itself in several ways – democratic and undemocratic transitions – that bring a less business friendly regime to power that threaten a large portion of the investment’s current capital and future profits. Not to be discounted are the other three types of risks that also are included in or approach the danger zone of the risk map. As such, these risks require active management, which will be considered below. First, however, a brief background on the political state of Sierra Leone will be given.

i. Introduction Sierra Leone has been at peace for nearly a decade following more than a decade of brutal civil war that engulfed the country and much of region. Despite the peace that has held since 2002, Sierra Leone remains a post-conflict state where the risk of instability caused by internal factors or broader regional developments remains real and must be taken into account by companies contemplating investing in the county must consider. The country has improved significantly in recent years on international rankings of stability including Foreign Policy’s Failed State index where it is now #30 (2011) in the world as compared to #6 in 2005.12 $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
"Failed State Index 2005." Foreign Policy. 01 July 2005. Web. "Failed State Index 2011." Foreign Policy. 17 June 2011. Web. .
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However, according the United Nations Human Development Index the country remains the 8th least developed in the world despite progress in recent years.13 This November, the citizens of Sierra Leone will go to the polls to elect a president for the third time since the end of hostilities. The campaign and election itself represent a significant window of uncertainty. This election will see less engagement by prominent international actors than previous elections and will test the durability of the still nascent and weak institutions in this small West African nation. This section will first provide a summary of political conditions since the country’s civil war and the current political situation. Next, following the IHS framework, it will examine in turn the threat to potential investment represented by external threats in the region, civil and labor unrest, internal violence, and finally, regime stability. The report highlights the coming election as the number one threat to stability in the short-term and continued regional instability and weak political institutions as the most important longer term threats for firms to consider.

Elections in Sierra Leone: A Fragile Democracy Takes Hold The international community accepted the results of Sierra Leone’s elections in 2002 and 2007 as acceptable, despite several incidents of low-level violence and allegations of fraud.14 The international community played a significant role in both elections through security provided by the United Nations, bilateral aid, and the deployment of international election observers. The 2007 proved to be a particularly important landmark in the history of Sierra Leone as the term$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
"Human Development Reports." - United Nations Development Programme (UNDP). Nov. 2011. Web. . 14 "NDI Final Report on Sierra Leone's 2007 Elections." National Democratic Institute. Web. .
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limited incumbent, President Kabbah of the Sierra Leone People’s Party (SLPP) did not run again and the main opposition party, the All People’s Congress (APC), led by Ernest Koroma won the election. Despite the acceptance by observers, there were several tense moments during the campaign where the international community exerted pressure on leaders of both parties to reject violence and continue with peaceful elections. Nevertheless, politicians on both sides remobilized groups of unemployed men and youth who had previously fought in the war, as special election security on task forces for both protection and to stir up trouble when need be.15 This process raised concerns about broad insecurity around the election that will likely reemerge with this fall’s election.

From Civil War to Post-Conflict Country: the Role of the International Community After failed peace processes in 1996 and 1998, the eleven-year civil war between the Government of Sierra Leone (GoSL) and the Revolutionary United Front (RUF) came to an end in 2002. Following the agreement the United Nations maintained at the time what was the largest peacekeeping mission in the world with 17,500 peacekeepers who demobilized more than 70,000 combatants in the first two years of its mission.16 The mission formally concluded in 2005 and gave way to a UN “Peacebuilding” mission, one of the first in the world, known as UNIPSIL which remains in Sierra Leone today. German diplomat, Michael von der Schulenburg, led this office for majority of the last seven years before a falling out with the current president who accused Mr. Schulenburg of meddling in internal affairs leading to his resignation this $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Christensen, M. M., and M. Utas. "Mercenaries of Democracy: The 'Politricks' of Remobilized Combatants in the 2007 General Elections, Sierra Leone." African Affairs 107.429 (2008): 515-39. Print. 16 "Old Tricks, Young Guns: Elections and Violence in Sierra Leone." Africa Research Institute. Web. .
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February.17 The termination of this relationship does not bode well for the broader relationship between Sierra Leone and the international community for which it depends on for significant aid and technical support.

ii. War and External Threats Risk Assessment: Few regions in the world have experienced the regionalization of conflict more than West Africa. Sierra Leone’s civil war and Liberia’s civil war were hopelessly intertwined. The recent conflict in Libya has fanned the flames of violence in Mali. Conflict in Cote d’Ivoire in 2010 has spread refugees throughout the region and reports of mercenaries in recent violence are ever present. As such, political risk in other countries in the region must be considered when considering risks in Sierra Leone. Conflict in adjacent countries increases the likelihood of conflict in Sierra Leone through a variety of mechanisms, including: destabilizing refugee flows, cross border funding of armed groups, and the use of international mercenaries. The capital at risk in such an event is the same as that in the case of a civil war which we estimate to be 25% of the total. In the case of such an event, oil rigs and other capital investments may be $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Gberie, Lansana. "Aftermath of President Koroma's Denial over UN Rep." Sierra Herald. Web. .
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at risk of attack or sabotage, personnel may be at increased risk of hostage taking, and international sanctions on the government may cut into expected profits. This event represents a significant threat to any investment, but given the offshore nature of investment does not represent a threat to the entire investment. We now consider the probability of such an event18:

Risk Evaluation: S Sierra Leone is bordered by two countries with similarly turbulent pasts – Liberia and Guinea. Led by twice elected President Ellen Johnson-Sirleaf who is extremely popular in the international community, Liberia has been hailed for progress made since the end of civil war in both economic development and democratic consolidation. After successful, if tense, elections in 2011 the country appears to be on the path of continued to peace and growth; however, fragile institutions and inequality in progress make the possibility of war a non-trivial possibility. Given the historical ties between the two countries, violence in Liberia would inevitably have a direct effect on Sierra Leone. Guinea has had a more tenuous path to democratic processes in recent years. A coup in 2008, state violence against opposition parties in 2009 and a close assassination attempt later that year all raised the prospect of outright civil war in the country.19 Guinea did however hold its first free and fair elections in 2010 bringing some stability to a country on the brink despite an extremely tense election. The situation today remains tenuous and would undoubtedly affect Sierra Leone if extensive violence were to break out. The capitals, Conakry and Freetown, of the two countries are separated by less than 80 miles. $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
"West Africa Map." Web. . "Sierra Leone - CIA Factbook." Web. .
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Other countries in the region, although not directly bordering Sierra Leone, could also have an impact on its stability. In the last month, both Mali and Guinea-Bissau have experienced military coups that have been widely condemned by the international community and represent ongoing crises. The back-to-back coups in the region rekindled fears of instability again sweeping through the previously coup-prone region of West Africa.20 In the interest of quantifying such risks, we turned to statistician and political analyst Dr. Jay Ulfelder who provided the results of several regressions he has run on countries vulnerable to conflict. Table 1: Coup and Civil-War Onset Risks Coup Risk Liberia Guinea Ivory Coast Senegal Guinea-Bissau Mali 3% 9% 3% 2% 12% 4% Civil-War Onset Risk 5% 6% 8% 5% 4% 10%

His results confirm both the significant risk of regime change in Mali and Guinea-Bissau as well as back the argument that the risk of instability in Guinea is above average, event for the region. Taken together, we estimate that, there is between a 10% and 20% chance of unrest effecting Sierra Leone in the next two years and between 20% and 30% chance in the next five years. $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Hudson, John. "Why Are There So Many Coups in West Africa?" The Atlantic Wire. 17 Apr. 2012. Web. .
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War and External Threats Short Term Average Risk Rating Delphi Survey Response (4 Respondents) Team Response Consolidated Response 1.75 1 1.375 Minimum Risk Rating 1 1 Maximum Risk Rating 4 4 Standard Deviation of the Rating 1.399 1.34 Standard Deviation of the Rating 1.225 1.3 Confidence Interval (95%) ±1.14718 1.1

War and External Threats Long Term Average Risk Rating Delphi Survey Response (4 Respondents) Team Response Consolidated Response Risk Management: We assess the above political risk as significant enough to actively manage. This management should take three parts: • Contingency planning triggered to protect staff and vulnerable on-shore capital investments (equipment, offices, etc.) in the event of domestic unrest • Advanced contingency planning triggered in the case of significant unrest in Liberia or Guinea • The purchase of political risk insurance, subject to guidelines in part IV. 3 2 2.5 Minimum Risk Rating 2 2 Maximum Risk Rating 5 5 Confidence Interval (95%) 1.0045 1.1

iii. Civil and Labor Unrest Risk Assessment: Significant protests and civil unrest affect multinational companies such as IPIG in 23

several ways. Such events have the potential to cause labor disruptions, damage to capital investments, and prevent the company from exporting their product. As such, we judge that no more than 15% of the projects capital would be at risk even in cases of sustained unrest. There are few cases of significant protests or labor unrest in recent years in Sierra Leone outside of the context of political rallies. With the coming election in November, the country is at increased risk of experiencing wide scale unrest surrounding political rallies that can lead to sustained protests or low-level violence.

Risk Evaluation: Sin Since 1961 Sierra Leone has held 16 elections (combined Presidential and Parliamentary) each one of which has been accompanied by some amount of unrest and violence.21 The last election in 2007 saw rioting, reported assassination attempts, and threats from the government that a state of emergency and suspension of the election would be imposed without a stop to the violence.22 There has been no legal action against those who have committed election violence in the past which, in the eyes of some, has legitimized the use of violence as a part of the path to power. This election is expected to be no different. Indeed violent clashes between the two major political parties, the incumbent APC and the main opposition, SLPP in 2009, 2010, and in 2011 upon the announcement of SLPP presidential candidate Julius Maada Bio.23 Adding to the tension is Mr. Bio who briefly ruled the country after participating in the 1992 and then staging a military coup himself in 1996, his participation $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Old Tricks, Young Guns Elections and violence in Sierra Leone, Africa Research Institute Ibid 23 "1 Killed and Opposition Leader Injured in Sierra Leone." Voice of America. Web. .
22 21

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has not inspired faith in the democratic process among outside observers.24 Outside observers, including the United Nations, have also expressed concern with the incumbent, President Koroma, criticizing his research purchase of $5 million worth of small arms for use by the country’s police force. Critics have suggested that the purchase in the election year will be used to intimidate or crackdown against opposition supports in what will be a competitive election season.25 Several recent African elections have seen medium to large scale unrest and violence following closely disputed results including nearby Cote d’Ivoire who is still recovering from an attempt to steal an election by the incumbent there, Laurent Gbagbo. Furthermore, political lines in Sierra Leone are drawn geographically (see map below) increasing the likelihood that tensions and violence associated with the election could escalate into broader conflict in the country. Taking these factors into account, we assess an extremely high risk – near certain – of low scale unrest around the election with the probability of this spiraling into a broader problem ranging between 25% and 30% based on projections and expert surveys. Over the longer term, in the five year time frame, this risk is slightly lower, given the $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$ ibid "Sierra Leone Ruling Party Dismisses Arms Intimidation Concerns." Voice of America. 16 Apr. 2012. Web. .
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absence of a second election coming in around 25%. Civil and Labor Unrest Short Term Average Risk Rating Delphi Survey Response (4 Respondents) Team Response Consolidated Response Minimum Risk Rating Maximum Risk Rating Standard Deviation of the Rating 1.87 Confidence Interval (95%) ±1.5334

2 2 2

0

4

0

4

1.89 Standard Deviation of the Rating 1.803 1.92

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Civil and Labor Unrest Long Term Average Risk Rating Delphi Survey Response 47 Respondents) Team Response Consolidated Response Risk Management: IPIG must take into account the overwhelming influence that the 2012 fall election will have on Sierra Leonean politics this year and act accordingly. Similar to the previous section, risk management includes: • Contingency planning triggered to protect staff and vulnerable on-shore capital investments (equipment, offices, etc.) in the event of election related violence or broad civil unrest • Avoiding involvement in any significant engagement that is not absolutely necessary with the government in the period immediately around the election • The purchase of political risk insurance, subject to guidelines in part IV. 26 2.5 1 1.75 Minimum Risk Rating 0 0 Maximum Risk Rating 5 5 Confidence Interval (95%) ±1.47846 1.57

iv. Internal Violence Risk Assessment: It goes without saying that civil war dramatically affects business operating in a given country, Sierra Leone being no exception. In addition to the physical threat to infrastructure, conflict makes it more difficult to export a company’s good (practically and legally speaking if oil companies are subject to international sanctions for dealing with belligerents), as well as causing severe economic issues that make day-to-day business more difficult. As in part one of this political analysis that dealt with war and external threats, we estimate the total capital at risk in the occurrence of such an event is 25%.

Risk Evaluation: Civil wars are high-impact, relatively low probability adding a high degree of uncertainty to their prediction. According to modeling conducted by political scientist Jay Ulfelder based solely on current socio-economic trends, Sierra Leone has a roughly 6% chance of experiencing a civil war this year. This does not take into account the possibility that elections this fall not only cause significant civil unrest but also trigger widespread violence. Moreover, intrinsic characteristics of Sierra Leone align with several features that prominent political scientists such as James Fearon and David Laitin have identified as determinants of civil war. In their landmark 2003 work, Ethnicity, Insurgency, and Civil War point to weak institutions including those overly dependent on resource extraction and terrain and infrastructure that favor insurgency – two conditions that are clearly evident in Sierra Leone.26 Evidence from previous elections that $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Fearon, James D., and David D. Laitin. "Ethnicity, Insurgency, and Civil War." American Political Science Review 97.01 (2003): 75. Print.
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politicians have had some success in remobilizing previous combatants for political ends also increases the likelihood that Sierra Leone could dip back into the depths of civil war as countries with previous conflicts are more likely to re-experience civil war. As a result of the above, we estimate that the risk of civil war ranges between 10 and 15% annually over the short term, around two years, as well as medium term, five years.

Internal Violence Short Term Average Risk Rating Delphi Survey Response (7 Respondents) Team Response Consolidated Response Internal Violence Long Term Average Risk Rating Delphi Survey Response (7 Respondents) Team Response Consolidated Response Risk Management: IPIG must take still concern itself with the risk of civil war and severe internal violence in Sierra Leone as it is a low probability, high impact event. Similar to the previous section, risk management includes: • Contingency planning triggered protect staff and vulnerable on-shore capital 1.5 1 1.25 Minimum Risk Rating 1 1 Maximum Risk Rating 3 3 Standard Deviation of the Rating 0.866 0.894 Confidence Interval (95%) 0.71012 0.73 2.5 1 1.125 Minimum Risk Rating 0 0 Maximum Risk Rating 3 3 Standard Deviation of the Rating 1.37 0.837 Confidence Interval (95%) ±1.1234 0.686

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investments (equipment, offices, etc.) in the event of the early stages of conflict • The purchase of political risk insurance, subject to guidelines in part IV.

v. Regime Instability Risk Assessment: Firms such as IPIG can plan for all political risks associated with a given regime in power today; however, they must also consider the risks associated with regime change and dealing with a new set of leaders. Slowly, the stereotyped African strongman-president is fading in prominence across the continent. As democracy continues to spread and deepen its grasp on SubSaharan Africa, democratic transitions between political parties are becoming increasingly frequent. When paired with the possibility of irregular regime changes, such as those caused by coups and assassinations, firms must consider other political parties and major leaders that they may have to work with in the near future when they make investment decisions. The incumbent government matters a great deal in setting the investment climate. Regime change can expose companies to new regulations that were not previously anticipated and in extreme examples, the risk of nationalization and expropriation that might not be originally anticipated. There is an additional dimension of regime instability that must be addressed when it comes to weak states with expanding extractive industries – state failure caused by the so-called “resource curse.” In states where corruption is high, institutions are weak, and politics revolve around extensive patronage networks, there exists the risk that governments will become solely reliant on tax collection from a single resource base to finance their political base. This severely cuts into the expected profits of a company over the long term and creates a poor business environment for

29

the company to operate in. For all of the reasons above, we judge that regime instability represents a broader threat to capital than the explicit outbreak of conflict as it more directly can affect off-shore oil. We thus set the value for capital at risk at 10% for democratic changes and 35% for irregular changes.

Risk Evaluation: The risk of regime change by democratic or undemocratic regimes in Sierra Leone is non-trivial and must be considered in the risk management plan. Indeed, there is also a real risk that the oil industry will come to dwarf the existing mineral extractive industry as the main source of government revenue, presenting challenges in managing revenues responsibility by the Sierra Leonean government. President Koroma and the incumbent government have gone to great lengths to stress the pro-business, pro-investment attitude of the government.27 Both political parties style themselves as center-left parties committed to social justice and democracy. At this time there is no talk of nationalization of the oil industry as the country desperately needs foreign investment to get the projects off the ground; however, IPIG and any other firm investing in the region must monitor ongoing political discourse for a shift in tone over time. The 2007 election showed that both national parties, the SLPP and APC, have a chance at winning the presidency meaning that long term investors must take both seriously as entities that they might have to work with someday. There is a high probability of democratic regime change given this history which we estimate to be between 30% and 35% - particularly high figures for emerging democracies in Sub-Saharan Africa. $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
"In Sierra Leone, President Ernest Koroma Gives Investors Double Assurance." 21 Nov. 2011. Web. .
27

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To evaluate the risk of a coup we again consulted Dr. Jay Ulfelder who placed the likelihood of a coup in Sierra Leone this year at only 3% this year. Given past threats and attempts in past election years, we set the risk of assassination increases the odds of an irregular regime change each year at approximately 10%. Democratic Change Short Term Average Risk Rating Delphi Survey Response (7 Respondents) Team Response Consolidated Response Irregular Change Short Term Average Risk Rating Delphi Survey Response (7 Respondents) Team Response Consolidated Response Democratic Change Long Term Average Risk Rating Delphi Survey Response (7 Respondents) Team Response Consolidated Response Irregular Change Long Term Average Minimum Maximum Standard Confidence 2.75 4 3.375 Minimum Risk Rating 1 1 Maximum Risk Rating 5 5 Standard Deviation of the Rating 1.785 1.87 Confidence Interval (95%) ±1.4637 1.5334 0.75 0 0.375 Minimum Risk Rating 0 0 Maximum Risk Rating 2 2 Standard Deviation of the Rating 0.829 0.894 Confidence Interval (95%) ±0.67978 0.733 4 3 3.5 Minimum Risk Rating 3 3 Maximum Risk Rating 5 5 Standard Deviation of the Rating 0.707 0.837 Confidence Interval (95%) ±0.57974 0.68

31

Risk Rating Delphi Survey Response (7 Respondents) Team Response Consolidated Response Risk Management:

Risk Rating

Risk Rating

Deviation of the Rating 0.707 0.707

Interval (95%) ±0.57974 0.58

1 1 1

0 0

2 2

The risks presented in this section can either develop slowly (resource curse related changes) or overnight (coup) and must be actively monitored overtime. Steps that IPIG can take to best address these risks include: • Devoting staff or hiring a consultant to monitor domestic political developments and legislative progress within each party • Purchase political risk insurance that covers regulatory risk, expropriation, and nationalization, subject to guidelines in part IV. $

32

B. Socio-Economic Risks i. Economic Instability Risk Assessment: As the least developed country in the world with an estimated GDP of USD 1.9 bn in 2009, Sierra Leone’s economic outlook goes hand in hand with the political and social situation. Representing a skewed economy with an overdependence on the mining industry, Sierra Leone has not only shown unsustainable growth in the past, but also demonstrated a conscious neglect of crucial sectors of a diversified stable economy such as agriculture and industrial development. A country rich in precious natural resources such as diamonds, gold and rutile (a titanium ore), Sierra Leone’s exports are concentrated in these specific minerals. A purely export-based economy exposes the country to international currency changes and economic situation. The mining sector has often been credited for being one of the key factors for the civil war, with revenues from diamond and other mineral trade making it’s way to private enterprise rather than as government revenue. It has been termed as the “resource curse” since weak government policy and laws, has allowed for the loss of revenue for the government. The diamond mining industry was used as a method of payment for arms and ammunition for the rebels, almost in a way to fund the earlier civil war. These diamonds represent a ‘conflict resource’, which need to be better managed to avoid falling into the wrong hands. Red tape, apart from the just inefficient laws and government control, allowed for such severe leakages from the economy. Agriculture engages more than two-thirds of the population of Sierra Leone, but hasn’t flourished in the past due to the government’s over-dependence on the mining sector. The period of civil war also disrupted other sectors of Sierra Leone’s economy such as tourism. Civil war 33

also worsens investor sentiments due to the political instability and civil turmoil it encompasses. A primarily export-based economy is has the severe threat of drop in international demand for its resources, due to a price hike or such an unforeseeable circumstance. A sudden price hike in a mineral can decrease demand for the mineral in the short run thereby cutting-off the government’s already tight monetary stream. Sierra Leone’s economy has a large dependence on foreign aid and assistance to finance many of the activities being carried out in the country. Without being able to finance day-to-day activities the economy and the country can come to a standstill. Having established some of the primary causes for the civil war, it is suffice to say that the economic outlook of the country is tied in directly to its political stability.

Risk Evaluation: The overdependence on mineral resources leads to inflated growth projections for the economy and stays true to its unsustainable nature. Historically it can be seen that the 32% and 107% GDP per capita growth in the 1960s and 1970s respectively, were followed by a shrinking in GDP per capita by 52% in the 1980s, followed b a further 10% reduction in the 1990s. However, the recent transparent and peaceful elections in 2007 have allowed for the existence of a free and fair democratic government. Given the turmoil and uncertainty of the civil war, a stable government allows for the international associations to be developed to aid Sierra Leone to break its cycle of economic mismanagement. A stronger government would lead to more efficient laws to ensure that the revenues from the extracted minerals makes it’s way back

34

into the hands of the government. NACE28 claims that had the government’s revenue could increase seven fold by 2020 through redrafting its mineral legislation and reviewing individual mining contracts. An example is the review of the 2003 agreement with Sierra Rutile, which reduced the mining companies royalty rate to 0.5% and slashed corporate income tax on profits till 2014. Higher government spending has strong repercussions on the economy as it is estimated that it can uplift almost 1 million people out of poverty. As can be seen in the chart below, the 4.5% growth in 2010 is expected to rise to almost 6% in 2012.29 The medium term outlook for the economy remains positive, with the IMF and organizations like USAID, helping Sierra Leone with their structural reform, redirecting the emphasis on ignored sectors like agriculture. The services sector is also slowly being expanded leading to job growth. The financial reforms, that have been mentioned earlier, are accompanied by tax reforms and undertaking of large scale projects such as the Bumbuna power station. Figure 1: Real GDP Growth

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The second issue has to do with the lack of information. More specifically, as one report has adequately described, in each aspect of the investment process in Sierra Leone, information is unavailable, inconsistent, or difficult to understand. This lack of information thus also contributes to informality since regulations and procedures are easier to ignore if information is not available.51 This problem becomes particularly severe when it comes to access to industrial land for foreign investors. Because the law in Sierra Leone prohibits the ownership of land by foreign entities, foreign companies seeking to acquire land may lease privately or publicly held land. However, the process of leasing land is lengthy due to the fact that much of the governmentprovided land-related information is either lacking or inconsistent. Much of the land in Sierra Leone has yet to be surveyed and maps from the colonial era are out of date; as a result, it is nearly impossible to get credible land information from a public agency without visiting and surveying the land in person. In fact, out of the countries surveyed for World Bank’s Investing Across Borders study, Sierra Leone stands ahead of only Afghanistan as the second slowest economy for leasing land from a private holder, with the process taking an average 210 days. Sierra Leone does not fare much better when it comes to leasing land from the government – standing as one of the slowest countries at an average of 277 days [see graphs below].52 Figure 7: Fastest and Slowest Economies for Leasing Land

$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$ _%$M-*)!3.$2.#)?0H).0$5E#!?-*6$()*#!4)"$28#''+$9#&:#@$?)48:86-'+-8+)1$L"$ 61

In June of 2006, the Euler Hermes Group assigned Sierra Leone a grade of “D” for its external transfer and inconvertibility risks – the lowest grade available on the scale.55 Nevertheless, this grade overstates the risks for future oil and gas investment in Sierra Leone because it heavily weighs industries unrelated to oil and gas. For the present and near future period, for the oil and gas industries specifically, a grade of B makes more sense. In explaining the D grade for Sierra Leone, Euler Hermes group focuses on the controls surrounding the mining industries in the country. After agriculture mining makes the largest contribution to Sierra Leone’s economy at 4.5% of GDP and 42% of national income.56 The country’s main mineral exports are diamonds, rutile, bauxite, and gold. The diamond industry incurs the majority of external transfer and inconvertibility risks as “blood diamonds” (diamonds with revenues redirected to purchase weapons for local militias) continue to drive political, ethnic, and religious violence throughout sub-Saharan Africa.57 Liberian president Charles G. Taylor catalyzed civil conflict in Sierra Leone to gain access to the country’s conflict diamonds, a war crime for which he was convicted by an international tribunal on April 26.58 Though his conviction, the first such conviction of a head of state since the Nuremberg Trials, encourages a positive outlook for international regulation of stability sabotage from corrupt African governments in the future, Sierra Leone remains a country of particular concern to investors in the diamond industry.59 Additionally, like all sub-Saharan African diamond exporters, Sierra Leone’s diamond exports remain subject to the Kimberley Process, an $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$ http://www.eulerhermes-aktuell.de/de/dokumente/country-review-sierra-leone-20100910.pdf http://www.globaltrade.net/m/c/Sierra-Leone.html 57 Federico, Victoria (2007), The Curse of Natural Resources and Human Development: A New Perspective on Institutions, retrieved 20 February 2012. 58 http://rendezvous.blogs.nytimes.com/2012/04/27/taylor-gone-but-blood-diamonds-are-forever/ 59 http://www.nytimes.com/2012/04/27/world/africa/charles-taylor-liberia-sierra-leone-war-crimes-courtverdict.html?_r=2&ref=africa
56 55

62

alliance of governments, organizations, and companies that review and approve diamond exporters and impose revenue regulations meant to remove incentives for members to buy unapproved conflict diamonds.60 Nevertheless, the international restrictions on the diamond industry do not apply to external transfer and inconvertibility risks for Sierra Leone’s currency in general, and the oil and gas industry is extremely unlikely to face the regulatory process deterioration that plagues diamond sales. Firstly diamond mining requires relatively inexpensive equipment, and local actors with an ideological or financial incentive to sell conflict diamonds can open and control diamond mines. In contrast oil and gas extraction requires sophisticated technology available only, at present, from large corporations specializing in extraction. Therefore the industry depends on foreign investors, whose incentives align with regional political stability and low regulatory barriers. This makes some sort of “conflict oil” industry extremely unlikely to develop. Over the long-term, the obsolescing bargain model posits that local actors and Sierra Leone’s government gain knowledge about extraction technologies and control over multinational corporations’ fixed assets. The time frame for such a power shift, though, spans decades. Political and social volatility throughout Sub-Saharan Africa renders impractical predictions for political risk decades from now.

Risk Evaluation: Since the end of Sierra Leone’s civil war, the country has boasted one of the highest economic growth rates in the region thanks to continuous high growth in foreign direct $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$ http://www.kimberleyprocess.com/web/kimberleyprocess/enforcement;jsessionid=71018C8540E44FF99F1BA6FC8D74FDD0 60

63

investment (FDI). Sierra Leone maintains highly favorable external transfer and currency convertibility conditions to encourage the continued growth of FDI, and the U.S. Commercial Service predicts the continued dynamic growth of FDI in the country over the next 3-5 years.61 Sierra Leone’s investment code, affected in 2005, is designed to protect companies investing in Sierra Leone.62 The code legislates the nondiscrimination of foreigners and protects the absence of regulations against the repatriation of profits. So far, the government has behaved in accordance with the investment code, suggesting that free external transfer and currency convertibility should continue into the future. This indicates low external transfer and inconvertibility risks for oil and gas investors over the next five years. This low risk assessment comes not only from the stability of Sierra Leone’s attractive investment code over the past seven years, but also from the governments’ institutionally imposed incentive to keep it that way. Sierra Leone’s government undergoes a structured and monitored economic reform program under an IMF Extended Credit Facility (ECF) designed to increase investments in infrastructure and increase access to the financial sector.63 The most recent review, in June 2010, suggested satisfactory progress, though persistent corruption in the country could dissuade donors between now and the ECF’s expiration in June 2013. Regardless, Sierra Leone’s dependence on foreign investment incentivizes the government to maintain its attractive foreign investment environment in the coming years. The only realistic threat to external transfer and convertibility conditions in Sierra Leone is the effort by the Economic Community of West African States (ECOWAS) to produce a common currency for the West African Monetary Zone (WAMZ). First, this currency change $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
61 62

http://www.globaltrade.net/m/c/Sierra-Leone.html http://www.sliepa.org/doing-business 63 http://www.imf.org/external/np/sec/pr/2010/pr10228.htm

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would subject Sierra Leone’s new currency to the preferences of other states in the WAMZ, notably Nigeria, whose relatively large economy would give it a large influence over the fate of the new currency. This could threaten the currency’s convertibility because Nigeria has historically displayed a cooler attitude towards currency convertibility; it has only in the past two months debated moving to full current account convertibility.64 Second, the establishment of a common currency for the WAMZ would increase intraregional trade, thereby reducing Sierra Leone’s economic dependence on foreign investors from outside the region like Germany and the United States. It remains unclear how much trade would shift away from Sierra Leone’s primary economic partners. Although agriculture accounts for the largest section of Sierra Leone’s economy – and intra-regional trade of agricultural products might produce comparative advantages that boost regional economic efficiency – foreign investors are most heavily involved in the mining industries, which produce products that West African countries do not use and would not trade with one another. The weak infrastructures in the region produce relatively little demand for oil and gas, so investors in the oil and gas industries would also see relatively small trade displacement from the establishment of a common currency in West Africa. Nevertheless, any decrease in Sierra Leone’s dependence on FDI from countries may outside of West Africa could reduce the government’s incentive to keep terms of profit transfer as attractive as possible. Third, a regional currency would allow the WAMZ to coordinate its activities and act as a larger, more influential, integrated economic system on the world stage compared to several small, relatively poor juridical states. Their increased relative economic power would also reduce the incentive to sweeten terms of trade for investors from foreign countries. $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
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