Taylor Covert (3/9/16)- ISP Country Analysis Report
I. Country Introduction: Chile v. Peru
Extending 2,880 miles down the western coast of South America, between the Pacific Ocean and the Andes mountains, is the remarkably slender country known as Chile. Due to its large geographical scale, encompassing 38 degrees in latitude, Chile has a range of climatic zones, from the arid Atacama Dessert in the north to the subtropical regions in the south. These diverse climates and topographies provide Chile with a wealth of natural resources including timber, iron ore, hydropower and most prominently, copper, an element known for its inherent ductility and electrical conductivity. Beginning in the mid 1960s, concurrent with China’s exploding GDP growth rate, the value of copper in the modern industrial market place began to soar due increased global demand. Chile, whose copper reserves account for 28% of the world’s total supply, experienced the positive economic impact from this increased demand, as seen through the country’s GDP growth of over 400% between 1970 and 2014, adjusting for inflation, (Appendix 1). Coupled with the solid GDP growth over the last 45 years, Chile was also able to establish strong institutions, an efficient government with relatively low levels of corruption, and solid macroeconomic stability, which subsequently established Chile as the most competitive economy in Latin America according the 2015 Global Competitiveness Report (GCR) (Appendix 2).
Directly to Chile’s north lies Peru, a country almost double Chile’s size and population (Appendix 3). Similarly to Chile, Peru’s economy reflects its wide-ranging topographies including arid coastal regions in the west, mountainous highlands in central Peru, and tropical Amazon forests bordering Colombia and Brazil. These provide the country with an abundance of natural resources comparable to Chile’s: timber, fish, iron ore, hydro-power, and copper, of which Peru has 13% of the world’s supply, making it the second largest copper producer. Peru also has extensive supplies of coal, natural gas, and crude oil, reducing its energy dependence, and precious resources of silver and gold, further diversifying its economic exports. However, according to the 2015 GCR, Peru was ranked #65 in terms of global competitive advantages, significantly worse than Chile’s #33 rank (Appendix 2). While having the necessary natural resources to support a prosperous economy, ongoing issues concerning the effectiveness of Peruvian institutions, the quality of its education system, its resistance to technological adoption, and its government’s apparent corruption have stunted Peru’s economic growth.
Despite the aforementioned issues, for the past five years, Peru’s economy has been growing steadily at 5.6% due to high global prices for metal exports. Metals and minerals account for 60% of Peru's total exports, of which copper alone accounts for 18% (Appendix 4). Chile, notwithstanding its relative political, institutional, and technological strengths, has an even greater reliance on copper exports, accounting for 49% of its total exports. Evidently, Chile and Peru’s dependency on copper exports makes both economies susceptible to copper commodity price risk. Thus, it is necessary to investigate both country’s copper industries, as well as the competencies and inefficiencies of key industry players, in order to determine ways to sustain the copper industry’s growth within the ever-changing global economy.
II. Copper Industry Analysis:
In Chile, large-scale copper mining began in the early 20th century when an influx of American capital launched extensive copper mining projects in the Atacama Desert. By 1951 however, the Chilean government made their first intervening step into industry by creating The Washington Agreement. This agreement gave the Chilean government 20% control of domestic copper production. By 1971, the government further intervened by nationalizing Chile’s American-owned mines, forming the Chilean mining company Codelco. Today, Codelco is the world’s largest copper producer, responsible for mining over one tenth of the world's copper. This brief history of the copper industry’s nationalization, culminating with Codelco, highlights three basic strengths of the Chilean copper industry: the sheer size of Chile’s reserves, the unwavering government support for mining, and the country’s overall stability. Firstly, Chile controls 28% of the world’s copper, while Peru, the second largest copper producer, only has 13% (Appendix 8). This advantage, along with Chile’s free trade agreements with the US and China, will enable Chile to remain the world's largest copper producer for the forecasted period through 2020 (Appendix 5). Secondly, Codelco’s success indicates that there are industry advantages in being nationalized, primarily in the form of government support. The Chilean government has historically maintained a pro-mining outlook due to the sector's importance in generating government income. To ensure additional growth and stability of the copper sector, the government has been willing to provide billions of dollars to Codelco in the form of aid and investments (Appendix 6). And lastly, Chile’s overall stability compared to its Latin American neighbors has led to increased prospects for mining investments. Compared to its population and GDP in 2006, Chile had the largest amount of foreign direct investment (FDI) in Latin America at $86.1 billion, with investments in mining accounting for approximately 35% of that amount. FDI provides significant advantages for the receiving companies including resource transfers and reduction in the disparity between revenues and costs. Thus, Chile is able to attract FDI due to its sound infrastructure, uncorrupt government, and strong financial institutions etc. This benefits Chile’s copper industry and stimulates further economic development.
In contrast to Chile’s advantageous political stability, the Peruvian government has a history of corruption, with bribery and favoritism amongst government officials in awarding contracts being common practice. This corruption, in the form of preferential treatment towards mining companies, has led to upheaval and anti-mining protests showing the Peruvians distrust of mining companies and their relations with the government. Further, social protests over income inequality and environmental degradation continue to create domestic uncertainty within Peru, weakening the country’s ability to attract FDI. In contrast to Chile, the Peruvian copper sector has experiences some benefit from being not nationalized. Peru’s mining participants, Rio Tinto PLC, Anglo America PLC, and Southern Copper Corporation, are predominantly multinational firms that maintain active mines while constantly investing in new projects, subsequently stimulating industry growth. In addition, these Peruvian private sector mines have proven to be more efficient in their production of copper than Chile’s state-owned Codelco. As such, Chile’s nationalization of copper can be viewed as a strength or a weakness dependent on perspective (Appendix 7). Another notable strength of Peru is its mining diversification, producing gold, silver, tin, lead and zinc as well as copper. Thus, Peru’s economic growth is not solely reliant on copper, placing less emphasis on the copper industry to maintain production in the face of decreasing demand. On the contrary, Chile has significant revenue reliance on copper as a primary source of export revenues. This threatens Chile’s economic stability, exposing the market to copper price fluctuations and the probable decreases in world demand.

However, Chile’s greatest threat is its dependence on water and electricity, both scarce resources, which keep copper production costs high. Chile's copper miners have begun investing in alternative water projects, particularly relating to desalinization, but the steep upfront costs have reduced cash flows and caused operational disruptions. Currently, Chile’s government is considering implementing reforms to lessen red tape and to mitigate project delays because, once the desalinization plants are complete and the necessary procedures are properly implemented, they will alleviate water conflict within local communities and improve long-term corporate efficiency. While alternative water sourcing is a long-term opportunity for Chile, recently, Chile has attempted to combat increasing production costs by reducing capital expenditures. And yet, Chile’s operational costs remain markedly higher than Peru’s, presenting an opportunity for Peru. Although Peru has higher tax rates than its neighbors, due to its open investment framework, supportive political environment, and low operating costs, Peru's copper mining sector has a competitive stance, particularly given the elevated production costs in Chile.

While distinct opportunities and threats exist for each country, both Peru and Chile face the threat of a slowdown in global copper demand. Considering that 45% of global copper consumption comes from Asia, the slower-than-expected 2015 growth rate in China weighed heavily on copper prices (Appendix 8). Additionally, weak investor sentiment across that commodities sector could continue to negatively affect future willingness to invest in copper. So, what strategic approaches will copper mining companies like Peru’s Southern Copper and Chile’s Codelco take in order to combat these country-specific threats while capitalizing on the opportunities?
III. Copper Company Comparison: Peru’s Southern Copper V. Chile’s Codelco
Southern Copper Corporation currently operates two mines in Peru that, as of 2007, were producing approximately 359,665 tons of copper per annum. Additionally, Southern Copper Corporation has two equally significant mining operations in Mexico, making the company the seventh largest copper mining company in the world. Southern Copper has attained this global success by strictly focusing “on copper production, cost control, production enhancement and maintaining a prudent capital structure to remain profitable,” avoiding diversification into other commodities like most of its competitors. Instead, Southern Copper has attained its growth by maintaining output of existing operations while developing new mining projects, like the $1.4 billion Tia Maria mine project in southern Peru started in 2011. Despite receiving immediate approval from the Peruvian Ministry of Engineering and Mining, the project had to be stopped due to violent local protests in 2011 and 2015, claiming the project had dangerous implications for the environment, particularly the Peruvian water supply. Southern Copper plans to resolve the dispute and start copper production in the Tia Maria mine by 2018. While there is resolution in sight for the Tia Maria mining project, the incident exposed Southern Copper’s weakness: their willingness to take advantage of the Peruvian government’s pro-mining orientation without consideration for all of the stakeholders. Southern Copper’s strength clearly lies in their knowledge of effectively producing copper, while controlling costs in order to obtain a profit. But if they plan to continue expansion in Peru, the company must not repeat this costly mistake of not considering the broader consequences to communities and to the environment. These community protests against the copper industry are frequent and effective in Peru, as seen through the abrupt halt of the $5 billion Conga mine project earlier in 2011 due to community remonstrations. Recognizing this trend would present an opportunity for Southern Copper if instead of brushing off the public outcry, they developed technological solutions to resolve the issues associated with mining and environmental damage.
Chilean state-owned Codelco copper mining company has similarly put it expansion plans on hold, but for different reasons. With persistently low copper prices and increasingly high production costs, the firm strategically chose to reduce costs by delaying their El Teniente mine expansion plan and by reducing their $7.5 billion Andina mine expansion plan. Overall, through these cost reductions, Codelco reduced total investments in 2014 Q4 by $4.0 billion. Codelco demonstrated corporate sagacity in recognizing financial limitations, but without expansion, Codelco cannot expect to continue significant growth. Codelco recently indicated that their 2015 strategy was to remain focused on maintaining output levels while cutting operation costs, but with the threat of falling copper prices and the imminent decrease of the global copper demand, this strategy may not be enough.
The shifting industry with low projected growth rates requires copper companies to use innovation to turn industry threats to opportunities. As the world’s largest copper producer, Codelco has the resources and know-how to implement a more innovative strategy that would sacrifice short-term profits for long-term solutions. Codelco should continue strategic investments that would turn the Chilean copper industry’s threats, like reliance on commodity pricing, high domestic production prices, and public outcry over environmental concerns, into opportunities. Codelco has started taking steps to address the issue of dependence on copper by looking to diversify interests into gold and uranium. Additionally, domestic production challenges have encouraged Codelco to look abroad, to Ecuador, for new mining opportunities and to invest in its own power production facilities. Investment in power production would enable Codelco to avoid power supply shortages that affect production in most Chilean mines. The firm has embraced the notion of renewable energy technology to reduce operational costs, thus planning to capitalize on solar power in the north and wind power in the south. However, successfully implementing these advanced power generation facilities would require significant investment, of which Codelco has been purposefully cutting back. Yet, one of Codelco’s strengths is its support from the Chilean government, most recently demonstrated in 2015 by the first $600 million installment of a $3 billion governmental aid package. Codelco seems to have recognized the industry threats. Now, the company must act strategically with their capital from investments and government aid to convert threats into opportunities, enabling long-term development and growth in the volatile global copper industry. IV. Report Overview: The Key Success Factor
Globally, copper producers have been able to maintain production, but if low copper prices continue into 2016, there could be “further production curtailments and mine shutdowns down the road.” Projections for the industry suggest zero to slow growth in the near term, with many experts forecasting industry-wide contractions due to decreasing Chinese growth rates and demand. We have reached an inevitable shift in the copper industry at large, where mining companies, even the world’s strongest, can no longer rely on rising copper prices to facilitate growth. Despite major differences existing between Chile’s nationalized copper industry, seen through Codelco, and Peru’s multinational copper industry, seen through Southern Copper, for both countries, the key to future success lies in their abilities to adapt and innovate.
According to the GCR, with its high GDP per capita, relative political stability, etc., Chile has begun to transition from a Stage 2 efficiency-driven economy to an advanced Stage 3 innovation-driven economy. Yet relatively low innovation investment, especially in the private sector (77th) has resulted in low overall innovation capacity (76th), which could ultimately threaten Chile’s transition towards a knowledge-based economy. Chile must look to innovation to reduce copper production costs, not just merely cutting employment and investments. Codelco has identified prospects in renewable energy sources and desalinization processes that could propel the mining industry, allowing it to lead Chile into the highest GCR stage based on innovation and knowledge. Peru, classified as a Stage 2 efficiency-driven economy, should be looking to emulate Chile by boosting innovation in order to enter into the transitional phase between Stage 2 and 3. The Peruvian mining sector mainly consists of Multinational Corporations, thus there should be a greater flow of information and technology between Peru and developed countries. Peru’s goal is to boost technology adoption (92nd) in order to raise its innovation capacity (117th), which still remains fairly small. The mining industry needs to further innovate in order to reduce the environmental impact of its operations. These renewable energy and water innovations would improve miner’s rapport with local communities while reducing production costs, allowing both Chile and Peru to sustainably continue production and maintain their competitive edges in in unpredictable global copper market.