Paraguay Plant a Coup for Rio Tinto
Calla is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In 2010, Rio Tinto (NYSE: RIO) proposed to build a $4 billion aluminum plant in Paraguay. Then-president Fernando Lugo set up a technical team to explore the costs, benefits, and impacts, and the project plodded along until June, when the opposition-controlled legislature impeached Lugo and swore in his disgruntled vice president, Frederico Franco, in what neighboring countries have labeled a coup. The following week, Franco’s new government struck up new negotiations with Rio Tinto.
The Franco administration, which most Paraguayans and neighboring countries regard as illegitimate, is tripping over itself to start construction on the project. The new administration has started negotiations without waiting for the results of the cost-benefit or environmental impact analyses that the government's technical team was supposed to produce, and without ordering new studies. Rio Tinto has not only brought tax incentives to the negotiating table – Paraguay already has the lowest tax rates on the continent – but also environmental regulations and energy prices. Estimates put the plant’s annual electricity consumption at 9,000 gigawatt/hours a year -- nearly the current annual consumption of the entire country in 2011. Rio Tinto wants a 30-year fixed-price energy contract, and media and official sources close to the negotiation hint that the Franco administration is considering giving the company just that, and at 20-40% below the current market price.
We will not know the final terms of the closed-door negotiations for some time, but signs point to Rio Tinto getting a very cheap deal by industry and continental standards. On one hand, the Franco administration stands to offer Rio Tinto tax, energy, and environmental conditions that it cannot find elsewhere in South America, and closing such a deal should send Rio Tinto’s shares higher. Likewise, Paraguay – a landlocked country reliant on agribusiness and with the second lowest GDP per capita on the continent -- would welcome $4 billion in fixed asset foreign investment. However, the generous terms that the Franco administration is poised to offer could sow problems for Rio Tinto and its share price further down the road.
First, moving ahead on the project without the standard environmental and economic impact studies is imprudent. The plant will be a massive and unprecedented industrial project in Paraguay, and the proposed site is on the country’s major waterways, the Paraná River, and atop the Guarani aquifer. Pollution from the Rio Tinto project – accidental or not – could quickly lead to an expensive clean-up and a drawn out public relations mess.
Second, an excessively generous agreement will generate resentment toward the project and tempt future politicians to initiate a politicized renegotiation. Paraguayans deeply resent the fixed-price electricity contract that the country has with Brazil, a contract that for decades required Paraguay to sell its excess hydroelectric power to Brazil at far below market price. Lugo pledged to renegotiate the contract as part of his his campaign and did so in 2009. Governments in Ecuador and Bolivia have scored political points with their electorates by nullifying and renegotiating unpopular natural resource contracts -- and Lugo has suggested that Rio Tinto may be setting itself up for just that.
Paraguay stands to benefit from Rio Tinto’s massive investment only if the government negotiates a reasonable contract. While Rio Tinto shareholders will benefit in the short term from slashed rates and regulations, long-term investors and Rio Tinto’s management should see the benefit in due diligence.
CallaMarie has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.