ZAMBIA: SOME IMPLICATIONS OF THE COPPER INDUSTRY'S IMPENDING COST-PRICE SQUEEZE

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R001500220030-5
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 17
• Document Creation Date: December 16, 2016
• Document Release Date: December 27, 2004
• Sequence Number: 30
• Publication Date: March 1, 1968
• Content Type: IM

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Confidential
O
DIRECTORATE OF
INTELLIGENCE
Intelligence Memorandum
Zambia: Some Implications
of the Copper Industry's
Impending Cost-Price Squeeze
Confidential
COPY NO.
ER IM 68-28
MARCH 1968
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WARNING
This document contains information affecting the national
defense of the United States, within the meaning of Title
18, sections 793 and 794, of the US Code, as amended.
Its transmission or revelation of its contents to or re-
ceipt by an unauthorized person is prohibited by law.
GROUP I
EXCLUDED FIIOAI AUTOMATIC
UONUUIIAIIINO MW
ftC LA MS IFICATI ON
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CENTRAL INTELLIGENCE AGENCY
Directorate of Intelligence
March 1968
INTELLIGENCE MEMORANDUM
Zambia: Some implications
of the Copper Industry's Impeding
Cost-Price Squeeze
Summary
Settlement of the crippling US copper strike
would cause the very high world market price of copper
to tumble, since the United States is the leading
copper-producing nation. Long-term prospects are
for lower copper prices than have prevailed over
the last few years. Zambia, whose economy is
dominated by copper, is now a high-cost producer and
finds these costs to be increasing rapidly. Hence,
it can be expected that foreign exchange and govern-
ment revenues will decline seriously.
The relatively high prices for copper since
Zambia became independent in 1964 have allowed
Zambian President Kaunda great latitude in carrying
out policies. With government revenues soaring,
Lusaka embarked on a massive development program
while at the same time spending large sums on efforts
to break its deeply embedded economic ties with
white-ruled Rhodesia. Meanwhile, the mining companies
absorbed much higher costs and still received an
adequate return on their investments. The requirement
to use poor-quality local Zambian coal has damaged
smelters recently, requiring a 20-percent cutback
in output until at least July 1968.
After a settlement is reached in the US strike,
Zambian government revenues will fall faster than
prices, and Lusaka will soon face the problem of
financing an annual budget deficit of more than
Note: This memorandum was produced by CIA. It: was
prepared by the Office of Economic Research and co-
ordinated with the Office of Current Intelligence.
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$140 million in order to continue its extensive
programs. Company profits will also be severely
squeezed, so that the government will be unable to
raise tax rates without risking a closure of mines
with higher operating costs.
Significant reductions in production costs are
unlikely because rising costs have resulted mainly
from higher wage payments to mine workers which
were obtained by the influential Zambian Mineworkers
Union and from the political decision to implement,
as far as possible, the policy of a complete economic
break with Rhodesia. There is also little likeli-
hood of obtaining sufficient funds from abroad or
from non-copper local sources. Zambia thus will be
faced with long-term financial difficulties and
much slower economic development.
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Background
1. Copper dominates the Zambian economy,
accounting for about 50 percent of the gross national
product, 90 percent of total exports, and about 65
percent of government revenue. The industry, largely
owned by US, UK, and South African interests, produces
nearly 15 percent of the world's copper. Zambia's
economic well-.being and economic development both
depend heavily on the industry's prosperity.
2. Since it achieved independence in October
1964, Zambia has enjoyed the benefits of relatively
high copper prices. Company profits have been
adequate and government revenues have jumped sharply.
Despite a 20 percent decline in the volume of pro-
duction and sales during fiscal year 1967,* sales
revenues increased about 10 percent because of high
prices. But these large earnings have been accom-
panied by rapidly rising production costs, and in
recent years Zambia has moved from a relatively low-
cost to a high-cost producer of copper. Thus a
serious cost-price squeeze is likely to emerge
quickly once prices begin to fall.
Copper Price-Trends
3. During 1959-63 the average annual price paid
for Zambian copper remained relatively stable, fluc-
tuating between 29 cents and 31 cents per pound.
In 1964, world demand for copper jumped sharply,
mainly as. a result of a surge in economic activity
in Free World developed countries. With prices on
the London Metal Exchange (LME) rising rapidly,
Zambian producers, like those in Chile and other
major producing countries, agreed to sell their pro-
duction at fixed prices in an effort to forestall a
rapid shift to substitute metals. The price was
set at 29-cents and was raised gradually to 42 cents
in January 1966. LME prices, however, continued to
skyrocket, reaching more than 80 cents per pound in
early 1966, as demand was outrunning supplies. The
US consumption of copper expanded rapidly as a result
of requirements for Vietnam, and there were production
* Companies report on a 1 July-30 June fiscal year
basis.
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problems throughout the world, such as strikes in
Chile. In order to benefit from the high world
prices, the Chileans decided to abandon fixed prices
and sell their output at the higher three-month future
LME price. The move forced Zambia and other Free
World producers, outside the United States, to take
similar actions. As a result the LME price fell to
about 70 cents per pound.
4. Toward the end of 1966, prices moved down-
ward as an increasing supply outpaced demand (see
Figure 1). Copper consumption declined as substi-
tution of other metals that had been stimulated
during the period of high prices started to be felt
and because of a slowdown of economic activity in
Western Europe. In addition, copper stocks were
becoming ample, A further price decline was staved
off by the US copper strike starting in mid-1967,
although, thanks to the high level of stocks in the
United States and Europe, the price remained at about
45 cents a pound through October. As stocks in the
United States neared exhaustion, however, the London
price moved up rapidly, reaching 70 cents as of the
end of February 1968.
Rising Production Costs
5. The high prices over the last few years have
allowed Zambian copper companies to absorb new taxes
on copper and rapidly increasing production costs
without serious adverse effects on their return on
investment. This return for the last three fiscal
years has been more than 20 percent, about the same
as earned by other mining companies in southern
Africa. Despite the 10-percent increase in gross
sales revenue in fiscal year 1967, resulting from
price increases which more than offset reductions
in output, company profits declined slightly (see
Table 1) .
6. The cost of producing copper, which covers
outlays of mining, smelting, and refining in Zambia,
as well as selling and transporting charges, rose
from 17 cents per pound in fiscal year 1964 to 25
cents per pound in fiscal year 1967 -- an increase
of some 50. percent. As shown in Figure 2, the
sharpest rise occurred during 1967. The increase
in costs that year is somewhat overstated because
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-
anuary 1968
Figure 1
80
70
1 11-0
40 Zambia abandons
producers' price
I
30 Zambian Producers' Price
20
10 I I
0
1 F M A M 1 1 A S 0 N D 1 F M A M J J A S 0 N D 1 F M11 A M J 1 A S 0 N D J
1965
58499 2-68 1966 1967
1968
Copper Prices
1965
J
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Zambia: Distribution of Copper Revenues
Fiscal Years 1964-67 and First Half Fiscal Year 1968*
Cents per pound
70 r
FY 1967 FY 1968
FIRST HALF
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*Fiscal year-i July to 30 June
58498 2-68
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Table 1
Zambia: Copper Industry Sales and Profits
Fiscal Year 1967 a/ Fiscal Year 1966
Thousand Short Tons
Sales revenue
Royalty and tax payments
Royalties
Export taxes
Income taxes
Production costs, including
transport and selling
Net profit
Million US $
594.8
542
9
220.4
.
181.3
80.1
111.4
82.6
1.6
57.7
68.3
299.6
284
5
.
a. Fiscal years run from 1 July to 30 June.
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all the ore that was mined could not be processed
because of coal shortages. On the other hand, the
increase in costs since then has probably been
understated because some ore processed in the first
half of fiscal year 1968 (1 July-31 December 1967)
came from the stockpile rather than being newly
mined.
7. Wages, particularly for mine workers, have
been the major element contributing to higher pro-
duction costs. Labor unrest in the copper industry
in 1966 was stimulated largely by the wide gap in
wage scales and working conditions between native
and expatriate employees. Yielding to pressures of
the strong Zambian Mineworkers Union, the government
approved an increase that pushed up wages 42 percent.
While labor costs have increased, productivity in
the copper industry has declined since independence.
For example, at one important mine the overall pro-
duction per mine worker fell 25 percent between fiscal
year 1963 and fiscal year 1967. This decline is
attributable to white and black supervisors. being
unwilling to enforce discipline and work norms for
fear of provoking violence. Moreover, the govern-
ment policy of replacing white expatriates with
Africans has proceeded much faster than the availa-
bility of newly trained local personnel, with a
resulting loss in efficiency.
8. President Kaunda's efforts to sever all
economic ties with Rhodesia have contributed greatly
to rising cost, especially for fuel and transport.
Lusaka's immediate response to Salisbury's Unilateral
Declaration of Independence (UDI) in November 1965
was an attempt to redirect Zambian foreign trade --
almost all of which traditionally moved through
Rhodesia -- to non-Rhodesian routes. The traffic
which has been shifted, however, has had to use
longer, less efficient, and less reliable routes,
resulting in higher transportation and handling
charges. (For costs of shipping copper on all
routes, see Table 2.) The numerous difficulties
encountered in using alternate routes often have
resulted in delays and shortages which forced a
reduction in copper production and added to unit
costs. In addition, the freight which still transits
Rhodesia must now pay rates about 30 percent higher
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Table 2
Transport Charges for Shipping Zambian Copper to African Ports a/
US Dollars per Short Ton
October 1966
October 1967
44.70
58.30
48.20
59.10
Great East Road to Salima, Malawi,
and hence by rail to Beira,
Mozambique
Great North Road to Dar es Salaam
Large vehicles
Small vehicles
61.05 b/
89.30
Airlift to Dar es Salaam
158
20 c/
.
a. Inc luding port char es
b. This price is char ed
not include g for government-owned trucks and may
fuZZ depreciation as a cost element.
c. The price charged by the artiall
Air Cargoes, which handles all copper yshgvernmet-e
ipmentsnbyoair,d ismbian i probably Zess than their actual costs.
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than before 1967 as Rhodesia attempts to compensate
for the revenue loss resulting from the diversion of
Zambian traffic. In all, the higher costs for shipping
copper to African ports added roughly 1.5 cents per
pound to total costs.
9. The costs of supplies have also risen. There
have been increased freight charges, and higher prices
have been paid for many goods which were previously
bought in Rhodesia but are now purchased elsewhere.
The copper industry is affected indirectly by this
upward movement in prices through pressure for higher
wages and directly by the increased prices paid for
imported items and locally produced supplies which
generally have a high import content.
10. Coal is the most important commodity con-
tributing to higher production cost for copper.
Zambia normally consumes about 1.3 million short
tons of coal annually, most of which is used directly
or indirectly by the copper industry. Prior to UDI,
all of Lusaka's coal requirements were met from
Rhodesia's Wankie collieries, which provided cheap,
high-quality coal. Since 1965, however, Zambia has
attempted to reduce this dependence by rapidly
developing its domestic coal resources. Thus far,
these efforts have been only partly successful, and
the coal obtained from Zambia's Nkandabwe mines has
proved to be more expensive and of lower quality.
The price of domestic coal delivered to the Copper-
belt is about $20 a short ton, more than triple the
pre-UDI Wankie price. Moreover, because of its high
ash content and low calorific value, it takes about
one and one-half tons of domestic coal to replace
one ton of Wankie coal. The cost of Zambian-pro-
duced coal is thus about five times the cost of
Wankie coal. The copper industry has also been
using some heavy fuel oil and small amounts of coal
imported from South Africa as substitutes for the
Rhodesian product. In an effort to compensate for
the loss of coal sales, Salisbury has introduced a
sliding scale of prices which has also increased
the cost of coal to Zambian users. Altogether the
higher cost of coal to the mining companies has
added nearly one cent per pound to production costs.
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Government Spending and Copper-?r_ived Revenues
11. The amount the copper companies pay to the
government has increased faster than copper prices.
Government revenues from the industry are derived
from royalties calculated at a rate of 13.5 percent
of the LME price less one cent per pound, an export
tax which absorbs 40 percent of the difference between
37.5 cents per pound and the LME price, and an income
tax rate of almost 45 percent. Government revenues
more than doubled between fiscal year 1963 and fiscal
year 1967, when the government took 40 percent of
all receipts from copper sales. The proportion of
government revenue from the copper industry would be
even higher if indirect taxes, such as import duties,
paid by the copper companies were included.
12. With the large tax revenues generated by
copper, the government believed it could accomplish
many of its policy goals. It embarked on an ambitious
$1.2 billion four-year economic and social development
program on 1 July 1966 and spent large sums on trying
to break economic relations with Rhodesia. The
various schemes, however, fell far behind schedule
because of shortages of materials caused by the
attempt to break ties with Rhodesia and a severe
deficiency in trained manpower. As a consequence,
by 30 June 1967 only about two-thirds of authorized
expenditures for the first year of the development
plan had been actually spent.
13. Government fiscal planners, however, are now
finding that spending is rising too rapidly, even
with the additional tax revenues generated by the
high copper prices. Wage rate hikes for civil
servants have been larger than expected and costs
of goods have increased as a result of the policy to
reduce Zambia's dependence on Rhodesia. Also the
funds required to operate the new schools, hospitals,
and other facilities being completed under the four-
year development program are mounting. Lusaka
officials estimated that there will be a deficit of
$62 million in the last half of calendar year 1967.
The government, aware of its growing financial
difficulties, has formulated a budget for 1968 which
cuts back the growth rate for expenditures.
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Prospects -- After the US, Copper Strike Ends
14. The resumption of US production of more
than 100,000 tons a month will'affect prices
immediately, particularly futures. A price drop
could be precipitious. Moreover, there is now
little expectation of an upsurge in prices for
the years ahead. Major.world copper producers
have increased their production capacities and
plan further large increases in the next few ,
years. Meanwhile, the rapid increase in demand
since 1963 has leveled off because of a significant
shift to less expensive metals such as aluminum.
A study carried out by a Zambian mining company
indicates that through 1977, in the absence of a
major long-term strike, Free World copper con-
sumption will fall short of the amounts mining
companies will be able to produce.
15. Zambian government spending will suffer a
sharp setback from a price decline and the ensuing
cost-price squeeze. Since the industry provides
most of the government's current revenues, a sizable
drop in income and profits will further erode
Zambia's financial position. Copper prices averaging
at least 55 cents per pound are required to generate
sufficient revenue to match present spending levels.
When the US copper strike is settled, the average
copper price for 1968 probably will be much lower.
Over the next few years if prices settle at about
40 cents per pound and there is no prolonged major
copper strike, the Zambians would face an annual
deficit of almost $200 million under the present
tax structure. At a price of 45 cents per pound
the deficit would amount to at least $140 million
a year. The above calculations are based on full
mined production, but actually for many months
copper output will likely amount to only 80 percent
of normal production. The increased use of the
low-quality Nkandabwe coal has been causing copper
companies to close down their smelting plants more
often for maintenance than when they were using
only Rhodesian-supplied coal. At this lower rate
of output the annual deficit would amount to some
$220 million at the price of 40 cents per pound
and $170 million at 45 cents. The full impact of
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a price decline can be postponed for a while, how-
ever, because the Zambian government has about $120
million in deposits in London to draw on.
16. A government which has enjoyed a large
income since independence will not willingly permit
its revenue to decline sharply. However, Zambia's
options for dealing with the consequences of a price
decline are limited. The mining companies would be
earning much lower profits as a result of a cost-
price squeeze and thus would be unable to pay higher
tax rates to the government. The companies probably
will even seek some tax relief. Only recently,
Anglo-American, one of the two copper companies in
Zambia, hinted that it may have to discontinue its
lead and zinc operations (already faced with declining
prices) in Kabwe (Broken Hill) unless the government
reduced the size of the royalty payments. There is
little likelihood that the costs of production can
be cut. Because of domestic political considerations,
wages cannot be reduced. In fact, it is probable
that the rising domestic price level will eventually
stimulate demands for further wage increases. UDI-
associated costs also are not likely to be reduced
but may actually increase. A return to the use of
Rhodesia's economic routes and resources is politically
unpalatable to Kaunda. Meanwhile, the development of
economic alternate routes is still well in the future.
17. Zambia might consider devaluation as a device
to lower the domestic cost of production and to
increase government revenue. However, devaluation
would immediately raise the price of most manufactured
consumer goods purchased by copper workers and of the
materials and parts used by the copper companies.
Moreover, the copper workers would not long accept
a decline in their real wages, and consequently the
benefits of devaluation to the companies and the
government would be transitory.
18. Zambia will most likely request more foreign
aid in order to continue the development program and
the effort to break economic relations with Rhodesia.
The United Kingdom will probably be asked tc make the
major contribution because Lusaka blames London for
the Rhodesian affair. For 1968, Zambian Finance
Minister Mudenda hopes the United Kingdom will provide
$67 million, which is his estimate of Zambia's cost
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in supporting sanctions against Rhodesia. But
despite its close economic ties with Zambia, the
United Kingdom probably will give considerably less,
primarily because of its balance-of-payments problems.
Other countries, including Communist countries, are
also likely to be approached, but their response
may be small because they have little direct interest
in Zambia. As a result, foreign aid probably will
fall short of the $140 million or more a year required
to meet Lusaka's financial deficit. Furthermore,
sufficient local sources of revenue other than from
copper could not be raised over a sustained period.
Thus, with a possible 10-year period of low copper
prices, Zambia will face long-term financial pro-
blems.
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