EC 460 MSU Economics Case Study American Industrial Structure and Behavior Essay This is the case study about economics. You need to read the “Financing th

EC 460 MSU Economics Case Study American Industrial Structure and Behavior Essay This is the case study about economics. You need to read the “Financing the Mozal Project” and write the critical paper following the prompt. I already post the pdf of “Financing the Mozal Project” and rubric below. It is an important assignment for me! Thanks! Your 500 words analysis of the case study entitled “Financing the Mozal
Project“ should address the following issues/questions. Investors in the Mozal Project
face different types of risks including construction, operating and sovereign risk.
Using details in the case study:
1. Briefly discuss how important you think these three different risks are.
2. Discuss how the IFC has constructed their investment to minimize the sovereign
risk and provide some suggestions as to how the IFC can further reduce the sovereign
risk. When discussing sovereign risk and how it is affected by the strategies of the
relevant players: the IFC, Alusaf, Eskom, EdM, the Mozambique government and the
South African government. Use game theoretic analysis in your explanation. (You may
even want to depict a game tree and relate how your suggestions involve addressing
the hold-up issue. You need not discuss the roles of all the different players in this
game )
[For those who are not familiar with the meaning of sovereign risk, what I think is a
good definition can be found at
(http://www.businessdictionary.com/definition/sovereign-risk.html ) which states:
“Probability that the government of a country (or an agency backed by the
government) will refuse to comply with the terms of a loan agreement during
economically difficult or politically volatile times. Although sovereign nations don’t
‘go broke’, they can assert their independence in any manner they choose, and cannot
be sued without their assent.”]
Additional Links:

https://thesa-mag.com/features/mining/mozal-aluminium-economic-beacon-21stcentury-mozambique/
https://furtherafrica.com/2017/02/13/mozambiques-mozal-smelter-expansion-oncourse-but-electricity-is-needed/
https://mozambiqueminingpost.com/2019/02/07/mozambique-mozal-aluminum-plantexpansion-contract-goes-to-lesedi/
https://clubofmozambique.com/news/lesedi-to-assist-mozal-in-its-aluminiumexpansion-project/
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REV: APRIL 15, 2003
BENJAMIN ESTY
Financing the Mozal Project
Mozal represents a leap of faith in the economy of a poor African country that is
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still recovering from a long civil war and years of central planning.
Mozal is a wonderful example of the African renaissance being alive…We know
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they (the sponsors) are going to make money.
Takuro Kimura and Akbar Husain of the International Finance Corporation’s (IFC) Sub-Saharan
Africa Department were adding the finishing touches to a report for the IFC’s board of directors. In
the report, they were recommending a $120 million investment in the Mozal project, a $1.4 billion
aluminum smelter in Mozambique. While board approval at the June 1997 meeting was not a
binding commitment to lend, it would be their last signoff on the deal and a signal of IFC’s
commitment to the project. More importantly, their approval would allow the project team to
proceed with structuring the deal even though it could take up to 18 months to finalize all the details.
What made this recommendation difficult was the fact that it would be the IFC’s largest
investment ever, and by far its largest investment in Africa. At $1.4 billion, it would also be large
relative to Mozambique’s gross domestic product (GDP) of $1.7 billion. Perhaps more important than
its size, however, was its location. Mozambique was one of the poorest countries in the world and
had only recently emerged from a 17-year civil war that had destroyed most of the country’s
infrastructure. Despite the size and location, Kimura and Husain were recommending approval
based on the project’s significant economic and developmental benefits. The project was, after all,
consistent with the IFC’s mission of promoting private sector investment in developing countries as a
way to reduce poverty and improve people’s lives.
The Investment Opportunity
The Mozal project was a joint venture between Alusaf and the Industrial Development
Corporation (IDC) of South Africa. Alusaf was the aluminum subsidiary of the Gencor Group, a
South African natural resource company (Exhibits 1a and 1b provide financial data for both Gencor
and Alusaf.) Gencor became the world’s fourth largest aluminum producer after acquiring Billiton
from Royal Dutch Shell in 1994, and finishing the $1.8 billion Hillside Smelter in Richards Bay, South
________________________________________________________________________________________________________________
Research Associate Fuaad A. Qureshi prepared this case under the supervision of Professor Benjamin Esty. HBS cases are developed solely as the
basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective
management.
Copyright © 1999 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685,
write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be
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Financing the Mozal Project
Africa in 1996. Hillside was, at the time, the world’s largest greenfield aluminum smelter. As of June
1997, Gencor had two divisions, one for precious metals (gold and platinum) and the other for base
metals (aluminum, nickel, steel, etc.), and was in the process of spinning off the base metals division
into a publicly traded company under the Billiton name. Paul Snyman and Louis Irvine, Alusaf’s
Financial Director and Treasurer, respectively, were leading the Mozal negotiations.
The project’s other sponsor was IDC, a $3.6 billion government-owned development bank located
in South Africa with a longstanding business relationship with Alusaf. IDC’s mission was to
contribute to sustainable growth in South Africa by promoting entrepreneurship and financing
private sector enterprises. In fact, IDC was instrumental in financing the Hillside smelter. It
regularly took both debt and equity positions in new ventures though it did not seek control or dayto-day management involvement. As of 1996, IDC’s five-year plan called for $5 billion of industrial
investment, including a number of investments outside of South Africa. Jaco Kriek, IDC’s Head of
Project and Structured Finance and its lead negotiator on the Mozal deal, described IDC’s
involvement this way, “As part of our mandate, we actively seek investment opportunities in
Southern Africa as a way to ensure economic stability in the region.”
According to the feasibility study, Alusaf and IDC would each own 25% of Mozal; ownership of
the remaining 50% had yet to be determined. While it was possible that one or both of the original
sponsors would increase its investment, they were more interested in finding an industry participant
to join the deal and share the output. Mitsubishi Corporation, the $78 billion Japanese industrial
conglomerate with a large metals group, was the leading candidate at the time. Mr. Seiei Ono, a
senior manager in the Metals Department, had been negotiating a possible deal with IDC and Alusaf.
Aluminum Production
Because aluminum metal does not occur naturally in its pure form, it must be processed from
compounds containing aluminum. The primary raw material for producing aluminum is bauxite,
which comes mainly from mines in Australia, Guinea, Brazil and Jamaica. Once mined, bauxite is
refined into an intermediate product called alumina and then transformed into aluminum in a
smelter. This energy-intensive process yielded one ton of aluminum for every two tons of alumina.
Aluminum was used primarily in the transportation, construction, packaging, machinery, and
electrical industries. Industry demand stood at 20 million tons per year and was expected to grow at
2% to 3% per year. In terms of supply, even though secondary production in the form of recycling
and scrap was growing, analysts projected a need for five million tons of new primary capacity over
the next ten years.
The interaction of supply and demand was the major determinant of aluminum prices.
Investment funds, however, also affected market prices and volatility through speculation,
particularly during 1995. Exhibit 2 shows aluminum prices from the London Metal Exchange (LME)
over the past ten years. During this time, prices fluctuated between a low of $1,040 per ton in
November 1993 and a high of $3,645 per ton in June 1988.
The Mozal Project
The Mozal project began as the confluence of interests among three entities: Eskom, Alusaf, and
the Mozambican government. Eskom, the South African power utility that provided 95% of the
country’s and 50% of the continent’s power, wanted to expand its operations outside of South Africa
and utilize some of its excess capacity. In Mozambique, it saw an opportunity to rebuild some of the
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Financing the Mozal Project
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country’s damaged electricity infrastructure and to develop inexpensive hydroelectric generating
capacity on the Zambezi River. Alusaf, too, saw an opportunity in Mozambique. It wanted to build
another aluminum smelter making use of the potential availability of hydroelectric power in
Mozambique. Such a plant would also benefit from access to Maputo’s harbor and proximity to the
Hillside smelter in Richards Bay. Given their shared interests, they met with officials from the
Mozambican government to see if there were sufficient interest in supporting the construction of a
smelter in Mozambique. From these discussions, the parties developed the Mozal project that
provided Mozambique with new electrical and industrial infrastructure, Eskom with an entrée into
Mozambique and a customer for its excess power, and Alusaf with a new smelter and access to
competitively-priced power.
Exhibit 3 provides an artist’s rendition of the smelter as it would appear along the Maputo
Corridor, a major trading route between Johannesburg, South Africa, and the Mozambican capital of
Maputo. The team estimated it would take 34 months to complete the project and another six months
to reach full capacity. Although Mozal, a single potline smelter with annual capacity of 250,000 tons,
was half the size of the Hillside smelter, a double potline smelter with annual capacity of 500,000
tons, it would be constructed with all of the necessary infrastructure to double capacity at some point
in the future. For example, the sponsors would have to build a dedicated berth in Maputo harbor to
handle the import of raw materials and the export of aluminum, but this berth could handle the plant
expansion without additional expense. Like Hillside, Mozal would use proven, state-of-the-art
smelting technology from Pechiney of France. And since construction was winding down at the
Hillside project, they could use essentially the same project construction team and the same
contractors under similar lump sum, turnkey contracts. Exhibit 4 shows the project’s sources and
uses of cash. Based on these projections, Mozal would have an overall capital cost of $4,750 per ton
compared to an average capital cost of $4,850 per ton for other recently constructed smelters.
In terms of operations, the major inputs needed to produce aluminum were alumina, electricity,
labor, and other raw materials. Alumina accounted for approximately one-third of production costs
and would be imported from Billiton’s Australian operations under a 25-year supply agreement. The
sponsors agreed to set the price for alumina as a function of the LME aluminum prices, thereby
creating a natural hedge for the project. When output prices were high, input prices would be high,
and vice versa.
Eskom and Electricidade de Moçambique (EdM), the Mozambican electricity company, would
supply electricity under a 25-year contract. They planned to build two 400 kV transmission lines
from South Africa to Maputo to supply the plant with 450 MW of power. Like alumina, the
electricity price would be, at least in later years, a function of LME aluminum prices. Unlike alumina
prices, which were set in competitive markets, albeit under long-term contracts, electricity prices
were negotiated prices. The variation in negotiated prices combined with the fact electricity
accounted for 25% of total production costs, meant that electricity was the most important
determinant of a plant’s competitive position.
Labor and other raw materials were less important determinants of a plant’s competitive position.
Initially, the skilled labor and management expertise would come from South Africa.
Billiton/Alusaf, in particular, would provide plant management for which it would receive a
management fee. The majority of the unskilled labor, both during construction and for operations,
would come from Mozambique. The low cost of labor in Mozambique meant the plant’s labor costs
would be one-fifth that of a typical Western-world smelter. Other raw materials, such as coke,
petroleum, and liquid pitch, would be imported from the same suppliers that were currently
supplying the Hillside smelter under similar long-term supply arrangements.
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Financing the Mozal Project
Finally, there were taxes and other fees. Because the plant was targeted for an Industrial Free
Zone, it would be exempt from customs duties and income taxes, though it would be subject to a 1%
sales tax. The sponsors planned to purchase all of the output subject to long-term purchase
agreements at market prices. Currency exposure was not a problem since the major inputs and all of
the output would be denominated in U.S. dollars. A trustee, such as Chase Manhattan Corporation,
would be responsible for collecting sale proceeds, paying debt holders, remitting operating expenses,
and distributing remaining cash flows to the sponsors in the form of dividends.
Based on this construction and operating plan, Mozal would be a low cost producer—its
production costs would be in the lowest 5% of industry capacity (see Exhibit 5). The average
production cost excluding depreciation and financing charges for the world’s 164 aluminum smelters
was $1,510 per ton. In comparison, Mozal’s projected break-even price including depreciation and
financing charges was $1,493 per ton in the fourth year (in constant 1997 dollars), declining to $1,070
in the eleventh year. These breakeven prices were relatively protected from aluminum price volatility
because two-thirds of production costs were variable, of which almost 75% varied with LME prices.
Exhibit 6 shows Mozal’s projected cash flows in constant 1997 dollars. The projections assumed
an aluminum price of $1,750 per ton compared to a current market price of $1,560 in June 1997. Over
the past 30 years, there were only two years—1992 and 1993—when the average real price of
aluminum price fell below $1,500 in 1997 dollars. Louis Irvine commented:
Obviously, we would like to see aluminum prices higher, but the project is able to
sustain a low LME aluminum price. Hillside was built at a time of low aluminum
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prices, which rose after the project came to fruition.
Mozambique: A Brief History
th
The Portuguese ruled Mozambique as a colony from the 16 century until the Marxist Frente de
Libertação de Moçambique (Frelimo) declared independence in 1975. Shortly thereafter, a civil war
broke out between Frelimo and a rural-based rebel group known as the Resistencia de Moçambique
(Renamo). A U.S. official described this war as “…one of the most brutal holocausts against ordinary
human beings since World War II. Between 1975 and 1992, the war claimed the lives of over 700,000
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people …most of these were victims of the Renamo.” Besides the human toll, the war destroyed
most of the country’s infrastructure.
The two sides signed a peace accord in 1992 that ushered in a period of transition from war to
peace, from socialism to capitalism, and from one-party rule to democracy. In an effort to hasten the
transition to a market economy, the Mozambican government initiated a series of economic reforms.
They privatized more than 900 state-owned enterprises, including the Commercial Bank of
Mozambique, and removed price controls from goods and services. The country held its first
presidential elections in 1994. Frelimo won, but Renamo made a surprisingly strong showing.
Exhibit 7 provides macroeconomic data for Mozambique from 1980 through 1996 and clearly
shows the devastating effect the war had on the country: real gross domestic product sank and did
not recover until the early 1990s. Throughout the period, Mozambique ran enormous current
account and government deficits causing it to sink deeper and deeper into debt. War, crime,
corruption, and an inefficient Marxist bureaucracy hindered private sector investment and economic
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development. According to a study done by the World Bank, starting a new enterprise entailed 12
procedures, 151 steps, and 70 government bodies. If done sequentially, this process could take up to
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five years. Conditions were, however, improving particularly since the end of the war: GDP and
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foreign direct investment were increasing while inflation was falling. One reflection of these changes
was the improvement in the country’s Institutional Investor and ICRG risk ratings from 7.6 to 14.0.
Despite this improvement, Mozambique remained by almost any measure a very poor, underdeveloped country. Exhibit 8 compares Mozambique against other sub-Saharan countries along
several dimensions. Relative to other countries, Mozambique had a lower per capita income, higher
indebtedness, and higher country risk. According to the World Economic Forum, out of 20 African
countries surveyed, Mozambique ranked last in terms of road infrastructure, completion of
secondary education, and legal effectiveness (i.e. stability and certainty of the legal system). It ranked
second to last in terms of openness to trade, and time and expense needed to obtain permits and
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licenses.
What was most noticeable at this stage in the country’s development was the speed with which
things could and were changing. For example, the Economist Intelligence Unit (EIU) painted a
somewhat pessimistic picture of the situation in early 1996:
…the country is a long way from being truly calm or stable…There may well be more
violent confrontations…(because) the degree of bitterness between the two groups
(Frelimo and Renamo) remains excessive…The delicate peace and new democratic
system have come under increasing strain in recent months and it is clear that,
ultimately, an improvement in the political situation is dependant on an
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improvement in the economy.
Yet only a year later in 1997, the EIU had become decidedly more optimistic:
The economic outlook is bright, and will be underpinned by buoyant international
investment, which has been responsive to the government’s ongoing commitment to
moneta…
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