Riches In The Ground

By Oliver August

Visitors who return to an African country's capital after several years away are often stunned by the abundant evidence of a construction boom. A new airport is rising out of grassy ground in Nairobi, commuter rail lines crisscross the chaos of Lagos, and new hotels overlook the windy coast in the Angolan capital of Luanda. Many African cities remain horribly clogged with traffic, perhaps even more so than before, but the cars inching along next to you are no longer all rusty old bangers. Cities across the continent appear to be flourishing.

And yet a lot of Africa's wealth is not produced in cities. It comes from places far away—from mines and oil wells beneath deserts, atop mountains, and below the seabed.

Mining and Natural Resources Spur Economic Growth The breadth and volume of African commodities has long been known. Diamonds powered southern Africa's economy a century ago in the days of Cecil Rhodes, the founder of diamond mining giant De Beers. Botswana is the world's top producer; De Beers, still the industry leader, is in the process of moving its global diamond-trading hub from London to Gaborone, the Botswanan capital.

But only in the last few years has industrial exploitation reached all corners of the continent. The rapid expansion of iron ore production in remote parts of West Africa is making the area the fastest growing on the continent, while also slowly displacing memories of civil war. In the heart of Africa, gold extraction is gathering pace. Last year saw the inauguration of the first industrial gold mine in the Congo in half a century. The mine's location, in violence-plagued South Kivu province, makes this development especially impressive. The continent's landlocked center is also rich in rare metals like coltan, which is used to produce the tantalum capacitors found in the circuitry of electronic devices and most smartphones—meaning many of us carry a small piece of Africa around in our pockets.

Tracking a Resources Boom—And Its Challenges

The health of Africa's mining sector is rivaled by the oil and gas industry. The continent is so rich in fossil fuels that only five of Africa's 54 countries do not currently produce or explore for oil.

African oil used to come mostly from the continent's west coast, running southward from Nigeria via Equatorial Guinea down to Angola, which now competes with Saudi Arabia to be China's biggest oil supplier. But the east coast is fast turning into an alternative destination for drillers. Countries such as Kenya and Uganda that were once considered resource-limited now have plans to sink hundreds of wells into the ground. And not just for oil. Recently discovered reserves of natural gas are believed to be equally abundant down the east coast, fueling the area's rise as a potential rival to the Persian Gulf states.

Such good news has buoyed the commodities sector. Professional conferences and events focused on commodities occur with great frequency, and investors—and workers—are keen to follow the mining companies. In fact, salaries for jobs in Africa have been rising rapidly in concert with demand, and the skills base in Africa is limited. South African and Zimbabwean miners have a good reputation, but many of these jobs are being filled by non-African specialists and members of the African diaspora who now see good financial reason to go home.

Any boom attracts black sheep, and Africa is no different. Rogues seek out government officials willing to sell them mining licenses under the table. Diamonds are especially attractive to shady operators because they are easy to transport. But everything from coal to cobalt to copper is being stolen and smuggled, and piracy remains a worry.

As a result of the sector's growth, the political world has taken note. Western diplomatic missions are being expanded, and African leaders are in much more regular contact with the White House. By turn, African governments have become friendlier to foreign investors.

Natural Resources Driving Foreign Investment

The U.S., Europe, and, increasingly, China, all have political as well as commercial reasons to seek African investments. They want to safeguard future energy sources and deny them to strategic competitors. And by going out of their way to help their nation's companies trade with Africa, governments boost their political weight on the continent.

Despite political and strategic concerns, international investor interest in African resources is driven by the fundamental fact that there is a lot of money to be made. Commodity prices have been at or near historic highs in recent years, in part because of increased demand from fast-growing nations in Asia. At the same time, recent growth in the U.S. and Europe has been exceptionally low, requiring investors to look for returns in less familiar places.

Taken in aggregate over the last decade, the U.S. has been the top foreign direct investor in African extraction projects, followed by Britain, Australia, Canada, and France, according to fDi Intelligence, a specialist research division of the Financial Times. The top seven resource companies investing in Africa are all in oil and gas, led by Chevron. Mining companies are more numerous, but tend to work on comparatively smaller projects.

Investors from emerging markets have been catching up with the West in recent years. Turkey has become active in Somalia, and Malaysia has shown interest in Congo. Often, sovereign nation investments from emerging markets go where Western firms are reluctant to tread. The same goes for investors from African countries. South Africans have plunged into mining across the continent since the end of Apartheid, and Nigerians and Kenyans are slowly following suit. Investors' cultural and historical links also play a major role: Brazilian firms like Vale benefit from a shared official language (Portuguese) in Mozambican coal mining, and Indian firms leverage their diaspora links in East Africa.

The Future Promise for Economic Growth

There is evidence that resources will help to lift Africa out of poverty. A report by McKinsey & Company in 2010 estimated that the continent's resource boom is responsible for a third of its new economic growth. According to recent studies by the World Bank, Equatorial Guinea's per capita income ($27,000) is higher than Greece's ($26,000).

That said, there are good reasons to believe that the main beneficiaries will first be governments rather than the people. State revenues have increased significantly. Officials have been able to extract all manner of fees, charges, royalties, and signing bonuses from resource companies. Poor countries like Guinea may soon pay off long-standing debts, and relatively rich countries such as Angola, Ghana, and Nigeria are setting up sovereign wealth funds, which were previously the domain of Gulf nations and the like.

There are still examples of countries where resource extraction is not really reducing poverty. South Sudan, a big oil exporter, is technically classed as a middle-income country by the World Bank, but most of its residents remain illiterate and hungry. And various resource curses still afflict Africa. Extraction frequently damages the environment. It can feed corruption, prolong violent conflicts, and enable dictatorship. And this can spark fights over spoils between workers, feed demand for nationalization, skew economies away from other productive sectors, and drives up inequality.

Natural Resources Give Hope to Africa Nonetheless, there is a net gain for Africa. Hundreds of thousands of Africans earn salaries as miners. They are taught specialist skills like driving and welding, which they can later transfer to other sectors. Mining companies also often feel compelled to give money to local charitable causes like schools. More importantly, mining activity routinely leads to the creation of better road and power infrastructure. For instance, in Zambia, copper mines are driving the expansion of the electric grid. And financial windfalls have allowed governments to expand public services, by building new schools, hospitals, and road networks.

Will Africa's resource boom continue and eventually benefit all people? High growth is likely for a while, since many new deals are in the pipeline and Asian demand shows little sign of wilting. There may be dips along the way, as there often are in booms. But that is unlikely to trip up Africa. The longer the resource boom continues, the more it will seed growth in the rest of the economy. And that is likely to pay dividends for years to come.

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Oliver August is a correspondent and editor for The Economist, currently focusing on Africa and the Middle East. After studying Philosophy, Politics, and Economics at Oxford University, he became New York correspondent for The Times of London, and has been based in Beijing, Singapore, Damascus, Beirut, and Baghdad. His writing has appeared in Wired, the Los Angeles Times, The Wall Street Journal, the Financial Times, and The Washington Post.

Nestlé represented 1.87% of the T. Rowe Price Africa & Middle East Fund as of 9/30/12. The following companies are not held by the T. Rowe Price Africa & Middle East Fund as of 9/30/12: DeBeers and Vale. The fund's holdings are historical and subject to change. This material should not be deemed a recommendation to buy or sell any of the securities mentioned.

T. Rowe Price and Oliver August are not affiliated.

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Jaco Wolmarans