Resource-backed loans are a divisive topic. While they can help cash-strapped countries raise money for crucial development projects, transparency is often lacking, or simply non-existent, especially when used by governments with poor financial governance. Jacob Atkins assesses the benefits and drawbacks of this controversial form of debt.
What is a resource-backed loan?
A resource-backed loan involves lending to a government or state-owned enterprise in exchange for deliveries of a natural resource from that country – typically oil, gas or minerals. It also includes loans that are collateralised by a country’s commodity exports. They are often referred to as “pre-financing” arrangements.
The proceeds of the loans are generally used for capital expenditure or general government spending, rather than for project finance related to the extraction of the resources.
Who provides them?
These facilities have typically been provided by state-run export and development finance institutions in China, such as the Export-Import Bank of China and the China Development Bank, often referred to as China’s “policy banks”.
Public finance institutions of other countries, such as South Korea and even the pan-African African Export-Import Bank (Afreximbank) have also used the structure.
The other main lenders are large commodity traders, such as Glencore and Trafigura. They are enticed by the prospect of securing long- or short-term access to a country’s output of a particular commodity (most commonly crude oil). Their immense financial wherewithal and relationships with hundreds of commercial banks around the world mean they are also willing to take a financial risk on countries with poor credit ratings.
Who are the borrowers?
While resource-backed loans have been around since the previous century, they gained popularity in the 1990s and became widespread in the 2000s, particularly in Sub-Saharan Africa and Latin America, thanks to China’s massive expansion of state-backed lending to sovereigns. Resource-backed lending accounts for around 8% of all borrowing in Sub-Saharan Africa, according to a World Bank estimate.
The usual recipients of these loans are resource-rich but cash-poor developing countries that struggle to access international financing or investment due to low credit ratings and high perceived risks. The use of physical commodity exports as collateral makes lenders more comfortable compared to just a legal undertaking to repay.
Cost | Pros:
Although the question of whether resource-backed loans are affordable is difficult to settle, the World Bank found some loans from Chinese and Korean public finance institutions that had “outstandingly low rates”. In a study of 52 resource-backed loans provided between 2004 and 2018, the Natural Resources Governance Institute (NRGI) found those from Chinese lenders had “relatively favourable” terms compared to other forms of debt, although only limited data was available. The non-profit also found that some such loans are designed to allow the borrower to shrink repayments when commodity prices fall and repay faster when the price of the export goes up, giving a flexibility not often seen in other forms of financing. For example, in the 2018 renegotiation between Chad and Glencore, the two sides agreed that interest and principal repayments would rise if the price fetched by the oil surpassed around US$55 a barrel, according to the World Bank. However, the World Bank also noted that the downside trigger was “set at a very low level”, and even when it was reached during the Covid-19 oil price slump, the benefit for Chad was “very limited”.
Due to the borrowers’ high credit risk, traditional investors and markets may only agree to lend money at a steep cost. This can make resource-backed loans appear as a more attractive option. Christophe Salmon, Trafigura’s chief financial officer, has defended resource-backed loans as a cost-effective opportunity for commodity producers. “My experience is that pre-payment financing is much cheaper than what a national oil company or national public entity could get by issuing a bond on the capital market or trying to raise money on the corporate syndication market,” he told a 2020 webinar by the Extractive Industries Transparency Initiative (EITI). “When the banks are entering into the facility, obviously the banks are making a thorough analysis of the creditworthiness of the producers, not the trader.”
Cost | Cons:
Those who have studied resource-backed loans (and have managed to pierce the veil of secrecy) tend to find that the cost of these loans is both a pro and a con: they can be very cheap, or they can be very expensive.
NGRI’s research found that the market for resource-backed loans is not competitive, suggesting lenders can dictate terms to cash-strapped sovereign borrowers. Commercial banks are less likely to engage in this type of lending, meaning the sector has traditionally been dominated by the large Chinese policy banks. The dearth of public information on resource-backed loans means it is difficult to build a picture of typical interest rates, although an analysis by the World Bank found that they are on average “somewhat higher” than other forms of financing with similar terms. On the limited data available, it appears loans provided by state-backed lenders such as the Chinese policy banks offer much lower interest rates than those from traders, at least in the past. In contrast to the relatively generous rates offered by Chinese lenders, the World Bank found that the initial interest rate on two loans Chad agreed with Glencore last decade was Libor+6.6%, although the spread dropped to around 2% after a second re-negotiation in 2018. Data on loans extended by traders is very limited.
In addition, if the price of the commodity being used to repay a loan goes down, the producer has to use up even more export volume on paying down the pre-payment debt. This drawback came to the fore most dramatically in 2020, when the prices of many commodities collapsed as the global economy contracted during the Covid-19 pandemic.
Overall – and with a strong caveat about the limited sample size it examined – the World Bank found that resource-backed loans probably “do not provide a uniquely cheap mode of financing”, but given the possibility of securing very good terms, they should not be dismissed out of hand as a mode of borrowing.
Transparency | Pros:
When the existence and details of resource-backed loans are disclosed, some argue they stack up as good option for sovereigns or sovereign entities in need of cash.
The EITI, which provides widely used standards on data reporting about natural resources and how they are financed, includes several requirements on reporting resource-backed loans that it believes can help inform the public and wider markets about the loans. It notes that Chad has disclosed details of its arrangement with Glencore since 2018, giving visibility on the interest, fees and repayment schedule. Glencore, too, has reported some details about the loan since at least 2020 in its annual report on payments to governments. Trafigura also makes similar disclosures in its equivalent of the same report. Those two companies are also members of the EITI, along with many of the world’s biggest commodity traders and natural resources giants such as BHP, Rio Tinto, bp, ExxonMobil and Total.
Transparency | Cons:
African Development Bank (AfDB) president Akinwumi Adesina said last year that one of the reasons he believes resource-backed loans are “a disaster for Africa” is because they are “opaque” and “non-transparent”.
Government borrowers rarely disclose significant information about the resource-backed loans they have agreed to. Basic elements of deals – such as interest rates, fees, third-party agents or intermediaries, repayment terms, tenor, or whether a loan is based on volume or value – are often kept secret. The lack of public knowledge also makes these arrangements vulnerable to corruption. Of the 52 loans analysed by NRGI, in only one case was the “key contract document” publicly available. Interest rates were available for only 19 of the deals.
In some cases, even the existence of a loan has only been confirmed due to regulatory reporting requirements imposed on the lender, or when the deal has gone badly awry. For example, long-running pre-financing arrangements between oil traders, including Glencore and Trafigura and the Republic of Congo’s state oil company, only came to light as a “debt surprise” when the country experienced a debt crunch and the International Monetary Fund (IMF) combed through its finances in 2019. The government said it hadn’t previously disclosed the debt (which equalled 14.8% of GDP in 2019) because it was not contracted directly by the state, according to an IMF document.
While the World Bank has found that proceeds from loans generally do make their way to intended infrastructure projects, some deals are kept “off the books”, making the funds vulnerable to diversion. In 2019, the Organised Crime and Corruption Reporting Project reported that at least US$45mn lent by Trafigura to South Sudan in an oil pre-payment deal, which was intended to fund a huge agricultural development project, was instead used by the government to buy weaponry. There was no allegation of wrongdoing against Trafigura, which said it adhered to all applicable rules and regulations. The same year, IMF urged South Sudan to stop obtaining “expensive and nontransparent” advances on its oil output. One of the most extreme recent examples is a €12bn loan being considered by the government of South Sudan, one of the world’s poorest countries [see below].
Impact | Pros:
Like many loans sought by developing countries, the proceeds may be used for sorely needed infrastructure development that, in turn, can aid economic growth. For example, at least 85% of the loans analysed by NRGI were earmarked to be used for long-term capital expenditure such as roads, energy and housing. Resource-backed loans “can be an opportunity to get governments to commit proceeds derived from natural resources to productive investment rather than recurrent expenditures”, the NRGI found. If the terms of a loan are favourable to the borrower and the proceeds are deployed in a well-chosen infrastructure project, the World Bank says they can “be expected to generate positive returns” for the economy. “Such increased economic activity helps to generate the tax base available to the sovereign for repaying the loans, and also helps the country deliver on its development strategies,” it says.
Angola’s first ever resource-backed loan, a US$2.5bn deal with China Eximbank, was spent on at least 50 different projects, according to the World Bank, including on building schools, hospitals, power lines and water projects. Ghana handed over US$600mn in revenue from cocoa to the same lender to finance the construction of a hydroelectric power station in 2007. But the World Bank also noted that of the loans it surveyed from commodity traders, “most… do not appear to be earmarked for any project and the proceeds appear to be used at the discretion of the borrowing government”, including to cover budget shortfalls.
In some cases, this type of financing also bridges a gap between sovereigns and funding from international banks who may otherwise be willing to fund them. Traders can act as conduits between their large retinue of banking partners and cash-strapped governments. “If you are a copper mine in Peru or an oil producer in Ghana you may not have the technical ability [or] the financial acumen to be able to structure and present the opportunity to the banking market,” Trafigura’s Salmon argued. “This is where we play a role by originating and structuring.” He also pointed out that loans are usually in US dollars, and making repayments through an exportable commodity helps skirt issues of foreign currency shortages and local currency volatility. Trafigura says pre-repayments “provide reliability and certainty for producers”. “They draw on and channel a deep pool of global banking liquidity handled by institutions with long-standing expertise in pricing and risk management,” the company says in a 2020 paper on pre-payments. “Unlike the public capital markets, which can close to borrowers suddenly and unpredictably, prepayments are constantly available and loan pricing is not very volatile.”
Impact | Cons:
A frequent criticism of resource-backed loans is that they cause problems when a country struggles to service its debt burden and governments are forced into debt resolution discussions. While sovereign lenders may band together to discuss ways of helping a distressed government pay down its debt, those talks can be difficult when a non-participating creditor has locked up one of the country’s top sources of revenue, such as its oil or mineral exports. Commodity traders and commercial lenders generally don’t participate in multilateral debt reduction negotiations. This reality was borne out when Chad’s massive debt to Glencore and other creditors under a resource-backed loan reportedly significantly complicated an IMF bailout for the poverty-stricken country.
In April this year, the AfDB’s Adesina’s called for resource-backed loans to end, “because it complicates the debt issue and the debt resolution issue”. Instead, Adesina urged international debt providers to boost the volume of concessional loans being extended to borrowers in Sub-Saharan Africa, a type of loan with below-market interest rates or other generous repayments terms. Last year IMF managing director Kristalina Georgieva, said the organisation would study resource-backed loans and “will come with a strong voice to tell countries not to create avenues for predatory and enslaving loans”.
The fact that a few countries have repeatedly taken on this type of debt raises, in the World Bank’s opinion, the prospect that they may be crowding out more conventional and less risky forms of debt-raising, as well as the possibility that the loans “carry the risk of increasing resource dependency”.
The case of South Sudan
The world’s newest country is an acute example of the dangers of reliance on resource-backed lending by nations with weak finances and governance. Although economically undeveloped, it sits on significant reserves of crude oil.
The UN panel of experts on South Sudan reported in April that “commercial oil-backed loans have made up the bulk of the government’s borrowing” and noted “servicing these loans continues to place significant strain” on the country’s finances. In 2019 the IMF baldly called on South Sudan to stop striking oil-backed debt deals.
Among the loans the panel identified is an almost US$600mn debt to the Eastern and Southern African Trade and Development Bank for “future” oil pre-payments signed in 2021. The government did not classify the arrangement as a loan, disclose it as a debt or capture it in an independent audit. The panel also recorded a claim against South Sudan by Qatar National Bank for some US$825mn. The panel reported that in 2018 the bank agreed to refinance a previous, smaller debt, through an oil delivery repayment mechanism, but that South Sudan did not make the first two repayments so QNB demanded the amount be repaid in full.
More worryingly, the panel obtained hundreds of documents suggesting South Sudan’s then-finance minister was in advanced negotiations with a little-known UAE company for a staggering €12bn loan which the government promised to repay with discounted oil deliveries for the next 17 years.
“Servicing this loan would likely tie up most of the country’s oil revenues for many years, depending on oil prices,” the panel noted, adding that the deal appears not to have been subject to almost any scrutiny or financial oversight. The finance minister who led the deal has since been fired and its current status is not publicly known.
