Ecuador's El Dorado

Ecuador is the biggest anomaly in international mining. It sits plum in the middle of the rich metallic belt that runs along the Andes mountain range, where other countries, such as Chile, Peru and Colombia, have built world-class mining industries. Yet until this year Ecuador didn’t have a single large-scale mine. It’s not for a lack of metals. Over the last decade more gold and copper have been found in Ecuador than anywhere else on earth. But as so often in the extractives industry, the risks above ground outweighed the riches below it and political and economic factors prevented the development of a modern, internationally-focused mining sector. But, as its neighbours grew rich from mining, it became harder for Ecuador to ignore its rich reserves of copper, gold, silver forever. Indeed, in the last few years the country has opened up to mining. That’s led to a modern-day gold rush, with 12 of the world’s largest mining companies setting up offices in Ecuador and the country’s first two large-scale mines – one is copper and one is gold – entering production this year.

Metal rich

You won’t find Ecuador in any of the global top rankings for metals production and reserves. The US Geological Service, which has excellent data on international mining, doesn’t rank Ecuador in its top ten for gold, copper or silver. The reason, as the USGS readily admits, is that only about 10% of Ecuador has been explored for mining. But even that small amount of surveying has been enough for some major discoveries. In 2006 Canadian explorer Aurelian Resources found Fruta del Norte, home to around 5 million ounces of gold and 6 million ounces of silver. Then in 2012 SolGold discovered Alpala, a deposit that grows with each new drilling campaign and currently has inferred resources of 2.5 million tonnes of copper and 3.8 million ounces of gold. To give you some idea of the scale of the discovery, if it’s fully developed it could become the largest underground silver, third-largest gold and sixth-largest copper mine in the world.

"Over the last decade more gold and copper have been found in Ecuador than anywhere else on earth…"

These discoveries have tempted some of the biggest names in mining into the Ecuadorian goldrush. BHP, Newcrest Mining, Anglo American, First Quantum and FMG are among the major miners that have acquired stakes in smaller Ecuador-focused exploration companies. Indeed 12 of the world’s biggest mining firms have bought in to Ecuadorian projects or set up offices in the country in the last few years.

The strange thing about today’s Ecuadorian gold rush is that people have always believed it has lots of gold, copper and silver. Ecuador sits on the Andean copper belt, which is responsible for almost half the world’s copper production. Meanwhile gold has been mined since pre-Columbine days. Yellow metal mined from the south of modern-day Ecuador, in a province that is now called El Oro, was turned into intricate religious and ceremonial jewellery prized by the Incan’s ruling class. Yet despite half-hearted attempts by the Spanish and then other international investors following Ecuador’s independence in the 19th century, the country never fostered the type of large-scale mining industry that arose in Mexico, Brazil, Colombia, Peru, Bolivia or Chile.

Why now?

One reason might be that Ecuador had so many other export industries to develop. During the 19th century its economy was powered by coffee and cacao exports while during the 20th oil, banana and shrimp were added to the mix. Mining remained small scale, with an array of locally-owned mines in the country’s south operating with varying degrees of formality. Different attempts by foreign miners to establish large operations during the 20th century were expropriated or side-lined as political instability brought radical changes in mining policy.

The indifference towards mining turned to outright hostility in the early years of the government of Rafael Correa, the socialist firebrand who ruled Ecuador from 2007 to 2017. Buoyed from high oil prices, and fresh from defaulting on the country’s sovereign debt in 2008, Correa imposed strict new terms and extra taxes on the few international miners in the country. Unsurprisingly most left. Even Kinross, the Canadian company that found the mega gold deposit, eventually decided to sell.

"Correa, who has a PhD in economics from the US, found himself in desperate need of dollars…"

But, to his credit, Correa was a pragmatic populist and changed his tune when low oil prices started to drag down the Ecuadorian economy. Oil is a big deal in Ecuador, generating a half of export earnings and 25% of government revenues. Moreover, because Ecuador’s economy is dollarized – a banking crisis and hyperinflation did for its ill-fated sucre in 2000 – it is particularly dependent on oil. Ecuador needs a constant inflow of dollars to provide revenue for government expenditure. When the oil price fell, it meant Ecuador was suddenly running fiscal and current account deficits. The state, which doubled in size under Correa, wasn’t getting enough tax dollars to cover its outgoings. While the economy was importing more than it was exporting. Twin deficits are manageable when you have your own currency – the UK has been doing it for more than a decade – but a nightmare when you use someone else’s.

Correa, who has a PhD in economics from the US, found himself in desperate need of dollars. In the short-term he used opaque oil-backed loans from China to fund government spending. While drastic import tariffs helped to curb the trade imbalance. However, he understood that neither was sustainable in the long-term. He needed something that could generate both export dollars and government taxes and there was only one solution – mining. In a remarkable volte-face, the man who once boasted that Ecuador had the world’s strictest mining regulation invited US-owned consultancy, Wood Mackenzie, to redraw its mining code and royalty system. The new investor-friendly mining code was enough to convince the junior explorers and between March 2017 and December 2018, 275 mining concessions were granted. As projects began being built, direct investment in Ecuadorian mining grew from an annual average of $45million before the change, to $743million last year.

Protests

In 2017 Correa’s handpicked successor, Lenin Moreno, won a controversial election. But then, as is often the way with supposedly loyal presidential proteges, decided to follow his own path once in power. Moreno has been decidedly more pro-market than expected and has extended his predecessor’s mining push with gusto. But it hasn’t been smooth sailing. With Correa mortgaging future oil production to the hilt, Moreno was forced to seek an IMF bailout. Getting the $10billion loan from the IMF and the multilaterals was the easy part, implementing the austerity they demanded in exchange has proved difficult.

President Moreno’s recent attempts to remove long-standing fuel subsidies sparked violent protests from a small, but well-organised minority. Led by indigenous political movements from Ecuador’s highlands, the protestors forced Moreno to quit the capital and he only returned after agreeing to reinstate the subsidy.

Contrarian investors like to quote Baron Rothschild who, after supposedly profiting from early knowledge of the Waterloo outcome, noted, “the time to buy is when there’s blood in the streets”. Perhaps it’s a touch tasteless to quote, given that blood was spilt in Ecuador’s recent protests, yet more than 200 years on, Rothschild still has a point. The shares of the Ecuador-focused miners dived on the back of the protests as investors – rightly – worried about the impact on the sector. The protests underline the weakness of the main force backing mining in Ecuador – the central government – and highlighted the political strength of its opponents – many projects are in highland areas with indigenous local communities. Indeed, mining has also had to deal with attempts from local communities to hold referenda to ban the industry in their town and/or province. So far these have been rejected by the Constitutional Court – the highest in the land – as mining, just like Ecuador’s well-established oil industry, falls firmly under the aegis of the central government.

These legal challenges and violent protests are scary for investors but they provide attractive buying opportunities. Now Ecuador's first large-scale mines have begun operation, the genie is out of the bottle and modern, large-scale mining is in Ecuador to stay, as its people want the jobs and economic growth that mining can bring. The US dollar is far more popular than any politician in Ecuador, where people dread a return to the sucre. Moreover, the polls indicate that Moreno’s self-styled ‘transition administration’ will be replaced by centre-right opposition in the 2021 general elections. Even if Correa were to return – he could only do so as vice president – the pragmatic populist would look to reap the benefits of a mining boom that he started. Most of the bravest investment calls - think Soros shorting the pound or the hedge funds that spotted the flaw with subprime mortgages before the 2008 financial crisis - involve spotting a situation that is unsustainable in the long-run. A mix of political and economic factors made Ecuador an Andean mining anomaly as it left the world’s last great deposits of gold, silver and copper untouched. But its dollar-hungry economy won’t ignore international investors for much longer.

A version of this article first appeared in MoneyWeek on the 24th of October