The Kwale project - a titanium mineral sands venture sponsored by Canadian mining firm Tiomin Resources - is remarkable in a number of ways

It is one of the largest foreign direct investments the east African country has ever seen and the only project financed mining project there to date. As might be expected, its size and importance generated a host of political, legislative and environmental questions that had to be dealt with.

Add to this the task of penetrating the tightly controlled titanium offtake market and it comes as no surprise that from initial exploration, it took ten years of legal wrangling, the sacking of some dodgy judges and a change of government before the project closed this year.

The project

The Kwale project is located 40km south of Mombasa and just 10 km inland from the Indian Ocean and will mine rutile, ilmenite and zircon - products which vary in their titanium component and constitute the remains of an ancient dune system. Its location is typical of such deposits - found in dunes within some 35km of the sea. 

The minerals are extracted either by suction dredging, open cut mining or hydraulic mining and have a variety of uses from industrial dyes and glazes, foundry moulds and furnace linings to employment in the aerospace, military and nuclear industries. Australia has traditionally dominated the market, producing nearly half the world's zircon.
 
Nevertheless, the market has grown substantially in recent years and Chinese appetite will have a role to play in the predicted stable growth over the next decade (around 3 per cent per year). The east Asian giant already accounts for 'big contracts for the ilmenite' and 'a lot of the rutile and zircon' on this deal, according to Bruce Ramsden, Timoin CFO.

Current models forecast US$70m in annual sales on the Kwale project for the first five years and Tiomin has been keen to exploit those opportunities for some time now, having appointed Barclays Capital as adviser back in 1999. But the previous government was reluctant to grant the necessary permits.

A number of issues may have fuelled this decision, from ambivalence around foreign investment, to concern around the environmental and social implications to the desire for pay-offs. One banker highlighted legal corruption, saying that some judges presiding over the land issues of the scheme had to be replaced.

Ramsden was eager to highlight that Timoin was not party to such back-handed dealings: 'it would be done properly or not at all,' he said - a principle which meant that the project progressed very slowly or not at all for some time.

Nevertheless the election of a new more pro-FDI government in 2002 has proved to be a sea-change in the project's fortunes, with commitments having been inked including a 10 year fiscal agreement.

Another major issue was the lack of organisational capacity within the Kenyan bureaucracy to manage the project and its implications for the country. Those involved in the deal consistently highlighted the newness of the deal for the government - a reality symbolised by the fact that an environmental policy department had to be created from scratch.

Titanium mineral sands may be extracted from the topsoil, but there are still a number of environmental considerations to be addressed, including  protection of rivers and creeks from discharge, retention of top soil and its use in the rehabilitation of the area and emissions from the power generators.

There has been some debate about these and the social issues with local and international civil society - mainly around adequate resettlement and compensation of local farmers and the location of the marine export terminal. Most of these issues have now been addressed to the satisfaction of stakeholders.

Securing revenues - the offtake contracts

Securing project financing for titanium mineral sands projects is not an easy business, given the nature of the market. It is small, with limited liquidity and is controlled by about nine or ten global players that like to keep a tight handle on their own affairs - which makes carrying out due diligence a little difficult.

Purchasers prefer short-term deals - it is unusual to find anything above five years and most of the agreements for Kwale are two or three years long. Offtakers 'shop around', determined as they are to find the particular grade of product necessary to their business.

On the other hand the market is less volatile than that for other minerals. There's none of the same speculative buying that is found for steel inputs such as iron ore and nickel that tend to track industry growth to a greater extent and dealing with a smaller number of players can make business more manageable.

The sponsors secured deals with eight international offtakers for 87 per cent of the project production by revenue contracted over the life of mine, including 100% of rutile and zircon tonnages. All of the offtakers are located in China, Europe and America, but no specific names were divulged.

Expected revenues net of 2.5 per cent government tax were US$50/t, US$450/t and US$500/t for ilmenite, rutile and zircon as of May 2005.

Like many other things in the world at the moment 'everything comes back to China'. Chinese demand for the 330,000 tonnes of ilmenite, 75,000 tonnes of rutile and 40,000 tonnes of zircon Kwale is expected to produce annually is one element. Then there's the participation of metals and chemicals giant Jinchuan that agreed to bankstock the ilmenite and unsold amounts of the other two commodities.

And the junior loan provided by the Chinese conglomerate was seen as central to bringing the rest of the banks on board.

Financing

The US$201 million project value may not be a huge venture for the global project finance or mining markets, but it is one of the largest to close so far in Kenya and thus its successes and pitfalls 'certainly pave the way for the future,' according to one banker.

It is also the largest project financed mining deal to close in the continent this year - the other scheme was Palladin Resources' US$130m uranium mining scheme (which secured US$71m debt financing) in Namibia that closed at the end of June.

If one adds the capital already injected into Kwale by the sponsor - reckoned to be in the region of US$20m - but not included in the financial model, as well as a US$25m cost overrun facility provided by Dutch development agency FMO, then the project starts to take on greater financial weight.

Total senior debt amounts to US$120m and is split by the four MLAs as follows:

• US$80m
  Standard Chartered
  WestLB
  Caterpillar Financial
• US$40m
  AfDB

Pricing on both the commercial and AfDB senior loans is LIBOR plus 300bp and there is a commitment fee of 1 per cent on undrawn amount. Tenors are for eight and nine years respectively.

The Jinchuan Group is providing a US$35m junior loan at 400bp that is calculated as equity for the purpose of the debt: equity ratio. Senior debt will be paid in 6 month instalments and the junior loan as a bullet.

The US$25m cost overrun facility from FMO is not expected to be drawn, hence the very high price of 13 per cent to project completion, 12 per cent thereafter and a 1 per cent commitment fee on any undrawn amount.

Construction began this month, with detailed engineering designs to be completed by the end of October by EPC contractor Ausenco International that is itself in the process of tendering out the subcontracts to local and international firms. It will be completed in 22 months.

As well as the actual mine, investments include aquifers that will be built to bring water to the site, an access road and a four silo port at Likoni - 50km north of the site -  that will be within the responsibility of the Kenya Ports Authority and will be sold when the project finishes.

Affected households will be compensated some US$1,100 per acre (equivalent at today's rates), in addition to crops and property compensation, there is also the cost of resettlement of some 399 households in three phases between June 2006 and March 2007.

Future prospects

Although the project has a duration of 11 years, it can be extended after that period and the government exploration licence - that began 1 July 2004 - won't expire until 2025.

Expectations are that the sponsors will seek to renew it as further reserves are proven - SRK estimates that there are probable reserves of 30.04 million tonnes of 1.7t/m3 density in the central dune and 72.64 million tonnes in the south dune.

Meanwhile, Timoin already has licenses that could lead to similar ventures at three other sites across Kenya and there is talk of gold prospects in the north.

The Likoni port may also bring in some extra revenue - only some 25 per cent will be used by current levels of exports and the developers will be keen to maximise its potential, although nothing has yet been agreed.

But a key issue on the progress of this approach to foreign investment of the present and future governments, together with the level of transparency.

Some have been grumbling about high levels of taxation on a key and hitherto underexploited national resource - 2.5 per cent on gross revenues after transportation is deducted, 15 per cent corporate tax in the first ten years, doubling for the following ten years. Foreign banks will hope that these figures fall over coming years, stimulating wider investment in the sector.