Question

Dam tragedy underlines need for right joint venture structure

By Alison George

The Samarco disaster shows how risky governance can be around joint ventures. So why are they persisted with?

Much coverage of Samarco’s Bento Rodrigues dam collapse in Brazil has focused on technical factors which led to the tragic dam failure. But to what extent did inadequate governance play a part? The company’s key failure – apart from the tailings dam of course – was really one of oversight, and it is a common one around the world requiring greater attention than it gets. In order to prevent further value destruction, it’s time business and investors learnt the lessons of the costly Samarco disaster.

Samarco is a 50-50 joint venture between BHP Billiton and Vale, with Samarco established as a separate legal entity and independent operator. Joint ventures are common in extractive projects; they can offer important benefits like sharing of capital costs and providing access to quality resources. But these structures can also challenge management practice. This is especially the case where there is no clear majority partner in operational control, as in the case of Samarco; or where the operator is not of the same calibre, as was the case in the much less well-known Santos Banjar-Panji-1 incident.

In 2006, a Santos joint venture partner triggered the eruption of a toxic mudflow in Indonesia that continues to this day. Santos held only 18 per cent of the joint venture. Like Samarco, the headaches and ultimate costs to shareholders of this incident were out of proportion to the investment and contribution it represented to the company. Unlike Samarco, there was one clear majority partner with operational control, though without the same technical capacity and standards as Santos.

And while joint ventures are difficult, they are not the only structures of concern. Reliance on infrastructure operated by others is another common arrangement that – like non-operated joint ventures – allows influence but not control. When a Genesee & Wyoming Australia-operated train bound for Darwin carrying Oz Minerals’ copper concentrate derailed in December 2011 near Edith River, it was Oz Minerals that bore the brunt of the frontpage coverage. The company also suffered months of shipping delays while the line was restored and safer transportation options explored.

To its credit, BHP Billiton has flagged governance factors as a consideration in its response to Samarco. As the independent technical report was released, BHP also announced changes after its review of nonoperated joint ventures – these go to the heart of the ‘‘influenced, not controlled’’ dynamic of joint ventures.

As a result, BHP says it will centralise joint-venture management and develop a global standard for non-operated joint ventures. BHP will seek to limit use of nonoperated joint venture structures in the future; and where they are used, ensure a major partner has operational control.

BHP has said it will unwind existing nonoperated joint ventures if possible; likely, its two other joint ventures structured as Samarco-style standalone companies, Cerrejon in Colombia and Antamina in Peru. Other Australian companies have concerning joint venture structures.

Newcrest’s Wafi-Golpu development prospect in PNG is held – like BHP’s Samarco – through a 50-50 joint venture with an independent operator, Morobe Mining (MMJV).

The MMJV operates the Hidden Valley mine, which former CEO Greg Robinson once described as Newcrest’s ‘‘problem child’’

These structures pose specific challenges, given the operator must answer to two bosses. The Grasberg mine in Indonesia is also a joint venture, in which Rio Tinto has a non-controlling interest.

Operated by a subsidiary of Freeport McMoRan, the site uses controversial riverine tailings disposal, and has a history of security problems and poor safety performance: fatalities at Grasberg exceeded total fatalities at all other Rio Tinto sites combined in 2013 and 2014.

Rio Tinto clearly recognizes these risks, noting in its annual report that strategic partnerships represent one of the principal risks for their business. They also note that it has the potential to hinder growth, and there is potential for partners to act contrary to Rio Tinto policies and standards.

Joint ventures continue to be an effective way to share costs and benefits of major projects, but getting the structure right at the outset is key.

Unwinding or adjusting arrangements is difficult and potentially costly once operations are under way. It remains to be seen whether Rio Tinto, Newcrest and others with legacy structures will learn from BHP’s Samarco and make changes to their own joint venture arrangements.

Investors should encourage the companies they hold to think broadly about the implications of the Samarco incident and seek enhanced governance and oversight across all aspects of the value chain where material risks reside, even if only subject to influence rather than control.

For joint ventures, use of such arrangements should be adequately justified and efforts made to actively counter the oversight risks they present. Standards must be agreed with joint venture partners and, above all, care taken about who is appointed operator. If there is any doubt about whether the effort is justified, consider the $2.2 billion Samarco has cost BHP shareholders to date.

Alison George is head of governance for Regnan, advising investors on material environmental, social and governance risks and potential portfolio implications.

What parties have suffered losses and what damage has been done by this disaster? Explain why you think they have suffered losses and what type of losses do you think they have suffered? In the article, whose loss/losses was/were emphasized? Why do you think?
Do you think regulation should be introduced? (Hint: consider both views, and provide arguments for/against).
If you suggest some form of regulation, what is the target for the regulation? Whose interests (what parties) do you think the regulation should support? What about enforcement of the regulation and monitoring compliance? Will there be parties with conflicting interests? How do you think they will react/respond? What problems do you see?
Can accounting or the accounting framework be useful here? What about accountability more generally?
What is your conclusion?

Summary

This question belongs to accounting and discusses Samarco’s Bento Rodrigues dam collapse in Brazil.

Word count: 602

Preparation of Income and Cash Flow Statements and Balance Sheet