At a Glance

  • While it generally costs less to transport processed products than unprocessed commodities, these cost savings may be offset by several other factors.

  • The constraints on setting up forward linkages include higher tariffs; higher and longer-term capital investment costs; the need to develop economies of scale to remain competitive; and specialized input requirements.

Key Resources

Topic Briefing

A processed product generally costs less to transport than an unprocessed commodity. However, these lower costs are often offset by other constraining factors, particularly in developing countries.

Read more

The most critical constraints to downstream processes include the following:

  • Countries producing raw materials may face higher tariffs on processed products. Such tariff escalations have been sharply reduced in developed countries, and many developing countries now enjoy tariff-free access to developed country markets. However, access to some markets, such as China or India, may be hampered by high tariffs on processed products.
  • Downstream activities are very capital intensive and can take a long time to come onstream. Capital costs in developing countries, particularly in the long term, are high.
  • Many production processes in the extractive industries have significant economies of scale. For instance, an oil refinery needs a capacity of 200,000 to 250,000 barrels per day; a world-class plant for producing methanol from natural gas has a capacity of close to 2 million tons per year; new crude steel plants using blast furnaces generally have a capacity of at least 2 million tons per year (electric arc furnaces can be much smaller but require special inputs in the form of scrap or direct reduced iron that has to be available in sufficient quantity); and a new alumina plant would not be economical unless it produced at least 1 million tons per year. Therefore, processing the output from a relatively small mine or oilfield locally may not always be competitive. Accordingly, downstream processing may have to wait until production has reached required levels, or the situation may necessitate the pooling of outputs from several mines or oil production sites. This second option is not necessarily easy to realize, since it may require the cooperation of several owners of mines or oil wells, who probably have very different cost structures, market networks, and product characteristics.
  • In addition to the raw material, many processes also require specialized inputs, particularly power. For instance, aluminum smelters need access to low-cost electric power in order to be competitive. An iron ore mine located far from the coast and that does not have metallurgical coal deposits nearby would not be a favorable site for a blast furnace, unless local steel demand is sufficiently high and other costs are low enough to justify building a blast furnace using imported metallurgical coal. Access to low-cost energy is usually the main hurdle. A legal requirement to process copper concentrate in the Democratic Republic of Congo was delayed after copper producers demonstrated that there was not enough electric power available to smelt and refine the copper mined in the country. Energy is central to the processing of all minerals, especially aluminum/bauxite. Moreover, it is critical that electric power sources are reliable and guaranteed. Shortages of power have led to a decline in copper smelting in Chile and in Zambia.[1]
View footnotes

[1] See Table 3. Olle Östenson and Anton Löf, “Downstream Activities: The Possibilities and the Realities,” WIDER Working Paper 2017/113, World Institute for Development Economic Research (UNU-WIDER), Helsinki, 2017, 3-7.