Constraints

  • While processed products generally enjoy lower transport costs, compared to the costs of transporting unprocessed commodities, these cost savings may be offset by several other factors.
  • Critical factors of constraint include: higher tariffs on more processed products; higher and longer-term capital investment costs; the need to develop economies of scale to remain competitive; and specialized input requirements.
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[1] See Table 3. Olle Ostenson and Anton Loft, Downstream Activities. The Possibilities and the Realities. WIDER Working Paper 2017/113, (Helsinki: UNU-WIDER, 2017), p 3-7

 

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Topic Briefing

A processed product generally enjoys a lower transport cost as compared to the costs of transport of an unprocessed commodity. However, lower transport costs may be offset by several other factors. These other factors are particularly constraining for the development of downstream processing in developing countries.

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The most critical factors/constraints are:

  • Countries producing raw materials may face higher tariffs on more 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 more processed products.
  • Downstream activities are very capital intensive and can take a long time to come on stream. Capital costs in developing countries are high, particularly long-term capital costs.
  • 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 tonnes per year; new crude steel plants using blast furnaces generally have a capacity of at least 2 million tonnes 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); a new alumina plant would not be economic unless it produced at least 1 million tonnes per year. Therefore, processing the output from a relatively small mine or oil field locally may not always be competitive. Accordingly, downstream processing may have to wait until production has reached required levels or may necessitate the pooling of output from several mines or oil production sites. The latter alternative is not necessarily easy to realize, since it may require getting owners of mines or oil wells, who probably have very different cost structures, market networks, and product characteristics, to cooperate.
  • 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 which does not happen to have metallurgical coal deposits nearby would not be a favorable site for a blast furnace—unless local steel demand is sufficiently large 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 costs are important for all minerals – but especially critical for aluminum/bauxite. Moreover, it is critical that electric power sources are reliable – and can be guaranteed. Shortages of power have led to a decline in copper smelting in Chile and in Zambia.[1]