The Value Chain

What is the value chain?

A value chain is a way of describing the stages by which the full value of a product is managed and ultimately realized.  When applied to the extractive industries, the framework describes the steps from the extraction of natural resources, to their processing and sale, all the way through to the ultimate use of the revenues.

In his book The Bottom Billion, Paul Collier popularized this approach to stress the key steps in ensuring that natural resource wealth transforms into citizen wellbeing. This framework has since become a reference for other organizations working on natural resource governance, such as Revenue Watch Institute, the World Bank, and the Extractive Industries Transparency Initiative (EITI).

What are the steps of the extractive industries value chain ?

While different variations and definitions of the extractives value chain exist, RWI divides the process into the following five steps:

Deciding to Extract: The first decision faced by a government or community is if and when to begin extracting their natural resources and convert them into monetary or other benefits. During this stage, governments may take the opportunity to get prior informed consent from the local communities, to designate environmentally or culturally significant areas as off-limits to exploration and production, or even to reserve certain areas for particular methods of extraction (e.g., artisanal mining.)  The government’s chief task at this stage is to undertake a cost-benefit analysis that makes every effort to weigh all the costs, benefits and risks over the expected timeframe of extraction and beyond.

Getting a Good Deal: After a decision is made to extract, the government must decide on a framework for awarding rights to explore and extract, and establish the legal and financial terms governing those rights. Exploration and extraction rights may be awarded in a variety of ways, and the legal and financial arrangements governing the extraction process may result from licensing rounds (in which specific terms are left for bidding and the bulk of the arrangement is enshrined in general law) or they may be negotiated on a more ad-hoc basis.  In either case, the end result is typically a written contract of some form, complemented by a bevy of generally applicable laws and regulations, the goal of which, for the country, is generally to give it the best deal possible. Poorer countries are often at a disadvantage when negotiating with multinational oil and mining companies – particularly where terms subject to negotiation are not tightly constrained either by the terms of a licensing round or other rules – and consequently get less revenue than they should.

Ensuring Revenue Transparency: Once the terms are set, extraction will begin and the companies will typically pay a variety of financial or in-kind payments to the government.  The part of the government and the manner in which these payments are collected is dictated by the extraction contract and the legal framework, and varies from country to country.  This stage of revenue collection has been the focus of much national and international advocacy through efforts such as the EITI, new United States listing requirements for extractive companies, and the International Accounting Standards Board’s consideration of a reporting standard for extractives.

Managing Volatile Resources: As the revenues begin to arrive, the government and communities must decide how to make effective use of the revenues in light of their finite nature and the challenges of commodity price swings.  This stage requires deciding how much to save and how much to spend to mitigate against the adverse effects of dependency on natural resource revenues and encompasses long and medium-term planning, as well as annual budgets.  Some countries use special instruments to deal with the special challenges of managing natural resource wealth, such as natural resource funds and direct distribution schemes.

Investing for Sustainable Development: Extractive resource are non-renewable assets that must be replaced with other assets-physical, human and financial – which can support a country’s economic growth and development when the resources are depleted or prices decline.  Resource-rich government need to spend money well, which implies spending efficiently and practicing integrity in investment execution, and requiring systematic and rigorous monitoring and audits of public investment programs by independent organizations (including civil society groups.)

Doesn’t the industry use a different value-chain ?

Yes, another extractive industries value chain can be described from the industry perspective. This often includes the steps of exploration, extraction, refinement, sales, and distribution. The major difference is that looking at the value chain from this perspective follows the commodity instead of the assets of the government. This approach follows a private sector point of view to understand how to maximize companies profit and investors’ return while the framework presented in this note takes a government perspective to optimize value for a country and its citizens.

Why is the value-chain useful ?

Governments and civil society often use the value chain as a diagnostic tool to assess policy options and trade-offs for managing their natural resources.  It can help advocacy groups pin-point the challenges and prioritize places for engagement. Revenue Watch also uses the value chain to help organize relevant information on the Resource Center.