Challenging GoG Assessment Using Advanced Monte Carlo Simulation Technique

Opinions on Sunday, September 6, 2020

Columnist: Dr. Yakubu Abdul-Salam, Contributor

2020-09-06

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The nation has been affected in recent weeks by the controversy surrounding the Agyapa Royalties transaction, which seeks to tax the bulk of Ghana’s future gold royalties on a special purpose vehicle (SPV) company in Jersey in the United States. Channel Islands, in which some lawyers have argued. it is for an indeterminate term.

There has been an intense debate on various aspects of the transaction in the country, including;

• alleged infractions of the best corporate governance practices

• alleged conflict of interest in relation to an appointment to a senior management position in the SPV and the award of the contract to a legal advisory firm

• alleged lack of transparency with parliament that hinders the oversight role of the people’s representatives

• alleged lack of public consultation and commitment to civil society organizations

• the potential financial impact of the transaction on future government budgets

• the balance of transaction risk versus anticipated / perceived rewards, which I wrote about last week

• problems of allocation of shares between generations

• ideological differences on the structures necessary for a prudent management of the country’s mineral royalties, etc.

Perhaps, however, the issue that has attracted the most attention and controversy, and in some cases outrage, is the Government of Ghana’s (GOG) overall valuation of the Agyapa royalty transaction at $ 1 billion, prior to listing. from the Jersey SPV on the London Stock Exchange (LSE).

Two articles have since been published challenging this assessment of the transaction and have attracted a lot of attention. These are the articles by Fui Tsikata / Kofi Ansah and Bright Simons from IMANI Africa. Both articles show that GOG’s valuation represents a significant undervaluation of the transaction. Consequently, Ghana would be at a significant disadvantage if the transaction proceeds in its current form.

However, the valuation techniques used by Bright Simons and Fui Tsikata / Kofi Ansah are what analysts know as deterministic. Deterministic techniques are driven by a single scenario of the underlying variables, which in the case of the Agyapa Royalties transaction are the price of gold and the quantity produced by the companies / concessions assigned to the transaction.

Deterministic techniques implicitly assume that the analyst has a perfect forecast of the evolution of the underlying variables over time. They are unable to properly incorporate and account for the volatilities and probabilities that characterize naturally stochastic variables, such as gold prices and production levels.

This is a major limitation of deterministic techniques, making them less suitable for valuing assets such as Agyapa royalties, which of course have volatile underlying variable movements (i.e. the price of gold, the amount produced by the assigned companies / concessions to the transaction, and hence the level of royalties transferred). Gold prices, for example, can be very volatile and at times fluctuate significantly, as we have seen since the COVID-19 pandemic struck. For this reason, the deterministic techniques used by Bright Simons and Fui Tsikata / Kofi Ansah are simplistic at best, although to be fair, their articles had a somewhat clear purpose of simplifying analysis for appreciation and understanding of the public.

However, for a more realistic valuation of assets with underlying volatile movements, economists / analysts use more advanced stochastic techniques based on probability theory. These techniques more accurately capture and characterize the unpredictable nature of asset values ​​with underlying movements of volatile variables.

They ensure that the observed valuation results are not unduly biased by the choice of the values ​​of the variables chosen by the analyst. Therefore, for an unbiased valuation of the Agyapa royalty transaction, an advanced stochastic technique is required. There are several of these techniques, such as real options analysis and Monte Carlo simulation. The Monte Carlo simulation technique is perhaps most widely used. In order to make my analysis accessible to as wide an audience as possible, I have chosen to use this technique to value Agyapa’s royalty transaction.

In all Monte Carlo simulation scenarios, I assumed a minimum and maximum gold price of $ 1000 / oz and $ 2200 / oz respectively, and a minimum and maximum production level of Agyapa’s assigned companies / concessions at 5 million oz and 7 million oz respectively. After Fui Tsikata and Kofi Ansah, I applied a 4.40% royalty tax rate for simulated gold prices of $ 1500 / oz or more; and a royalty tax rate of 4.10% for simulated gold prices below $ 1,500 / oz. A 5% discount rate was also applied in all cases. For the sake of transparency and to assist the interested technical reader, the MATLAB computer software code that I wrote for my analysis is attached to this article.
The results of my analysis are provided in the figures below, which show the 95% confidence interval (CI) of the calculated value of the Agyapa royalty transaction for different median gold prices and production levels over a period of 15 years.

In summary, • Figure 1 shows that with an assumed average gold price of $ 1200 / oz, and an average production of 5.5 million oz, over a 15-year period, it can be said with 95% certainty that the actual value of the Agyapa Royalties vehicle varies between $ 3,218 – 3,227 billion.

• Figure 2 shows that with an assumed average gold price of $ 1600 / oz, and an average production of 5.5 million oz, over a 15-year period, it can be said with 95% certainty that the value Actual Agyapa Vehicle Royalties ranges from $ 3.536 – 3.544 billion.

• Figure 3 shows that with an assumed average gold price of $ 2000 / oz and an average production of 5.5 million oz, over a 15-year period, it can be said with 95% certainty that the true value Agyapa Royalties vehicle’s share ranges from $ 3,841 – 3,849 billion.

The following table provides further results of the Agyapa royalty transaction value for different permutations of the underlying variables (ie gold prices, production levels, and effective transaction term). It shows, for example, that if we assume a 25-year term of the transaction, with an average gold price of $ 1600 / oz and an average production level of 6.0 million oz at that time, then it can be said with 95% certainty that the real value of Agyapa’s royalty transaction ranges between $ 4.942 – 4.951 billion.

The most realistic scenarios of the underlying variables show that the GOG’s valuation of the Agyapa Royalties transaction at $ 1 billion constitutes a significant undervaluation of the transaction. As Bright Simons recently argued, “the initial undervaluation hurts Ghana, whose royalties must be discounted based on the initial ‘consideration’ in the acquisition contract.” What this means is that Ghana may suffer a significant drawdown in the capital markets if / when Agyapa’s royalty vehicle is finally listed on the LSE at the current GOG valuation.