PCA CASE NO 2020-21
In the matter of an arbitration
under the Arbitration Rules of the United Nations
Commission on International Trade Law 1976
and
The Agreement between the Government of the Republic
of India and the Republic of Mozambique for the
Reciprocal Promotion and Protection of Investment
dated 19 February 2009
- between -
PATEL ENGINEERING LIMITED (INDIA)
(Claimant)
- and -
THE REPUBLIC OF MOZAMBIQUE
(Respondent)
The Arbitral Tribunal
Prof Juan Fernández-Armesto (Presiding Arbitrator)
Prof Guido Santiago Tawil (Arbitrator)
Mr Hugo Perezcano Diaz (Arbitrator)
ORAL HEARING
PORTO, PORTUGAL
Saturday, 3 December 2022
Registry
The Permanent Court of Arbitration
A P P E A R A N C E S
The Tribunal:
Presiding Arbitrator:
PROFESSOR JUAN FERNÁNDEZ-ARMESTO
Co-Arbitrators:
PROFESSOR GUIDO SANTIAGO TAWIL
MR HUGO PEREZCANO DIAZ
Administrative Secretary:
MS SOFIA DE SAMPAIO JALLES
Registry, Permanent Court of Arbitration:
DR TÚLIO DI GIACOMO TOLEDO,
Legal Counsel
Court Reporters:
MS LAURIE CARLISLE
MS DIANA BURDEN (English language)
(Diana Burden Ltd, London)
Interpreters:
MR MANUEL SANT'IAGO RIBEIRO
MR CRISTÓVÃO TOMÁS BACH ANDRESEN LEITÃO
MS LARA CRISTINA JERÓNIMO DUARTE
A P P E A R A N C E S
The Claimant:
Representative:
MR KISHAN DAGA, Patel Engineering
Counsel:
Brick Court Chambers:
MR EDWARD HO
20 Essex Chambers:
MR BAIJU VASANI
Messrs CMS Cameron McKenna Nabarro Olswang LLP:
MS SARAH VASANI
MS LINDSAY REIMSCHUSSEL
MS DARIA KUZNETSOVA
Miranda & Associados:
MS SOFIA MARTINS
MR RENATO GUERRA DE ALMEIDA
MR RICARDO SARAIVA
Fact Witnesses:
MR KISHAN DAGA, Representative
MR ASHISH PATEL (via video conference)
Expert Witnesses:
PROFESSOR RUI MEDEIROS
MR KIRAN SEQUEIRA
MR PAUL BAEZ
MR DAVID DEARMAN
MR ANDREW COMER (via video conference)
MR DAVID BAXTER (via video conference)
MR GERARD LAPORTE (via video conference)
A P P E A R A N C E S
The Respondent:
Representative:
MR ANGELO MATUSSE, The Republic of Mozambique
Counsel:
Dorsey & Whitney LLP
MR JUAN BASOMBRIO
MS THERESA BEVILACQUA
MR DANIEL BROWN
Fact Witnesses:
MR LUIS AMANDIO CHAUQUE
MR PAULO FRANCISCO ZUCULA (via video conference)
Expert Witnesses:
MS TERESA F MUENDA
MR JOSE TIAGO DE PINA PATRICIO DE MENDONCA
MR DANIEL FLORES
MR LARRY DYSERT (via video conference)
MR DAVID EHRHARDT (via video conference)
MR MARK LANTERMAN (via video conference)
MR MARK SINGER (via video conference)
I N D E X
DR DANIEL FLORES ....................................1268
Examination by Respondent ...........................1269
Presentation.......................................1271
Cross-examination by Claimant .......................1301
Re-examination by Respondent ........................1423
DR DANIEL FLORES and MR KIERAN SEQUEIRA .............1430
Questions by the Arbitral Tribunal ..................1430
[Page 24]
1 (9.30 am, Saturday, 3 December 2022)
2 DR DANIEL FLORES
3 PRESIDENT: Good morning to everyone.
4 This is the sixth day in the hearing between Patel
5 Engineering Ltd as Claimant and the Republic of
6 Mozambique as Respondent.
7 Is there any point of order, Mr Ho?
8 MR HO: No, not from the Claimant. Thank
9 you, Mr President.
10 PRESIDENT: And from your side, Mr Brown?
11 MR BROWN: No points of order. Thank you,
12 Mr President.
13 PRESIDENT: Very good. So we are here
14 today to examine the expert, Dr Flores. Good
15 morning to you, sir.
16 DR FLORES: Good morning.
17 PRESIDENT: Dr Flores, you know the first
18 thing we have to do is take your declaration as
19 expert witness. Would you be kind enough to stand
20 up?
21 Do you solemnly declare upon your honour
22 and conscience that you will speak the truth, the
23 whole truth and nothing but the truth?
24 DR FLORES: I do.
25 PRESIDENT: And that your statement will
[Page 25]
09:28
1 be in accordance with your sincere belief?
2 DR FLORES: I do.
3 PRESIDENT: Very good. Mr Brown, would
4 you like to introduce the expert?
5 MR BROWN: I would. If you will just
6 excuse me for 30 seconds, I need to walk to the end
7 here.
8 Examination by Respondent
9 MR BROWN: Dr Flores, good morning.
10 DR FLORES: Good morning.
11 MR BROWN: I'm going to ask you just a few
12 quick questions here. Do you have in front of
13 you -- actually, I don't see that you do. I wonder
14 if we could get off the table three of your reports.
15 My apologies to the Tribunal for the
16 disruption.
17 Now do you have in front of you your three
18 reports in this matter?
19 DR FLORES: I do.
20 MR BROWN: You have a first report here
21 that's dated March 19, 2021?
22 DR FLORES: Correct.
23 MR BROWN: And if you could turn to your
24 signature page on that report, that's on page 51 of
25 the report?
[Page 26]
09:32
1 DR FLORES: Yes.
2 MR BROWN: Is that your signature,
3 Dr Flores?
4 DR FLORES: Yes, it is.
5 MR BROWN: And is there anything in your
6 report that you would wish to change?
7 DR FLORES: No.
8 MR BROWN: Can I take you to your second
9 report? I believe it's the one that's got a cover
10 page marked RER-9.
11 DR FLORES: Yes.
12 MR BROWN: Is that your second report in
13 this matter?
14 DR FLORES: Correct. 24 November, 2021.
15 MR BROWN: Thank you very much. And if I
16 could turn you to the signature page of that report,
17 is that your signature in this report?
18 DR FLORES: Yes, on page 74.
19 MR BROWN: Thank you. And is there
20 anything you wish to change regarding this report?
21 DR FLORES: No.
22 MR BROWN: Then if I may turn you to the
23 third of your reports?
24 DR FLORES: Yes, I have it.
25 MR BROWN: Is that report dated the 26th
[Page 27]
09:32
1 of August 2022?
2 DR FLORES: Yes, it is.
3 MR BROWN: And on the signature page of
4 that report, is that your signature?
5 DR FLORES: Correct. It is.
6 MR BROWN: On page 23?
7 DR FLORES: Yes.
8 MR BROWN: Is there anything regarding
9 your third report that you'd wish to change?
10 DR FLORES: No.
11 MR BROWN: Thank you, Mr President.
12 PRESIDENT: Dr Flores, I think you have a
13 presentation.
14 DR FLORES: Yes, I do.
15 PRESIDENT: And it's H-11, and you have
16 the floor.
17 Presentation.
18 DR FLORES: Great. Thank you very much,
19 members of the Tribunal. As you know my name is
20 Daniel Flores, and over the next 45 minutes I will
21 be talking to you about my work in this case as
22 summarised in this presentation.
23 If you go to slide 2, these are the topics
24 I will be covering. I will be focusing more time on
25 number 1 -- 1 to 4, and then I'll go quicker on tabs
[Page 28]
09:33
1 5, 6, and 7. Next, we're going to start talking
2 about the fundamental point that we need to
3 understand for valuation and assessment of damages,
4 which is there is no project. That's what I'm going
5 to explain here.
6 Next.
7 Now, we are in slide 4. Here you have a
8 summary of some relevant dates. As you know, the
9 concession was awarded to TML in 2013 and what we
10 know is that, as of today, the project as it was
11 envisioned in 2013 has not been built and will not
12 be built.
13 Let's go to the next slide, 5.
14 Why it will not be built? Because there
15 is no sufficient demand for this project. Remember,
16 this was a project that was supposed to transport
17 coal by railway, and then export it in a deep sea
18 port or via a deep sea port.
19 But the problem, as you are aware, I'm
20 sure, is that coal production and consumption are
21 steeply declining in developed countries. In North
22 America, plenty of coal mines have closed down. In
23 Europe, plenty of mines and generation of
24 electricity through coal have closed down.
25 Why? Because coal is one of the dirtiest
[Page 29]
09:35
1 ways in which you can produce electricity and, as
2 the years have gone by, more and more people have
3 realised that that's helping warm up the planet. As
4 you know, there's plenty of this in the newspapers
5 so we don't need to spend more time on that. So,
6 the idea of extracting coal which is very abundant
7 and very cheap throughout the earth to heat up our
8 homes and our industries is not sustainable and,
9 because it's not sustainable, people are shifting to
10 other cleaner ways to produce electricity.
11 Natural gas is a much better way to
12 produce electricity, and even better is to go with
13 renewable energy, like solar, wind, and
14 hydroelectricity. That's a trend that's happening
15 worldwide. It started in developed countries, but
16 it is spreading throughout the world. China
17 announced not long ago that they will no longer
18 finance coal-related projects overseas, so any
19 financing that could come from China will not be
20 there.
21 India, it was just a week or two ago but
22 it happens several times a year, I'm sure you've
23 seen newspapers or in the news when they have these
24 pictures of New Delhi. In the morning there's this
25 big, dense fog and you cannot see anything. That's
[Page 30]
09:37
1 produced by coal. So sooner or later India will
2 stop and will shift away from coal like everyone
3 else is.
4 So to invest billions of dollars in coal
5 assets at this point in time is a money losing
6 proposition. We need to keep that in mind.
7 It is true that in the short term India
8 still uses a lot of coal and at least in the short
9 term it's expected to continue to use coal.
10 However, India -- which, remember, is the main
11 destination of the coal from Mozambique that,
12 according to Versant's assumptions, would be where
13 the coal from Mozambique would be transported to,
14 India is shifting away from importing coal. I even
15 have here two slides from Argus Media, where they
16 show that there is a desire both by companies like
17 CIL, which is coal of India, it's a state-owned
18 company, and also by private companies like Jindal
19 Power, they are looking to end or diminish greatly
20 the import of coals from overseas. That doesn't
21 speak well for a project that would want to spend --
22 commit billions of dollars for the next 30 years to
23 coal.
24 Next, number 6. Now, I'm going to give
25 you two examples. Coal mines, existing coal mines
[Page 31]
09:38
1 in Mozambique. I am choosing these two, Chirodzi,
2 if I am saying it correctly, and Benga in the next
3 slide, because these two are the ones where Versant
4 says that almost two-thirds of the capacity of the
5 project will be taking coal from these two mines.
6 The first one, Jindal Chirodzi, you can
7 see that here the projections were very optimistic
8 in 2012 when Jindal acquired this mine, and they
9 were expecting that, by 2015, they would be already
10 producing 10 million tons per annum and that that
11 would increase in the next years to 20 million tons
12 per annum.
13 That did not happen. These ambitious
14 expansion plans have not gone through. They have
15 had a lot of operational issues that have prevented
16 the mine from growing. By the way, I'll get back to
17 this later, but this has nothing to do with oh, if
18 only we had a railway that would allow us to export
19 more. That's not the constraining factor.
20 If we go to the next one, slide 7, that's
21 the other mine, the Benga. This is even a more
22 stark example. Rio Tinto used to own this mine.
23 They bought it in 2011. I heard some of the
24 witnesses or read the transcript of some of the
25 witnesses referring, oh, we are talking to Rio,
[Page 32]
09:39
1 meaning Rio Tinto. Well, look at what happened to
2 them.
3 They bought in 2011 for almost $4 billion.
4 Just three years later, in what the financial banks
5 were calling one of the most disastrous acquisitions
6 in the history of Rio Tinto, they sold it for just
7 $15 million. This is the kind of return on
8 investment that you get when you invest in coal, an
9 investment of $4 billion, you have to sell it at a
10 huge loss for 50 million.
11 This was bought by ICVL at a big discount,
12 and also the same thing. They had big plans to
13 expand to 12 million tons per annum. That has not
14 happened. In fact, as we see at the bottom of the
15 slide, today the current capacity of the mine is
16 lower than when they got it from Rio Tinto. So
17 these are the mines that were supposed to be
18 sustaining the railway operation envisioned by
19 Versant.
20 Next, now, a very important point. The
21 Mozambican coal is not competitive in international
22 arena. Here in slide 8 you have a graph that shows
23 that's the total cost all inclusive of transporting
24 coal to India, and what you can see is that the
25 costs of Australia are very low. Australia has the
[Page 33]
09:41
1 advantage, it has very big coal mines that are very
2 close, or much closer, to the coastline and they
3 have much better already existing infrastructure.
4 So if you want to transport a ton of coal
5 to India, the cheapest way to do it is to get it
6 from Australia. No wonder then that the biggest
7 exporter of coal is Australia. Bringing coal from
8 any other place in the world to India, which is the
9 biggest consumer or the biggest importer, is much
10 more expensive, and this data which I believe is
11 from around -- yes, it is from 2017, shows that the
12 Mozambican coal was much more expensive.
13 So the key point here, there's been a lot
14 of argument by Claimant as, well, our railway would
15 have been much cheaper than the one in the north and
16 the one in the south. Even if that's true, that's
17 not the point. The point is are you competitive at
18 an international level, and they are not. You can
19 see the example here that if you were to put their
20 $35 per ton assumed in TML's feasibility study, that
21 still would not allow you to be competitive with
22 Australia.
23 Next. And that reflects in many things.
24 Everything I'm saying -- I'm not just making it up,
25 it's sustained by any evaluation that you see. For
[Page 34]
09:42
1 example, in slide number 9 I talk about the Nacala
2 corridor. That's a corridor that has railway plus a
3 deep sea port. You have heard about this. And the
4 interesting thing is that it was not me, it was
5 Mr Sequeira who said that these two projects, Nacala
6 and the project at issue in this arbitration, are --
7 and these are his words -- are "broadly comparable"
8 because they are performing essentially the same
9 business activity in the same geography.
10 So he came up with the idea of comparing
11 these two. And, yes, in 2017 there was a
12 transaction involving the Nacala corridor that had a
13 value of $348 million for a 35 per cent equity
14 stake, and that's true, but if you go to the next
15 slide, you can see that things got worse from there.
16 Vale, which was the owner of the mine, the
17 major owner, impaired its coal assets in Mozambique
18 in 2019 due to technical and operational issues, and
19 it had a huge impairment of $1.7 billion.
20 Then in January 2021, Mitsui, who had been
21 the one acquiring the interest in just 2017, sold
22 back that same asset, the Nacala corridor stake, for
23 $1, and I believe $1 is because any transaction has
24 to have an amount, so you cannot say sell it by
25 zero, so that's why you put $1.
[Page 35]
09:44
1 So if you go by Mr Sequeira's own point,
2 that there was a comparable asset, the comparable
3 asset price is $1.
4 Next slide.
5 Now, another point, you have to look at
6 the economics of transportation, and if you add the
7 third corridor, what that's going to create is going
8 to be a lot of competition. That happened already
9 when the Nacala corridor opened by increasing --
10 when Nacala was opened, that drove business, cargo,
11 away from the other corridor, the Beira corridor,
12 with the result that then there was price
13 competition and fares went down.
14 That would only be bigger in a situation
15 in which coal production is not increasing because
16 of international issues and then you're adding more
17 transportation, so by adding more capacity you're
18 going to have more competition. So that's a very
19 important point. It's a bit technical, but I think
20 it's worth understanding.
21 When you have competition from an existing
22 project with a project that has yet to be built,
23 that's very difficult to build a new project. Why?
24 Because the project that was already built already
25 paid for the capital expenditures, the 2 or the
[Page 36]
09:45
1 3 billion dollars. So that's what we call a sunk
2 cost.
3 The one that has not been built yet, the 2
4 or 3 billion dollars, is not a sunk cost, so when
5 you look at the competitive dynamics that's going to
6 happen if the second one is going to be built, the
7 existing line can make a very real threat. It's
8 like, look, as long as I can cover my variable costs
9 I will outprice you and I will compete you out of
10 the business.
11 Banks or lenders trying to finance a new
12 project know that, and they will be very sceptical
13 financing that because they say, well, we have the
14 choice of building or not building and incurring the
15 $3 billion or not. They do not, so they can be more
16 aggressive in their pricing. These competitive
17 issues have not been properly considered by Versant.
18 Next. So the result of all of this is now
19 we can understand why the project has not been
20 built. At some point there's been some suggestions,
21 maybe ITD is incompetent and so on. I think as of
22 now, no one is making that claim any more. ITD is
23 one of the -- is the largest construction company in
24 Thailand that has investments all over the world and
25 has projects all over the world.
[Page 37]
09:47
1 As you can see, this is what's called the
2 work-on-hand document, where they have listed every
3 project they have, how far along they are in
4 competing the project. As you can see, the last
5 data that we have in the record, it's that they have
6 completed very little of that, like 3.51 per cent of
7 the surveys and design and 1.87 per cent of the
8 total amount.
9 Next slide. So all of this put together
10 is what explains this article from June 2021, that
11 Mozambique's long awaited coal boom might never
12 materialise, and I believe it will never materialise
13 because other companies sold their assets. Vale
14 tried to continue investing, but now Vale has
15 decided to halt all thermal coal mining, and also
16 for international concern about global carbon
17 emissions, and that's why this leads this newspaper
18 article to conclude that the planned rail and
19 project at Macuse seems unlikely to proceed.
20 Next.
21 Now, a lot has been made by Claimant in
22 recent months about this Ethos announcement. This
23 is an announcement by someone called -- it's led by
24 a guy called Carlos Santos. He's a Portuguese
25 investor working in the United States, and
[Page 38]
09:48
1 in November 2021 Ethos announced that it was going
2 to have a partnership with Mozambique in which it
3 would invest $400 million. It "would" invest.
4 There's no evidence that that investment has
5 happened and, in fact, I'll show you the reference
6 in the next slide, but the latest news that we have
7 is that there has been a loan agreement signed,
8 actually signed, in the amount of $25 million.
9 That's all we know about an actual commitment.
10 $25 million.
11 However, in the source it says that that
12 was not project financing; that's a loan that
13 required ITD, the owner or the parent of TML in
14 Thailand, to provide a bank guarantee and to provide
15 a deposit of $5 million and a standing letter of
16 credit.
17 So when you have someone willing to give
18 you $25 million only if the parent company of the
19 entity you are loaning to is asking for a security
20 deposit and a collateral, that doesn't seem like a
21 big vote of confidence.
22 So, yes, so you have here -- and also one
23 thing else I wanted to mention also, you see in the
24 highlighted part of this release it says "At no
25 stage did the release, or the statement by Ethos
[Page 39]
09:50
1 Asset chairperson Carlos Santos, mention the word
2 coal", and the reason for that is just look at the
3 name of the company. It's called Ethos. It's about
4 what is the ethical, the ethos of this company.
5 They're all for social and corporate responsible
6 investment. So they are investing in all kinds of
7 things and trying to better the world and so on
8 which is a very nice thing, but I think, and in fact
9 this is publicly available, you can just look Carlos
10 Santos on the internet and you will see that he's a
11 big proponent of not investing in things that will
12 create climate change.
13 So that's why he didn't mention the word
14 coal. He's OK trying to help a project be built
15 that would be a general cargo port that would allow
16 merchandise to arrive and leave Mozambique, but not
17 a coal investment. That's why this article
18 concludes at the bottom saying "The future looks
19 bleak for a port and rail project originally
20 designed to transport coal".
21 To conclude this section, let's go to
22 slide 15, and I think it's interesting to look at
23 the financial statements of ITD, Italian-Thai
24 Development, which is the company that got the
25 concession and that invested. The more recent ones
[Page 40]
09:51
1 that we have in the record are the ones
2 through June 2022. The ones where we have quoted
3 only came up two days ago but they confirmed the
4 same information that I'm going to explain here.
5 You can see one of the notes to the
6 financial statements, note 17, talks about this
7 project in particular, and it says at the bottom,
8 "In 2020, the subsidiary's management" -- that means
9 TML -- "has revised its business plan to develop the
10 project by separate into 2 phases. Phase 1 is the
11 development of a general cargo sea port at Macuse
12 which has a shorter construction period and lower
13 investment costs, and phase 2 is the construction of
14 the railway and the deep sea port".
15 Two points. First, I think yesterday
16 there was some confusion about this point. It's not
17 that phase 1 is the port, phase 2 is the railway.
18 That's not the way it is. Phase 1 is a general
19 cargo sea port; phase 2 would be the deep sea port
20 and the railway. That's the proper comparison, as
21 the new construction is envisioned.
22 But look at the last sentence.
23 "Management of subsidiary will start phase 2
24 development when the economics of the project can be
25 justified".
[Page 41]
09:53
1 There's no commitment whatsoever of
2 building the deep sea port and the railway. Why?
3 Because today the economics cannot be justified.
4 Perhaps if at some point in the future they could,
5 maybe they would, but they won't.
6 More importantly, I wanted to draw your
7 attention in the right side of the slide to the
8 independent auditor's report of this financial
9 information. As you know, auditors have different
10 comments they can make. They can just give a blank
11 slate, they can have a qualification, they can have
12 a matter of emphasis.
13 There was a matter of emphasis regarding
14 this project, and this is what the auditor said.
15 I'm looking at note 17, he says, and then he says
16 well, yeah, they have invested this 2.4 billion --
17 that's baht, that's the currency of Thailand --
18 since they got the concession. You can see that in
19 note 17.
20 They're carrying that -- these are
21 expenses that have been capitalised, they are in the
22 balance sheet of the company -- as if they can be
23 recovered at some point, they can be monetised.
24 That's why they are counted as an asset.
25 However, the auditor says, "The progress
[Page 42]
09:54
1 of such project under development is dependent on
2 finding the strategic partner in the future as well
3 as the approval for the project finance from the
4 financial institution since the project requires
5 significant amount of investment for the development
6 of such project". So what this is saying is like,
7 yes, I see you are still carrying that in your books
8 but I'm a little bit concerned. That's what the
9 matter of emphasis is. It's kind of, in the soccer
10 card it could be a yellow card, not yet a red card,
11 but it's a yellow card because it's saying you may
12 need to write this off eventually.
13 So with this, this explains why there's
14 still some news articles that, yes, they haven't
15 abandoned their investment in Mozambique. Why?
16 Because this $2.4 billion that you see here, the
17 exchange rate between the baht and the US dollar is
18 about 35, so that was 70 million US dollars.
19 So, as of today, ITD is $70 million out of
20 pocket, in the red, so I understand they are trying
21 to do something to try to recoup all the money they
22 have thrown into this investment. Maybe, and
23 hopefully, this general cargo port will be the
24 answer, and maybe that will be NPV positive.
25 But remember, even if now they succeed in
[Page 43]
09:55
1 building the general cargo port, if the net present
2 value of this project will be $70 million, that
3 means that overall, considering that they have
4 forward looking $70 million and they have already
5 invested $70 million in the past, the overall
6 experience of ITD in Mozambique will be a big zero,
7 and I think that's an optimistic outcome, recovering
8 all the money that has been put in there.
9 I saw the opening statements via zoom, and
10 Claimants were making the point that the reparation
11 in this case should be to put the Claimant in the
12 position that it would have been if the concession
13 would have been granted to them, at least in the
14 same terms as TML got the concession.
15 So, to be clear, to put the Claimant in
16 that position would mean the Claimant today would be
17 out of pocket by about $70 million, and at best
18 would have a hope of developing a general cargo port
19 that hopefully will make some money. It would not
20 be swimming in money from a coal export business
21 that is not going to happen.
22 And with this, I conclude section 1. Now
23 I'm going to go faster for the remainder of the
24 slides. Next slide, please.
25 As a preliminary point we need to
[Page 44]
09:57
1 understand what it is that we are valuing, and what
2 Versant is valuing is a concession, the present
3 value of the concession. I understand that
4 Respondent's position is that there was no
5 obligation to give a concession and that the MOI was
6 void for several reasons, and of course if the MOI
7 is void, the value of it would be zero.
8 If we go to the next slide, 18, Versant
9 puts forward four different valuations, ex ante and
10 ex post, and then at a 100 per cent or at 90 per
11 cent.
12 Next, we take us to the ex post
13 perspective. To put it simply, the project has not
14 been developed, it no longer exists as it was
15 envisioned, so to try to build that cash flow
16 projection based on a feasibility study that's more
17 than five years old, I don't think that's sound from
18 an economic perspective. As we know, TML has
19 invested negligible amounts compared to everything
20 that would be required and has made no significant
21 progress on that.
22 Next, for the ex ante perspective, if you
23 do an ex ante analysis, what you have to look at is
24 what was information available as of date of
25 valuation, which is July of 2013 in their analysis.
[Page 45]
09:59
1 Well, if you look at the information there, there
2 was no prefeasibility study, so you cannot reach out
3 into the future, the then future, and say, well,
4 someone eventually did a feasibility study
5 four years later or three years later. No, that's
6 not -- you cannot do that. You have to base
7 yourself on the information that was available as of
8 the valuation date, and the only thing we have
9 available with regard to finance numbers as of that
10 day is this document, the famous document C-8, that
11 was submitted by Patel to Mozambique in May 2012.
12 It's the famous spreadsheet that was discussed
13 yesterday.
14 To be clear, if that's the only thing that
15 we have to go by, that spreadsheet speaks for the
16 proposition that the net present value of the
17 project was negative.
18 And yesterday I think there was some
19 confusion about all of these numbers and so on. I
20 think it's fun to look at Excel spreadsheets, but
21 let's be clear. The value of a project does not
22 depend on how you finance it. The financing
23 decision only affects who gets what, the debt
24 holders or the equity holders, but from that
25 spreadsheet you can look at the revenues minus the
[Page 46]
10:00
1 costs and then you do what's called the cash flows
2 to the firm, and the cash flows to the firm is all
3 the money that goes in, capex, to build the project,
4 and all the money that the project would go out,
5 before taking into account interest payments,
6 amortisation of debt and all that.
7 If you look at this line, the free cash
8 flow to the firm, it's around 7 per cent. What does
9 it mean? That if your discount rate is any higher
10 than 7 per cent, the project is not worth pursuing,
11 and even Versant used a discount rate over 7
12 per cent, so that should be the end of the story.
13 If you look at the projections that were done as at
14 that time, back then even the project was not
15 profitable.
16 And there's been an allegation that, well,
17 never mind because this was a very conservative
18 number. It was all like the worst case scenario.
19 That is simply not true, if you look at all the
20 assumptions that were made here, and that's not the
21 worst possible way you could model the cash flows.
22 Starting, for example, with a zero per cent income
23 tax rate for ever, from the beginning until the end
24 of the project, for example, all they would have
25 gotten would have been a tax holiday of five years.
[Page 47]
10:02
1 But then you would have to start paying taxes after
2 five years.
3 PRESIDENT: Dr Flores, the secretary tells
4 me you have used 30 minutes by now.
5 DR FLORES: But I have more time, right?
6 MS JALLES: It has been 30 minutes of
7 direct in general with the presentation. It was 30
8 minutes with the presentation of Dr Flores, the
9 direct. Normally it's 30 minutes but I mean --
10 DR FLORES: I was told I had 45 minutes.
11 MR BROWN: I'm sorry, Mr President, but I
12 had understood that, when we had talked at that time
13 pre hearing conference, in fact Claimants had asked
14 for 45 minutes for Mr Sequeira and that 45 minutes
15 would be given for Dr Flores as well.
16 I don't know how much Mr Sequeira used,
17 but we had gone on that. I mean we made the
18 presentation as we were instructed to before
19 Mr Sequeira had given his, so we were under the
20 impression that we had the 45 that had been
21 discussed.
22 PRESIDENT: Let's go on.
23 DR FLORES: I'll try to be as efficient as
24 I can.
25 So we were discussing this, and the point
[Page 48]
10:03
1 was this is not the worst possible scenario. It's
2 assuming 100 percent efficiency, it's assuming zero
3 per cent taxes, and many other assumptions that are
4 not that conservative and worst case.
5 Slide 21. Then at the very end of this
6 arbitration Claimant asked Ankura to put forward
7 three alternative ranges. I think it was covered
8 quite a lot yesterday so I will not delve into it,
9 just to restate that I disagree that those are any
10 serious valuation efforts from an economic
11 perspective.
12 Next.
13 Here is just a summary of the wide array
14 of valuations that the Claimant's experts have
15 presented, and then next, 23, this is the
16 compensation in this case, if it were to be awarded,
17 should be based on non-recoverable costs incurred.
18 That's the only non speculative, reasonable way to
19 look at compensation.
20 The DCF, it's very speculative, as I will
21 show you in a moment. Now, the only problem that we
22 have here is that the Claimants have not explained
23 how much money did they spend preparing, for
24 example, the preliminary feasibility study, if they
25 have said they have not found any documents.
[Page 49]
10:04
1 I find that surprising because, I mean,
2 you are all lawyers, I'm an economic consultant.
3 You all know, with all working projects the first
4 thing you do when you get the project is you put a
5 line in your accounts to identify that project. You
6 need to know whether you are billing hours for
7 Mozambique or for China, right? So that's one
8 thing, that it's surprising that they wouldn't keep
9 that level of proper business management to know
10 where are you spending the money.
11 So then let's go to the next slide, slide
12 25. Yes.
13 This is also an important point.
14 I propose a reasonableness test in my report where
15 I explain, well, we know that the concession was
16 awarded to ITD, the Thai company. ITD is
17 60 per cent owner of TML, which is the company in
18 Mozambique that supposedly was to develop the
19 project.
20 So let's see, I mean, if the project is
21 really worth what Versant says, which is like about
22 $563 million, that should be reflected in the share
23 price and the market capitalisation of ITD. It is
24 not. If we were to believe the ex post valuation of
25 Versant, that would mean that at the time I was
[Page 50]
10:06
1 preparing my report that would have presented --
2 that project alone would constitute 82 per cent of
3 all the value of the entire ITD, the largest
4 construction company in Thailand and one of the
5 largest in Asia.
6 That doesn't make any sense. In fact, if
7 you were to do that exercise as of today, it would
8 be over 100 percent. So think about that. What
9 that means is that if the value of the shares that
10 ITD has in this project in Mozambique was what
11 Mr Sequeira tells us, this is the only source of
12 wealth for ITD. That does not make any sense.
13 Then next slide. Then -- I think in the
14 interest of time, let's skip slide 26, slide 27.
15 Let's go to slide 28.
16 It's interesting to understand that when
17 you build these megaprojects, and I think we have
18 heard this word used by both parties several times
19 this week, that this is or would be a megaproject,
20 it's very easy to have cost overruns, and this
21 article that we have here, it displays that there's
22 been lots of cost overruns.
23 What Mr Sequeira said in his report in
24 reply to my observation, he said, well, one of the
25 projects discussed in this article is the building
[Page 51]
10:08
1 of the opera house in Sydney, that very beautiful
2 building. That had huge cost overruns. But that's
3 not what I was referring to. I was referring
4 specifically to railways, and railways tend to have
5 cost overruns of 45 per cent.
6 Mr Sequeira has said that, well, that
7 could be avoided by having EPC contracts. The EPC
8 contracts limit all the risks. But that's not true.
9 I'm sure you've been in construction arbitrations
10 where you know that EPC contracts are very carefully
11 drafted documents, and they specify very clearly who
12 carries what risks.
13 I was in an arbitration recently where the
14 contractor had promised to build foundations up to 4
15 metres deep, but then they said, well, if it is any
16 deeper than 4 metres, the owner has to pay for that.
17 I didn't know ex ante how deep the foundation would
18 need to be until you actually build it.
19 So having an EPC contract is not a friar's
20 balm to help eliminate any risk for the owner of the
21 project.
22 Then I would like to go to slide 30, just
23 to show some sensitivities that I did to the Versant
24 ex post calculation.
25 He said yesterday that I was doing all I
[Page 52]
10:09
1 could to bring down the value to zero. That's not
2 what I did. What I did is to try what's called to
3 stress test the model. That's what lenders do.
4 Lenders today do not take a feasibility study and
5 say, oh, it's bankable, you want a billion dollars,
6 here's the billion dollars; just I see the document
7 prepared by some engineers, that's it. That's not
8 the way they work.
9 What the banks will do is say, ok, I saw
10 your model, post sensitivities, let's look at that.
11 I'm not going to go through every line, but just to
12 put one example, the throughput, how much coal would
13 the project carry.
14 If you go from 30 million tons per annum
15 to 25 million tons per annum, the value completely
16 evaporates. That's the only thing you change in
17 Mr Sequeira's model. That could be very worrisome
18 for a financier, and that would explain why the
19 financier would not want to build this.
20 Let's look, for example, at cost overruns.
21 If you do a cost overrun of 22 per cent, meaning
22 that the capex would be just 22 per cent more than
23 what's currently in Mr Sequeira's model, there's no
24 value. Remember, if you go back a couple of slides,
25 the average cost overrun in railways projects is
[Page 53]
10:10
1 44.7 per cent. So I'm not just saying if it were to
2 cost three times as much as you forecasted then
3 there's no value. No. It's 22 per cent cost
4 overruns, and the EPC agreement will not protect
5 you, it will not insure you against 22 per cent cost
6 overruns.
7 One last final one, discount rate. Look
8 at the last value, the second line from the bottom.
9 Versant assumes a discount rate that starts at 18
10 per cent. Then it goes down a little bit as you
11 have less leverage of the project -- thank you for
12 the highlight.
13 It's not that -- you know, we all have
14 been in arbitrations with huge fights about discount
15 rate. One says high, the other one says low. We
16 don't need to have that discussion here because, if
17 you simply go here and you add about 1 or 2
18 percentage points to his discount rates, there's no
19 value.
20 So how can this be a reasonable DCF model
21 that will be stressed against anything bad that
22 could happen? That explains, this slide itself
23 explains why there's no financing. First, no banks,
24 no lenders in the developed countries will want to
25 finance this. China will no longer finance this, so
[Page 54]
10:12
1 perhaps you would have someone from somewhere else
2 in the world, but they would look at things like
3 this and will see how flimsy this is, and just by
4 changing something you can really destroy the model
5 very easily. That's why the project hasn't been
6 built, and will not be built.
7 Next slide.
8 The same applies to the other valuation,
9 the ex ante valuation. It's done as of July 2013.
10 The only thing we know as of that time is that the
11 only financial projection that had been prepared
12 reveals that the project was not viable for any
13 discount rate higher than 7 per cent, which we are
14 in agreement the discount rate has to be higher than
15 7 per cent.
16 Now let's go to slide 35, which has the
17 same analysis, the same stress test of the Versant
18 ex ante valuation, and you can see also how this
19 works. And look at the second line, the tariff per
20 ton. Versant assumes $39 per ton. If you only take
21 $3 out of that -- $3, I'm not talking about halving
22 the tariff, I'm talking about $3 less -- there's no
23 value.
24 So how would someone have financed this if
25 just -- if you have miscalculated the tariff
[Page 55]
10:13
1 slightly and by the time you build it due to higher
2 competitive measures, as I was talking about, the
3 tariff would have to be $3 lower, you are out of
4 business, and that's why it wasn't built and it
5 hasn't been built and will not be built.
6 And the same applies to the discount rate
7 at the bottom. You see Mr Sequeira assumes a
8 discount rate of 25 per cent in the first years. It
9 actually just -- that rate with some additional
10 spread in the following years also results in no
11 value.
12 That's why it is true that DCFs are used
13 in the mining industry and in the transportation
14 industry and they're used everywhere, but you have
15 to treat them with a grain of salt and you have to
16 see whether they really work and they're really
17 reasonable, and whether you can invest billions of
18 dollars and put your client's money at risk in
19 investing things that if things go a little bit
20 worse than modelled, your clients are going to lose
21 all of their money.
22 ΟΚ. So I think in the interests of time
23 I'm just going to -- let's go to slide 37, the
24 Ankura release damages.
25 This was not really one opinion of a
[Page 56]
10:14
1 concrete value using a different method. It's just
2 like a lot of numbers, a lot of ranges, a lot of
3 values and so on. I have a very careful analysis of
4 that in my third report, and in fact yesterday
5 Mr Dearman agreed with some of my corrections, and
6 he modified his analysis.
7 You will see the comments that are in
8 these slides are not reflective of his adjustments
9 yesterday because I have submitted the slides before
10 his presentation.
11 But I think that's -- I think I'm going to
12 leave this unless the Tribunal has any questions
13 about these release damages, and if we can go
14 briefly to slide 45, just one point on interest
15 rates. If any pre award interest were to be
16 awarded, it would have to be a risk-free rate that
17 takes into account the passing of time, but not
18 commercial risks to which any amount awarded would
19 not have been subject.
20 And with this, I conclude my presentation.
21 Thank you very much.
22 PRESIDENT: Thank you, Dr Flores.
23 Mr Brown, do you have any follow-up
24 questions for the expert?
25 MR BROWN: No, thank you, Mr President.
[Page 57]
10:15
1 PRESIDENT: Very good. I see, Mr Ho, you
2 are ready.
3 MR HO: Thank you, Mr President.
4 Cross-examination by Claimant
5 MR HO: Good morning, Dr Flores.
6 DR FLORES: Good morning.
7 MR HO: Could we start by looking at your
8 CV? We'll hand that up to you. It's in Core Bundle
9 volume 4, tab 103. For those following
10 electronically, it's QE-1. We'll get it up on the
11 screen for you as well. Hold on.
12 And if you just turn on in that to
13 internal page 2, I think it's page 3 of the pdf, we
14 can see a summary of your education, and you are, by
15 training, an economist, aren't you?
16 DR FLORES: Yes, that's correct.
17 MR HO: You don't have any training or
18 education as an engineer?
19 DR FLORES: Yes, that's correct.
20 MR HO: If we move down to your work
21 experience, we can see that you began your career as
22 an academic, and then, from 2004 onwards, you were
23 either at Econ One or Quadrant Economics, is that
24 right?
25 DR FLORES: Yes, that is correct.
[Page 58]
10:17
1 MR HO: During your time at Econ One and
2 Quadrant Economics you've worked as an expert
3 witness on valuation issues, is that right?
4 DR FLORES: Valuation -- economic analysis
5 generally. There are some analyses that we are
6 asked to perform that are not valuation.
7 MR HO: You've never worked or have
8 experience as a mining engineer, though, do you?
9 DR FLORES: That is correct.
10 MR HO: And you don't have any experience
11 running or operating a coal mine?
12 DR FLORES: That is correct.
13 MR HO: You've never worked as a
14 commodities broker, or have any experience buying or
15 trading coal?
16 DR FLORES: That is correct.
17 MR HO: And you don't have any expertise
18 trading coal futures either, do you?
19 DR FLORES: That is correct.
20 MR HO: You've never worked at a
21 consultancy like Wood Mackenzie, which has specific
22 expertise in the coal sector?
23 DR FLORES: I have not.
24 MR HO: You've never advised anybody, as a
25 consultant like Wood Mackenzie would do, on demand
[Page 59]
1 or trends in the global coal market or on coal 10:18
2 prices, have you?
3 DR FLORES: Well, I do analyse trends in
4 the coal market and so on, and I apply them in my
5 work.
6 MR HO: But has anyone ever hired you in a
7 commercial context, so outside the scope of
8 litigation, to provide consultancy services like
9 Wood Mackenzie would on trends in the global coal
10 market or coal prices?
11 DR FLORES: No.
12 MR HO: Has anyone ever instructed you to
13 provide advice on trends in the Mozambique coal
14 market or coal prices in Mozambique? Again, outside
15 of the context of litigation.
16 DR FLORES: No.
17 MR HO: As I understand it, in your career
18 as a professional expert, you've only been involved
19 in one case which concerned coal mining, is that
20 right?
21 DR FLORES: No, I don't think that's
22 right.
23 MR HO: Which cases have you been involved
24 in as an expert witness that involved coal mining?
25 DR FLORES: Well, so there's one earlier
[Page 60]
1 in my career, which is Churchill Mining. 10:19
2 MR HO: Yes, that's the one I'm aware of
3 that involves coal mining. I think if you want to
4 find that, that's at page 11 of the pdf. It might
5 be page 12 internal for you.
6 DR FLORES: Yes, that's correct.
7 MR HO: I think in that case you provided
8 an expert opinion. You submitted one report, but
9 I don't think you gave evidence at a hearing.
10 DR FLORES: That's correct. The case was
11 bifurcated, and it never got to quantum.
12 MR HO: But other than that case, I'm not
13 aware, having been through your CV, that you've been
14 involved in a case involving coal mining, but is
15 that wrong?
16 DR FLORES: Yes. I'm trying to find it.
17 Yes, OK. So this CV is as of March 2021.
18 MR HO: Since then have you --
19 DR FLORES: Yes, since then I have been --
20 I am actually still involved in a case in Vietnam
21 that has to do with coal.
22 MR HO: Right. And what does it have to
23 do with coal? Is it a project similar to this one,
24 or is it about a coal mine?
25 DR FLORES: No, it's about a project to
[Page 61]
1 create a power plant powered by coal. 10:20
2 MR HO: I see. So it's actually about the
3 construction of a power plant, is it, rather than a
4 coal mine?
5 DR FLORES: No. It was not about the
6 construction, it was about the operation of a coal
7 power plant, which would require procuring the coal.
8 MR HO: I understand. Thank you.
9 Sorry, just a few more questions about
10 your experience. You don't have any experience
11 working in the construction industry, do you?
12 DR FLORES: I have done arbitrations
13 involving construction issues.
14 MR HO: I see. So your only involvement
15 has been as an expert witness. You've not been
16 involved yourself, for example, in the construction
17 of a significant infrastructure project?
18 DR FLORES: No.
19 MR HO: Sorry, just one more question.
20 I think it's also fair to say that, just
21 as you've never worked as a mining engineer, you've
22 never worked in the mining finance sector either,
23 have you?
24 DR FLORES: That's correct.
25 MR HO: All right. Can I move on to ask
[Page 62]
1 you some questions now about a different topic? 10:22
2 Would you agree with me that a feasibility
3 study is a formal technical report that is used by a
4 company to determine whether a proposed project is
5 capable of being developed at a sufficient return to
6 justify the capital and managerial resources that
7 must be committed to the project?
8 DR FLORES: Are you reading a definition
9 from some document in the record?
10 MR HO: Just let's see whether you agree
11 with that as a proposition?
12 DR FLORES: I would probably define it
13 differently, but if you can show me what you're
14 talking about, we can compare.
15 MR HO: All right. If you want to see the
16 document, it's a document that you've referred to.
17 It's in Core Bundle volume 4, tab 106, so it may be
18 in the volume that you have there.
19 DR FLORES: I have it.
20 MR HO: For those of us electronically,
21 it's QE-82, and it's page 4 of that. There should
22 be a heading on page 4, Internal Feasibility Study.
23 Do you see that?
24 DR FLORES: Yes.
25 MR HO: Do you see underneath that there's
[Page 63]
1 the first paragraph and in the last sentence it 10:23
2 says: "Simply put, the feasibility study is a formal
3 technical report" and so on.
4 Can you see that?
5 DR FLORES: Yes.
6 MR HO: Do you agree with that?
7 DR FLORES: I would qualify it. It's not
8 a difference of opinion but I would say it's a
9 technical and economical report, because feasibility
10 study, as it says in the last part of the sentence,
11 has to provide a sufficient return to justify
12 capital that must be committed to a project, so that
13 requires an economic or financial analysis.
14 So I would prefer -- I don't strongly
15 disagree with this definition, but I would say it's
16 a formal financial and technical report.
17 MR HO: I understand.
18 Now, for billion dollar projects, a
19 feasibility study will routinely cost in the
20 millions if not tens of millions to produce, won't
21 it?
22 DR FLORES: It would cost millions.
23 I don't know that it would cost tens of millions.
24 MR HO: Really? You don't think it would
25 cost tens of millions?
[Page 64]
1 DR FLORES: It would depend on the scope 10:24
2 of the project for which the feasibility study has
3 been prepared.
4 MR HO: What about for a project costing
5 $3 billion? Would you accept that in that case it's
6 likely to cost in the tens of millions?
7 DR FLORES: No, because, I will give me my
8 answer, we know for a fact that TML prepared a
9 feasibility study and we don't know exactly how much
10 it costs but we know that everything they have spent
11 from 2013 until today, it's about $70 million, and
12 that includes things other than preparing the
13 feasibility study, so if by tens of millions you're
14 talking about $30, $40, $50 million, I think that
15 would be too high. They seem to have been able to
16 prepare a feasibility study for less than that
17 range.
18 MR HO: All right. If we look in the Core
19 Bundle, still volume 4 for you, tab 102, for the
20 rest of us it's R-42, page 247, for you it will be
21 internal page 213, Dr Flores, this is the
22 feasibility study which TML produced. Can you see
23 on page 213 that there is a table there, table 29?
24 DR FLORES: Yes.
25 MR HO: Can you see that? Can you see in
[Page 65]
1 rows 6 and 7, row 6 says "BFS" -- which I understand 10:25
2 to be Bankable Feasibility Studies -- surveys,
3 engineering development and design, and then row 7,
4 independent engineer, bankable -- "BFS" which,
5 again, I understand to be bankable feasibility
6 study, and if we add those two numbers together that
7 gets us to about 40 million.
8 DR FLORES: Yes.
9 MR HO: Does that sound about right to you
10 as the cost of the feasibility study?
11 DR FLORES: Without seeing more detail
12 I cannot tell you an answer, because this says --
13 you see the heading of this table says "Non
14 Financial Development Costs Until COD".
15 I don't know if they have their own
16 definition here of COD.
17 MR HO: I don't know, but if it's not
18 something you can help us with, that's very fair,
19 Dr Flores. I just wanted to put it to you.
20 Let's come back to talking about
21 feasibility studies in general.
22 So, since the whole point of a feasibility
23 study is to determine whether a project is capable
24 of being developed at sufficient returns, in the
25 real world financiers and investors will invariably
[Page 66]
1 use a feasibility study as a basis for a DCF 10:27
2 analysis, won't they?
3 DR FLORES: Could you repeat the last part
4 of the sentence?
5 MR HO: Yes. What I'm saying to you is
6 because the whole point of a feasibility study is to
7 determine whether a project can be developed at a
8 sufficient return, in the real world financiers and
9 investors will use a feasibility study as a basis
10 for a DCF analysis, won't they?
11 DR FLORES: I'm not sure I follow like why
12 the feasibility study as a basis for the DCF. In
13 fact, there may be a DCF in the feasibility study.
14 So I'm not sure the causation -- which comes first,
15 the feasibility study or the DCF?
16 MR HO: It's probably my fault for the way
17 I'm putting the question.
18 But would you then agree with me that the
19 inputs for a DCF are routinely taken from
20 feasibility studies because feasibility studies
21 provide you with reliable information that you can
22 use for a DCF analysis?
23 DR FLORES: I don't know necessarily
24 I would agree with the word "reliable". I would
25 think a feasibility study and a DCF are necessary
[Page 67]
1 conditions to obtaining financing, but they are not 10:28
2 sufficient conditions.
3 To put it in other words, I have never
4 seen a feasibility study that says actually we've
5 run a DCF and this is not profitable. The
6 feasibility studies will always show a positive
7 number. However, there's many, many feasibility
8 studies that they are not developed and they don't
9 result in an actual project being built. That's why
10 I say necessary but not sufficient.
11 MR HO: Yes. I mean it may depend on the
12 quality of the feasibility study, of course. If the
13 feasibility study is produced by reliable
14 consultants, they will invariably produce inputs
15 that are themselves reasonable and reliable.
16 DR FLORES: Not necessarily. Unlike --
17 remember before when I was talking about the
18 independent auditor auditing or commenting on the
19 financial statements of a company? That has certain
20 requirements. It has to be an independent. You
21 cannot have anyone at the company saying, yes, my
22 financial statements are great.
23 However, that's not the case with
24 feasibility studies. You do hire external
25 consultants to do a feasibility study, but they
[Page 68]
1 don't have any duty to be independent from the 10:29
2 sponsor of the project, and in fact, many
3 feasibility studies are clear that they're relying
4 on assumptions and premises provided by the sponsor
5 of the project.
6 So if the assumptions by the sponsor are
7 optimistic, the results of the feasibility study
8 will also be optimistic. That's why the bank or the
9 financier will have to come and come with his or her
10 own army of technical and financial people to say do
11 we agree or do we disagree with them.
12 MR HO: Would you agree with me, though,
13 that there's no incentive for the project owner to
14 present a misleading or unreliable picture to
15 financiers in a feasibility study because that will
16 only dissuade them from providing finance once
17 they've conducted due diligence, as you've just
18 explained they inevitably will?
19 DR FLORES: What two words did you use at
20 the beginning of the incentive?
21 MR HO: That there's no incentive.
22 DR FLORES: Incentive to what?
23 MR HO: For the project owners to present
24 a misleading or unreliable picture.
25 DR FLORES: I don't think they would want
[Page 69]
1 to intentionally be misleading, but without being 10:31
2 misleading you can be very optimistic. By nature,
3 people that like to be in this industry of
4 developing like big projects, they are eternal
5 optimists and they're always trying to tell you
6 please invest in my company, it's the best thing
7 since sliced bread was invented. And, yes, they are
8 optimistic. I think they believe what they say, but
9 I don't think everyone will agree with their very
10 optimistic assessments. So it's not about being
11 misleading; it's about understanding the dynamics of
12 the market. The people that are drawn to these kind
13 of businesses, they are marketing ideas.
14 MR HO: I understand.
15 Can I ask you some questions now about
16 some of the views in your second report?
17 Your second report contains your views of
18 the coal industry in Mozambique and demand for
19 Mozambican coal, and that was written on the 24th
20 of November, 2021, wasn't it?
21 DR FLORES: Correct. Or a few days
22 before.
23 MR HO: That was, of course, before
24 Russia's invasion of Ukraine, wasn't it?
25 DR FLORES: Yes.
[Page 70]
1 MR HO: And Russia's invasion of Ukraine 10:32
2 has had an enormous effect on the global energy
3 market, hasn't it?
4 DR FLORES: I would say it has created a
5 huge distortion of a temporary effect -- or
6 temporary nature.
7 MR HO: Well, you say it's of a temporary
8 nature. How do you know that it's going to be of a
9 temporary nature? Surely it depends on how long the
10 conflict goes on for?
11 DR FLORES: No, it does not.
12 MR HO: And why is that?
13 DR FLORES: Because -- look, I'll give you
14 a real life example.
15 When the invasions happened earlier this
16 year the prices of commodities -- coal, gas --
17 spiked as they hadn't in many, many years, and I
18 remember reading articles that said, look, this
19 winter is going to be horrible in Europe. There's
20 going to be electricity rationing, and very much the
21 lights in the streets will be dark. I just came
22 from Paris yesterday, and I can tell you Paris is as
23 bright as ever. And what has happened is that after
24 the initial surprise and the initial shock, economic
25 agents adapt, and even though gas from Russia is not
[Page 71]
1 coming to Western Europe as much as it was, what's 10:33
2 happening not too far from here in southern
3 Portugal, you have LNG terminals. The LNG terminals
4 here, in Spain, in the rest of the Mediterranean,
5 are working overdrive to bring liquefied natural gas
6 from the United States, and that has helped lower
7 the price of natural gas and has helped decrease the
8 need for coal use in energy plants, in power plants.
9 MR HO: Yes, in Western Europe, but not
10 necessarily in Africa or in India or in Asia or in
11 the Middle East, where environmental standards are
12 perhaps lower and the use of cheaper fuel like coal
13 is very much a priority now that Russian coal is not
14 so readily available. And Russian gas.
15 DR FLORES: But this -- if you want more
16 coal tomorrow and you have a German company that was
17 operating a coal plant and it was supposed to go out
18 of business by the end of this year and now it's
19 being extended by another 12 months or 18 months,
20 yes, that may cause a spike in prices, because then
21 what you may have is that now the Germans are
22 demanding more coal than they would have, and you
23 have the people from, let's say, India still
24 demanding the same amount of coal, so that creates a
25 spike in prices, but that's only a temporary spike.
[Page 72]
1 Remember, even if the decision were to be made today 10:35
2 to build this project that the Claimants want to
3 say, in the most optimistic of scenarios you
4 wouldn't have coal being transported at the earliest
5 in five years. Do you really believe that in five
6 years you still will have these lingering effects of
7 the Ukrainian invasion? No. The world will have
8 adapted.
9 MR HO: Are you aware of what the current
10 coal future prices are?
11 DR FLORES: I wasn't. I read what
12 Mr Sequeira said, that by December 2026 they're
13 expected to be high. I think that's what he said,
14 no?
15 MR HO: That's right. I think the
16 projection is they will be at something like $160 a
17 ton.
18 DR FLORES: Yes. And now are you telling
19 me that that would justify putting $3 billion in the
20 ground in Mozambique for coal that would not even be
21 available in December 2026? In fact, it's funny
22 that he uses that source because in other
23 arbitrations that we work on, futures -- that's why
24 he said December 2026 because there's no futures
25 traded after that date, but there are forecasts that
[Page 73]
1 are more longer term. One that we use very 10:36
2 frequently in arbitration is one published by
3 Consensus Economics in London. The latest forecast
4 of them, they show that by 20 -- that by the end of
5 this decade coal prices would be 75 per cent lower
6 than they are today.
7 So if you own a coal mine today, happy
8 you, because, yes, you can make more money today,
9 but you need to have the mine and the railway
10 operating today. What has been happening this year
11 as a result of the Ukrainian invasion does not
12 change the economics of investing in a project, a
13 30-year project, for which the first coal will not
14 be available until four, five, six, seven years from
15 today.
16 A short-term disruption, no financier
17 would use that to make a crazy decision to invest in
18 something that has no future.
19 MR HO: All I'm putting to you is you say
20 that the market shift is temporary, but if coal
21 future prices four years out from now are $160 a
22 ton, the futures market doesn't seem to suggest that
23 the shift is temporary, does it?
24 DR FLORES: The futures market tends to be
25 more and more unreliable the further out you go in
[Page 74]
1 time. The futures market for one month out, two 10:38
2 months out is widely used in the markets. Why?
3 Because there's a lot of people trading and selling
4 futures for two or three months ahead.
5 When you're talking the futures
6 for December 2026, that's like four years from now,
7 those are very thinly traded futures contracts, so
8 it means that the price is not really very
9 revealing, and you can see historically that the
10 very long-term, the three years out future prices
11 have very little predictive ability.
12 MR HO: In the months following the
13 Russian invasion, do you agree with me that India
14 was dealing with a domestic coal shortage?
15 DR FLORES: In the months immediately
16 following, yes.
17 MR HO: And, as a result, there was
18 renewed interest in Mozambican coal in India, wasn't
19 there?
20 DR FLORES: I'm not aware of that.
21 MR HO: And are you aware that there was
22 in fact a massive increase in the export to India of
23 Mozambican coal?
24 DR FLORES: That may well be true but,
25 again, this is a short-term phenomenon, and that
[Page 75]
1 coal came from existing mines that were 10:39
2 under-utilised, but what I have seen no news
3 whatsoever -- and I don't think there is any -- is
4 of now suddenly new mines being developed in
5 Mozambique. That's not happening. So, as I said
6 before, if you have an existing mine, given this
7 temporary disruption that's creating higher prices,
8 then yes, you can take advantage of that, but this
9 renewed interest is not causing suddenly people to
10 want to open new mines in Mozambique that would
11 require a commitment of billions of dollars for
12 decades into the future.
13 MR HO: And are you aware that, following
14 the invasion, there was a significant increase in
15 production from the very mines which would have been
16 serviced by the project?
17 DR FLORES: Yes, and that's fully
18 consistent with what I am telling you. In the short
19 term you're going to have existing mines and
20 existing infrastructure that can be used, will be
21 used, but that will not make suddenly financiers
22 want to finance brand new what we call greenfield
23 projects that will not be available for half a
24 decade when all of this will be in the history.
25 MR HO: But would you agree with me that
[Page 76]
1 if, in fact, you're wrong that the market 10:40
2 adjustments are not temporary, if in fact, because
3 of the invasion, developing nations choose to build
4 more coal-fired power stations, then the market
5 dynamics will change not just in the short term but
6 in the medium and long term as well?
7 DR FLORES: So are you asking me to make
8 an assumption? A hypothetical?
9 MR HO: Yes, I am. Yes, I'm asking you to
10 make a hypothetical.
11 DR FLORES: So you're asking me to assume
12 that coal will continue to be used for ever at very
13 high prices? Then my answer is yes, coal will be
14 used for ever at very high prices, but that's a
15 circular argument that has no basis in reality.
16 MR HO: All right. Let's look at some of
17 the detail of the DCF model together.
18 The first thing I want to talk about with
19 you is the tariffs that are used in the DCF model.
20 Now, you have suggested that Secretariat's
21 use of the feasibility study's tariff figures is
22 inappropriate because it ignores the downward
23 pressure on transportation tariffs due to
24 competition with existing logistics corridors. Do
25 you remember that?
[Page 77]
1 DR FLORES: Could you refresh my memory by 10:41
2 pointing me to the relevant paragraph?
3 MR HO: Well, I'm happy to represent it to
4 you, and then we'll see it.
5 Let me show you how Secretariat have
6 responded to what you've said. We can see that in
7 paragraph 122 of Secretariat's second report, that's
8 at internal page 54, and for those of us following
9 electronically it's CER-5, page 54 of the pdf.
10 Do you have paragraph 122 there?
11 DR FLORES: Yes.
12 MR HO: And we can see that they say,
13 "Dr Flores states that we ignored downward pressure
14 on transportation tariffs due to competition with
15 existing logistics corridors, which may 'lead to a
16 short-term reduction in tariffs'", and then there's
17 a citation to your report.
18 "Dr Flores ignores the fact that the rail
19 tariffs for the project are already 47 per cent and
20 49-72 per cent lower than the rail tariffs for the
21 Sena-Beira corridor and NLC, respectively ...
22 Therefore, we consider that there is very limited
23 risk of downward pressure on tariffs from other
24 corridors in this case. Indeed, we consider the
25 opposite view is more reasonable when compared to
[Page 78]
1 the existing corridors". 10:43
2 Now, you've not disputed those figures in
3 your second report, have you? You've not disputed
4 the figures in the second sentence that the rail
5 tariffs are already 47 and 49-72 per cent lower,
6 have you?
7 DR FLORES: I would need to refresh my
8 recollection. Can I look at my --
9 MR HO: Yes. I think you'll find it on
10 paragraph 88, internal page 35 for you. And all I'm
11 putting to you is you have not disputed in your
12 second report the figures that we see in the second
13 sentence, have you?
14 DR FLORES: Well, I want to make sure.
15 MR HO: OK, yes.
16 DR FLORES: And you are referring me to
17 which paragraph?
18 MR HO: Well, I think paragraph 88 is
19 where you respond to this bit of Secretariat's
20 second report, but obviously I leave it to you to
21 tell me if you have disputed these figures somewhere
22 else.
23 DR FLORES: I was looking at the wrong
24 report, sorry.
25 MR HO: Don't worry.
[Page 79]
1 DR FLORES: Yes, in paragraph 88 I do 10:44
2 think I disagree with his conclusion.
3 MR HO: I'm sorry. All I'm putting to you
4 is that you haven't disputed the figures in the
5 second sentence of Secretariat's second report,
6 paragraph 122. I understand you disagree with the
7 conclusion, and we'll come to that in a moment, but
8 we're just taking it in stages.
9 You haven't disputed those figures in your
10 second report, have you?
11 DR FLORES: I don't recall exactly.
12 I mean, I know he's not taking -- if I recall
13 correctly, when he estimates the tariffs for the
14 Beira corridor and the Nacala corridor he is not
15 using numbers from public sources, I believe. I
16 think he's using estimates or he's doing some
17 calculations, and I think I do mention that
18 somewhere in the reports, that he's just making
19 estimates and not actual published numbers.
20 MR HO: I'm afraid I don't accept that
21 that's right, Dr Flores, but if it matters we'll
22 come back to it.
23 Let's see what you have disputed. We can
24 see that, as I say, in paragraph 88 of your second
25 report. That's RER-9, page 36 for those following
[Page 80]
1 electronically, and for you it should be page 35. 10:46
2 Do you have that?
3 DR FLORES: Yes.
4 MR HO: And we can see that the point that
5 you've made is you say "[Secretariat] ignores the
6 fact that if the project would have indeed offered
7 its services at lower prices, competitors would have
8 reacted, resulting in uncertainty on whether the
9 project would have been able to secure the volumes
10 of transported coal assumed by [Secretariat]." Do
11 you see that? And that's the basis on which you
12 dispute what they say.
13 DR FLORES: Yes.
14 MR HO: Now, you say "competitors would
15 have reacted", but as we can see from paragraph 88
16 you've not actually conducted any factual
17 investigations or analysis as to whether competitors
18 would have been able to react and, if so, how, have
19 you?
20 DR FLORES: I mean I have described that
21 in my presentation, the dynamics of competition and
22 how it works that for an existing operation, you
23 don't even need to be profitable. What you need is
24 to just be able to cover your variable costs.
25 MR HO: But you haven't attempted to
[Page 81]
1 analyse whether, even if you only cover your 10:47
2 variable costs, that would mean the competitors were
3 able to offer a tariff lower than that proposed to
4 be offered by the project in the ex post DCF model,
5 have you?
6 DR FLORES: I don't have a quantitative
7 analysis, but that's a very sound economic
8 principle, that the more competitors you add, the
9 more the forces to depress prices will be, and
10 that's my only point here to make, that that
11 increases the speculative nature of the DCF
12 assumptions.
13 MR HO: But that only is true if
14 competitors can reduce their rates to the same
15 levels that the new market entrant is proposing, and
16 as we can see from the figures that, as I say, you
17 haven't disputed, there's a considerable degree of
18 headroom, isn't there?
19 DR FLORES: You just said I haven't
20 disputed. That's to be checked when we review the
21 entirety of the reports.
22 MR HO: I'm happy for you to do the check
23 now. Where do you think you dispute them?
24 DR FLORES: I'm happy to look at it. I
25 remember having seen that those were not actual
[Page 82]
1 numbers -- 10:48
2 MR HO: I see.
3 DR FLORES: They were estimates.
4 MR HO: So that's the only basis on which
5 you're disputing them?
6 DR FLORES: Yes, that the 49 to 72
7 per cent range, if my recollection is correct, is a
8 calculation that Versant makes. It's not that the
9 owners of these other corridors have come up and
10 said yes, our cost is this much per ton. It's an
11 estimate, not a hard number.
12 MR HO: All right. We'll come back to
13 that.
14 Can I move now to look at the operating
15 and maintenance costs that underpin the ex post DCF,
16 and the figures for those costs have come from the
17 feasibility study as updated in July 2017, haven't
18 they?
19 DR FLORES: Yes.
20 MR HO: So let's have a look at the
21 feasibility study. You can see that in Core Bundle
22 volume 4, which I think you have. It's at tab 102.
23 What I'd like you to do is can you turn to the first
24 page of the 2015 feasibility study. For those of us
25 in electronic it's R-42, page 20.
[Page 83]
1 DR FLORES: The 2015 is at the back? 10:50
2 MR HO: No, it should be about 20 pages
3 in. We've got it on the screen for you so you know
4 what you're looking for.
5 DR FLORES: Yes.
6 MR HO: You have that. So the page on the
7 left-hand side for you, what we have on the screen
8 for everyone else, is the covering page of the
9 feasibility study, yes?
10 DR FLORES: Yes.
11 MR HO: We can see in the middle that it
12 was prepared by ITD?
13 DR FLORES: Yes.
14 MR HO: And then we can see it was
15 prepared in co-operation with three other companies?
16 DR FLORES: Yes.
17 MR HO: Now, what do you know about the
18 China Railway Construction Corporation group?
19 DR FLORES: I don't know what you mean by
20 what do I know.
21 MR HO: Well, what can you tell me about
22 them?
23 DR FLORES: It's a Chinese company. I
24 think it's State-owned. It works in construction of
25 railways.
[Page 84]
1 MR HO: Did you know that in 2014 it was 10:50
2 the second largest construction engineering company
3 in the world by revenue?
4 DR FLORES: I may have seen that data
5 point. I didn't have it committed to memory.
6 MR HO: And are you aware of any of the
7 projects which the China Railway Construction
8 Corporation group has built?
9 DR FLORES: I think I have seen that
10 information. I don't have it committed to memory.
11 MR HO: Do you remember that they've built
12 around two-thirds of all the railways in China?
13 DR FLORES: The same answer as before.
14 MR HO: All right. And is the fact that
15 you don't have much of a feel for the China Railway
16 Construction Group because you don't have very much
17 expertise in the infrastructure industry?
18 DR FLORES: I would disagree with the
19 first part of your answer of I don't have much of a
20 feel. It's -- what I told you is that I don't have
21 this data committed to memory. There's only so much
22 one can have in his head, even if you have a big
23 head. I don't think that was central to the
24 preparation of the reports, so that's why I don't
25 have it now memorised.
[Page 85]
1 MR HO: And what can you tell me about the 10:52
2 second company, the China Railway First Survey and
3 Design Institute?
4 DR FLORES: I would tell you the same
5 answers as the first.
6 MR HO: Which is you don't know anything
7 about them or you can't remember anything about
8 them?
9 DR FLORES: It's what I told you before,
10 which is I may have seen information about these
11 companies which I do not have committed to memory
12 today.
13 MR HO: Let me see if I can remind you.
14 Do you recall that, as at December '15,
15 they had led the design and construction of over
16 48,000 kilometres of railways in western China?
17 DR FLORES: No, I did not have that
18 recollection today.
19 MR HO: All right. Similarly, can I just
20 ask you about the third company? Do you remember
21 anything about them?
22 DR FLORES: I do not have the specifics
23 about how many kilometres in western or eastern
24 China they had developed. I have not committed that
25 to memory.
[Page 86]
1 MR HO: Do you accept, though, that the 10:53
2 feasibility study was prepared with the assistance
3 of some extremely experienced and well known Chinese
4 infrastructure companies?
5 DR FLORES: Yes, I do not dispute that
6 these are well known and experienced railway
7 construction companies.
8 MR HO: And the whole point of using such
9 well known and experienced companies is to provide
10 banks and lenders comfort that the feasibility study
11 has been prepared properly and accurately?
12 DR FLORES: Again, we go back to the line
13 of questions from some minutes ago. If you see the
14 cover page, this feasibility study was prepared by
15 Italian-Thai Development Public Company Ltd. ITD.
16 This is the company that prepared the report. They
17 take final responsibility, and when they go to the
18 banks, the bank will say who prepared this? Like,
19 we prepared it. They are the ones that respond for
20 that. And then they say "in co-operation with", so
21 they get assistance from these Chinese companies but
22 that doesn't mean that they take full ownership or
23 full responsibility, or that they have independently
24 arrived at any number that's within this document.
25 It is that they have provided inputs to the company
[Page 87]
1 that prepared the feasibility study, which is ITD. 10:54
2 MR HO: Yes. But the whole reason why ITD
3 on the very first page identifies the very
4 experienced Chinese companies that have assisted
5 them preparing the report is because they want to
6 give lenders and financiers comfort that the report
7 is based on proper expert analysis. Would you
8 agree?
9 DR FLORES: It goes back to the answer
10 I gave before about necessary but not sufficient.
11 Of course, it's good to have the co-operation of
12 specialised companies that will provide data,
13 information, and assistance, and, of course, a bank
14 would prefer to receive a feasibility study that has
15 the co-operation of these companies than a
16 feasibility study that does not, but having those
17 names there does not mean that you take this --
18 like, what, 200, 250 pages, you bind it nicely, you
19 give it to the bankers and the bank says, yes,
20 here's your cheque, $3 billion. It does not mean
21 that. It has never meant that.
22 MR HO: I think you'd obviously accept
23 that the three Chinese companies that we've just
24 been talking about have far more knowledge than you
25 do about the likely costs of operating and
[Page 88]
1 maintaining the project. 10:55
2 DR FLORES: Yes. I don't know how to
3 answer that.
4 MR HO: Why don't you know how to answer
5 that?
6 DR FLORES: Because I do not know did the
7 level of knowledge that these companies had with the
8 specific issues in Mozambique, did they rely on TML,
9 the subsidiary based in Mozambique, to provide them
10 with certain information. Because they can be very
11 well respected companies, but if their
12 specialisation is building railways in western
13 China, they may make some broad assumptions but they
14 may lack specialised knowledge about the reality in
15 the ground in Mozambique.
16 I do not know how much studying they did
17 of the on-the-ground reality in Mozambique, and
18 that's why I cannot give you an answer.
19 MR HO: All I was putting to you was you
20 must accept that those companies have far more
21 knowledge than you do about the likely costs of
22 operating and maintaining the project?
23 DR FLORES: Again, I don't know how to
24 answer that question.
25 MR HO: Mr President, we've been going for
[Page 89]
1 about an hour and a half now. Is that a convenient 10:57
2 moment for a break?
3 PRESIDENT: I was going to propose that,
4 at some convenient stage, we should break.
5 How long do you still have to go?
6 MR HO: I would say about an hour. The
7 hope is in total I would be about two hours.
8 PRESIDENT: Very good. It's now 10.57, so
9 let's come back at 11.15, and of course Dr Flores,
10 you know the rules.
11
(Short break from 10.57 am to 11.18 am)
12 PRESIDENT: Very good. We resume the
13 hearing. Mr Ho, you have the floor.
14 MR HO: Thank you, Mr President.
15 Just to come back to a point we were on
16 before the break, you remember we were talking about
17 tariffs and you had a recollection at least that
18 Secretariat's exercise of comparing how much lower
19 the project tariffs were with the Sena-Beira and
20 Nacala corridors was based on assumptions about what
21 the Sena-Beira corridor and Nacala corridor were
22 charging. Do you remember that?
23 DR FLORES: Yes.
24 MR HO: I just want to show you that
25 they're based on actuals. If we look first of all
[Page 90]
1 in your direct presentation at slide 8, you see 11:19
2 there you have your diagram which shows the cost of,
3 amongst other things, Mozambique coal, do you see
4 that?
5 DR FLORES: Yes.
6 MR HO: And the first two elements are the
7 first element in the darkest red is land transport
8 and then the second element is port.
9 DR FLORES: Yes.
10 MR HO: So if you add those two together
11 you get $51.
12 DR FLORES: Yes.
13 MR HO: That, on my understanding, is the
14 actual tariff charged for the Beira corridor, and
15 that comes I think from the Wood Mackenzie report,
16 so that's an actual figure. Do you have any basis
17 for disagreeing with that?
18 DR FLORES: If you want to show me, I can
19 confirm. I don't recall one way or the other.
20 MR HO: But this is a table that you're
21 relying on in your direct presentation and I believe
22 in your reports. You aren't able, though, to
23 confirm to us now that that's an actual figure for
24 Beira?
25 DR FLORES: This is Wood Mackenzie's
[Page 91]
1 compilation for Mozambique. I assume it has to be 11:20
2 an average of different operations because not all
3 the mines are in the same location.
4 MR HO: Well, my understanding is that
5 it's an actual for Beira, but we'll leave it there.
6 Can I show you now for Nacala? If we go to C-88 --
7 we don't have that, I'm afraid, printed out for you,
8 but you'll be able to see it on the screen -- what
9 this is, Dr Flores, to explain, is this is the
10 annual report for Vale for the fiscal year ended
11 31 December 2019 that they filed with the SEC. Can
12 you see that?
13 DR FLORES: Yes.
14 MR HO: If we turn on -- now, just to
15 explain what I'm going to show you, there isn't in
16 this document a statement that the tariff for Nacala
17 is a particular number. What there is, though, is
18 an explanation of what the total revenue generated
19 from Nacala is and what the total coal throughput
20 is, and if you divide one by the other that
21 inevitably gets you to the tariff.
22 Would you accept that as a proposition?
23 DR FLORES: You can show it to me.
24 MR HO: All right. Let's see, first of
25 all, the total revenue. If we go on in this to page
[Page 92]
1 257, can you see -- yes, if you just stop there. 11:22
2 Can you see there's a table which is
3 for December 31, 2019 at the top of the --
4 DR FLORES: Yes.
5 MR HO: And can you see underneath that
6 date it says "Nacala Corridor Holdings"?
7 DR FLORES: Yes.
8 MR HO: And then if you scroll down in the
9 bottom of that column to the penultimate row, can
10 you see the number 782?
11 DR FLORES: Yes.
12 MR HO: And that is 782 million is the net
13 revenue from the Nacala corridor. Do you see that?
14 DR FLORES: Million US dollars?
15 MR HO: Yes, I believe so.
16 DR FLORES: Could we check to be sure?
17 MR HO: I'm happy to represent that to
18 you, Dr Flores.
19 DR FLORES: OK.
20 MR HO: OK. So that is the net revenue.
21 What I'm now going to show you is the total coal
22 throughput and we can see that on page 104.
23 Again, just to save time, I will represent
24 to you that what is being discussed here is the coal
25 throughput at Nacala.
[Page 93]
1 Can you see there's the column headed 11:23
2 "2019", "Year ended December 31, 2019"?
3 DR FLORES: Yes.
4 MR HO: And then if we scroll down in that
5 column can you see there's a line "Thermal coal and
6 metallurgical coal"?
7 DR FLORES: Yes.
8 MR HO: I'm going to, as I say, represent
9 to you that those are the throughput amounts for
10 Nacala. And can you see there's the numbers 4356
11 and 4427?
12 DR FLORES: I see but why do you need to
13 represent that to me? Can't we just see it in the
14 document?
15 MR HO: I'm just trying to save time us
16 flicking through this document, but don't worry
17 about that, Dr Flores. If I'm wrong about that,
18 someone will correct me later.
19 What I want is to put the proposition to
20 you that if you divide the total revenue figure that
21 we saw a moment ago by the total coal throughput
22 figures, which are here, you will get a tariff of
23 $89 and that's an actual figure that reflects the
24 tariff at Nacala?
25 DR FLORES: But the revenue was only
[Page 94]
1 revenue for coal? Or also revenue for the iron, 11:24
2 pellets, manganese?
3 MR HO: I'm so sorry. I didn't hear all
4 of that.
5 DR FLORES: Here you're showing volumes of
6 different products. Iron, pellets, manganese,
7 ferrous minerals, coal and base metals.
8 MR HO: Correct.
9 DR FLORES: So there are many different
10 products.
11 MR HO: Correct. And I'm asking you to
12 focus on the lines for thermal coal and
13 metallurgical coal, and I'm representing to you that
14 those volumes come only from Nacala. So if we want
15 to know the throughput for Nacala only, we just add
16 those two numbers together.
17 What I'm putting to you is this is the
18 exercise which Secretariat has done. They have used
19 these actual numbers in order to calculate a tariff
20 at Nacala and have therefore compared an actual, not
21 an estimate, as you were suggesting you had
22 recalled?
23 DR FLORES: I'm sorry, but I would
24 calculate these as an estimate. This is not
25 management of the subsidiary in Mozambique saying
[Page 95]
1 this is our tariff, this is our average tariff. 11:25
2 This is numbers you are pulling from an
3 F20 document, which is a filing for the entirety of
4 Vale.
5 MR HO: Right. But if these numbers only
6 relate to Nacala, then I think you would accept that
7 they are valid figures? Actuals?
8 DR FLORES: No, I -- I mean the definition
9 of an estimate is a number that you estimate because
10 you don't have the real figure. When you start
11 dividing things, that's not the actual number.
12 MR HO: I'm sorry, I don't really
13 understand that as a proposition. If you have two
14 actual numbers and you divide those, you will get an
15 actual output.
16 If I have the -- if I can tell you what
17 the actual total revenue is and the actual total
18 coal throughput, and I divide revenue by coal
19 throughput, I will get the actual tariff. There's
20 no estimate involved.
21 DR FLORES: No, you would get an average
22 that we would need to do -- so I would need to see
23 how these numbers have been calculated.
24 MR HO: All right. Very well.
25 Let's move on to talk about capex in the
[Page 96]
1 ex post DCF model, and that, unfortunately, requires 11:26
2 me to try and pronounce Professor Flyvbjerg's name,
3 I think. So far as capital costs are concerned you
4 have relied on some articles written by I think it's
5 Professor Flyvbjerg concerning cost overruns on what
6 he refers to as megaprojects, haven't you?
7 DR FLORES: Yes.
8 MR HO: And you have in particular
9 highlighted that Professor Flyvbjerg has concluded
10 based on cost overrun estimates for 58 rail projects
11 that the average cost overrun is 44.7 per cent. I
12 think we saw that in your direct this morning.
13 DR FLORES: Yes.
14 MR HO: And that data originates from a
15 2002 study from Professor Flyvbjerg, doesn't it?
16 DR FLORES: I don't recall the exact year
17 but it is early in the century. We can check the
18 number -- the year if you want.
19 MR HO: Do you agree with me that
20 Professor Flyvbjerg's data from that 2002 study is
21 limited because, first, it does not contain much, if
22 any, data from private as opposed to public
23 projects?
24 DR FLORES: I don't recall exactly the
25 split between private and public projects.
[Page 97]
1 MR HO: And do you also accept that it's 11:28
2 limited because it doesn't analyse the cost overruns
3 of different kinds of rail projects separately but
4 lumps all rail projects together?
5 DR FLORES: You started your question
6 saying "you also accept" -- I did not.
7 MR HO: I said "do" you also accept. I'm
8 asking. Do you also accept that
9 Professor Flyvbjerg's data is limited.
10 DR FLORES: But I did not accept the prior
11 question so when you say "also" you are implying
12 that I accepted the prior question. I did not
13 accept.
14 MR HO: I'm sorry. You're quite right to
15 pick me up then, Dr Flores.
16 I am sorry, just to be clear, then, you're
17 not accepting that the data is limited because it's
18 mostly from public projects, not private projects?
19 DR FLORES: You can read my prior answer.
20 PRESIDENT: Let's -- Dr Flores, let's try
21 to be --
22 DR FLORES: It's the answer I gave before.
23 PRESIDENT: You need to answer. Let's
24 keep the flow going.
25 DR FLORES: Yes. My answer before was I
[Page 98]
1 do not recall the split between private and public 11:29
2 sponsored projects.
3 MR HO: Do you also believe that the data
4 is limited, because it includes comparatively few
5 projects outside of Europe and North America?
6 DR FLORES: The sample did have more
7 projects in Europe and -- Europe and America, yes.
8 MR HO: Yes, North America. So you accept
9 it's limited because it doesn't have very many
10 projects from outside of those regions?
11 DR FLORES: That is correct, yes.
12 MR HO: And do you accept that it reveals
13 in fact very little about the likely cost overrun of
14 a private conventional rail project in Mozambique?
15 DR FLORES: Conventional as opposed to
16 what?
17 MR HO: As opposed to high speed rail,
18 rail with tunnels, metro rail?
19 DR FLORES: Yes, the average, it is what
20 it is. It's based on a number of actual projects,
21 and the conclusion is that most of them experience
22 cost overruns.
23 MR HO: I'm sorry, I don't think that
24 answered my question.
25 My question was do you accept that the
[Page 99]
data reveals very little about the likely cost
overruns of a private conventional rail project in
Mozambique?
DR FLORES: First, I'm not sure about that
characterisation of "private". I don't know if this
is a settled matter that this would be a private
project. I understood it was to be a concession
where government and the private sector would be
co-operating.
MR HO: Well, it's not a project that is
majority owned by the government, is it? It's going
to be a project that is majority owned by a private
individual who will be the Builder Owner Operator.
It's not a project like -- well, to use an English
example like High Speed Rail 2, which is a
government-funded project to build a railway from
London to the north of England.
DR FLORES: OK, if you define "private"
that way, then fine.
PRESIDENT: But the question, Dr Flores,
was the following, whether the sample takes other
construction projects which are in developed
countries and for sophisticated rail projects, and
whether that sample -- or the conclusions from that
sample can be extrapolated to conventional rail for
[Page 100]
mining operations in Mozambique. That is the
question of counsel.
DR FLORES: Yes, and I think the answer is
yes, it can be extrapolated.
It's true that it's based on a sample
that's not identical to the project we want to
analyse, but I also am not relying on that figure
from the Professor about the 44.7 per cent.
What I'm saying is that you only need a
cost overrun of 22 per cent, which is less than half
of what he estimates based on his sample, and
already the project is worth nothing. That's my
point. That generically you see cost overruns in
any kind of industries when you build them, and
that's universal throughout the world and you don't
need -- so if I have done the analysis, you get to
the project being NPV worthless. Once you rely on
the Professor's 44 per cent estimate then I could
see the value of this line of questions, but you
don't need that. With a 22 per cent cost overrun,
it's already worth nothing.
MR HO: Mr President, the 2002 study was
one of those documents that we wanted to add late to
the record, and I think what the Tribunal ruled was
that we could discuss or ask questions about them
[Page 101]
but we could only show them if the testimony
contradicts what's in them.
I think given where we've got to with
Dr Flores not accepting, as I understand it anyway,
that private projects are different and not included
in the data set, may I please show him that part of
the study?
PRESIDENT: Mr Brown, do you have any
problem?
MR BROWN: Mr President, I actually do
think that the line of questions had explored
Dr Flores' answer to this already quite completely,
but I don't have any particular problem if the
document wants to be shown.
PRESIDENT: Thank you. Thank you,
Mr Brown. That's appreciated.
Let's then -- it's H-12. So we
incorporate this document as H-12.
MR HO: So it's H-12. You may also have
it -- never mind. I thought you might have it
electronically already, but you don't.
Oh, you do have a copy there. Thank you.
Does everybody -- do you have a copy on your side?
MR BROWN: I do, thank you.
MR HO: OK, good.
[Page 102]
Now, Dr Flores, I don't want to go through
the whole study with you so I will just represent to
you that this is the 2002 study where the figures
that you relied on come from, so this is where the
58 rail cases with a cost overspend of 44.7 per cent
come from. What I want to show you is what is said
on page 5.
The pages are in the top right-hand
corner. There's a paragraph that begins "Finally".
Can you see that?
DR FLORES: Yes, I can see it.
MR HO: And so what Professor Flyvbjerg
says is, "Finally, we want to emphasise that
although the project sample used in this study is
the largest of its kind, it is still too small to
allow more than a few sub divisions, if comparative
statistical analyses must still be possible.
Therefore, in further work on understanding cost
underestimation, the sample should be enlarged to
better represent different types of projects in
different geographical locations. As to project
types, data for more private projects would be
particularly useful in allowing statistically valid
comparisons between public and private sector
projects. Such comparisons do not exist today, and
[Page 103]
nobody knows whether private projects perform better
or worse than public ones regarding cost
underestimation".
So what I want to put to you is, as
Professor Flyvbjerg says, nobody knows whether
private projects perform better or worse than public
ones, do they?
DR FLORES: This is what this sentence
says.
MR HO: So the data in this study which
you've relied on is inadequate to tell us anything
about the likely cost overruns in private projects,
isn't it?
DR FLORES: No, I do not think it is.
I mean first, to set the record straight, it's my
first time seeing this article, so if you want I can
spend a few minutes reading it. I assume you are
reading to me from the introduction, so early on in
the paper, right? I mean it would be nice to read
the entire paper, see what it says.
But what he's saying is that nobody knows
whether they're higher or lower, so there is not the
presumption that, well, the private projects
definitely must be lower. The private projects may
be higher. He just says he doesn't know.
[Page 104]
MR HO: That's absolutely true, and what
I'm putting to you is you are the one that has
relied on data from this study.
DR FLORES: No, I did not rely on
44.7 per cent. I did not rely on data. I relied on
the point, the qualitative point, that when you
build something very large, it's very likely that
you're going to have cost overruns. I do not care
about the 44.7.
What if the study is done and then it
shows that, well, for the private sector it's
actually 31 per cent cost overrun. That doesn't
change my analysis, which is you cannot do a
reliable analysis when just a 22 per cent cost
overrun in capex destroys the profitability of the
project. That's the main point. I don't rely and I
don't need to rely on a specific quantification. He
is talking in this paragraph that you led me to
about statistically significant analysis, right?
MR HO: It's on page 5.
DR FLORES: Yes, page 5. He talks about
statistically valid comparisons, so if you want to
do numerical assessments, then yes, more information
would be always welcome, but the qualitative point
that you cannot do a reliable DCF when just a 22
[Page 105]
per cent cost overrun kills the project, that
I stand with and it's not contradicted with this.
MR HO: But you've not referred to any
analysis or evidence which shows that cost overruns
are likely in private projects, have you? The only
thing you relied on was Professor Flyvbjerg, and
we've just seen that he doesn't deal with private
projects.
DR FLORES: He deals with all projects,
I believe. He hasn't done a separate study of
private versus public.
MR HO: Dr Flores, let's be fair. He says
"as to project types, data for more private projects
would be particularly useful", and he says "nobody
knows whether private projects" --
DR FLORES: No, no.
MR HO: -- "perform better or worse than
public ones".
DR FLORES: Sorry. You didn't read the
whole sentence. "The data for more private projects
would be particularly useful in allowing
statistically valid comparisons". He's not saying
that he doesn't have any private; he's saying that
to do statistical analysis, rigorous statistical
analysis, it could be good to have more of the two
[Page 106]
types. He's not saying that his sample doesn't
contain any private sector projects at all.
MR HO: But I think you'd agree with me
that, if the data doesn't contain enough samples to
do a statistically rigorous analysis, it's not a
very useful data set?
DR FLORES: Statistically valid
comparisons, because the idea -- so there's two
questions you might want to ask. One question is
like, are there cost overruns when you build
megaprojects. A different question is, like, is
there a difference in the magnitude of the cost
overrun between private and public sector. These
are two separate research questions.
What I read this paragraph to, without the
benefit of having read the entire paper, is that
he's saying for the second research question to do a
comparative analysis that is statistically
significant of difference between private and
public, more data would be needed, but that this
does not disqualify the point that, overall, cost
overruns do happen.
MR HO: I'll maybe just show you one more
thing in this document, if I may.
If we turn to page 39 at the very end, can
[Page 107]
you see that table 1?
DR FLORES: Yes.
MR HO: And do you see in the first row,
"Rail", we have the figures that you were referring
to. We have the number of cases, 58, and then
average cost escalation, 44.7 per cent. Do you see
that?
DR FLORES: Yes.
MR HO: That was what was in your report.
If we turn over the page to page 40, we
have a breakdown of that row, and it's broken out
into Europe, North America, and Other Geographical
Areas. Do you see that?
DR FLORES: Yes.
MR HO: And in "Other Geographical Areas"
there are only 16 projects.
DR FLORES: Yes.
MR HO: And we don't have any idea if any
of those are private projects, do we? It doesn't
say from the table here.
DR FLORES: In this table it does not say.
MR HO: And we don't know what type of
rail projects they are either, whether they're
conventional or metro or high speed and so on?
DR FLORES: It doesn't say.
[Page 108]
MR HO: And there's no explanation of
where in the world these other 16 projects are in
this table, does it? It's just other geographical
areas?
DR FLORES: In this table it doesn't say.
MR HO: We can also see there's a standard
deviation of 49.5, do you see that?
DR FLORES: Where? Yes.
MR HO: Thank you.
So this small data set -- I'm sorry, I
think we seem to have lost -- so this small data set
contains a very wide range of values, doesn't it,
because it has quite a high standard deviation of
49.5?
DR FLORES: It depends how you define it.
The standard deviation is slightly higher than for
the other ones but also the average is higher. So
if we were to look at the standard error, where you
divide the average by the standard deviation, I'm
not sure it would be particularly more dispersed in
relative terms than for North America and for
Europe.
MR HO: Do you accept that the fact that
the standard deviation is high makes it difficult to
extrapolate anything about projects generally when
[Page 109]
the range of values in a small data set is so large?
DR FLORES: I mean in general, when you
have a sample, you're always going to have a
standard deviation so no, I would not accept that as
a general proposition. You do have standard
deviations. Then you need to make a comparison to
see whether the sample is still -- whether it has a
central tendency that's meaningful or it is not.
MR HO: All right. Can we move on now to
look at some issues concerning the ex post DCF
discount rates together? So we can get rid of that.
Just to put this discussion in context,
having calculated all the cash flows over the
lifetime of a project, those cash flows are
discounted back to the valuation date in order to
give a value for the project as at a specific date,
aren't they?
DR FLORES: Yes.
MR HO: And in order to do that
discounting, which is essentially a mathematical
exercise, one needs to have produced a discount
rate.
DR FLORES: Yes.
MR HO: And the discount rate is typically
made up of a number of components, and I think some
[Page 110]
of those are in dispute between you and Secretariat,
is that fair?
DR FLORES: Yes.
MR HO: I think the areas of disagreement
are equity risk premium, country risk premium, pre
operational risk premium and additional risk
premium, so we will look at some of those together.
Can I start with equity risk premium? And
just to put the debate in simple terms, it's right,
isn't it, that the higher the equity risk premium,
the higher the discount rate will be and therefore
the smaller the value of the project?
DR FLORES: That is correct.
MR HO: And you've used an equity risk
premium of 7.25 per cent, haven't you?
DR FLORES: I don't remember the decimals.
MR HO: If you want help, it's page 81 of
your second report, paragraph 226.
DR FLORES: Yes.
MR HO: So let's see where that comes
from. If we could go, please, to QE-96, page 2, and
that for you, Dr Flores, is Core Bundle volume 4. I
think it may be the one in front of you, tab 109.
DR FLORES: No, I don't have 109 here.
PRESIDENT: Give me a second to catch up
[Page 111]
with you. Yes. Equity risk premium. And you want
me now to go to QE-96?
MR HO: Do you have it, Mr President?
DR FLORES: Yes, Duff & Phelps.
MR HO: Duff & Phelps, that's right.
PRESIDENT: Very good. I'm with you.
Sorry for the --
MR HO: No, no, not at all.
So this is a document prepared by
Duff & Phelps, and it provides their guidance on a
suitable equity risk premium, doesn't it?
DR FLORES: It's their analysis of equity
risk premium.
MR HO: And if we look on the first page,
page 2 of the pdf, you can see there that there's
Exhibit 3.1, and we can see that's headed ERP
guidance as of 31st December 2020.
Do you see that?
DR FLORES: Yes.
MR HO: And then in that exhibit, we can
see the 7.25 per cent figure you've used, which is
described as "Long-term Historical".
DR FLORES: Yes.
MR HO: And then below that we have
"Duff & Phelps Recommended", which is 5.5 per cent.
[Page 112]
DR FLORES: Yes.
MR HO: So, self-evidently, the
7.25 per cent you've used is not the figure which
Duff & Phelps themselves actually recommend, is it?
DR FLORES: That's correct, but to
clarify, the equity risk premium has to be added to
the risk-free rate, so for a company that has a beta
parameter of 1 you would sum the two components,
like equity risk premium plus risk-free rate.
Now, it's true I use a higher equity risk
premium than the one Duff & Phelps recommend, but
they recommend a higher risk-free rate than
I recommend, so that's -- you need to do the sum of
the two components because I do not use the same
risk-free rate that they use. They use a higher
one. That's why they recommend a lower equity,
otherwise they would be overestimating. I don't
know if that was clear or not.
MR HO: I have followed what you were
saying, so you and I at least are together.
DR FLORES: Good.
MR HO: If we go over to the next page, we
can start to see why --
DR FLORES: Hold on. Just to make sure,
you see the sentence that says -- the paragraph
[Page 113]
below the table there's a sentence that begins with
"This". "This recommendation is to be used in
conjunction with a normalised risk-free rate of 2.5
per cent implying a base US cost of capital of 8",
meaning 5.5 plus 2.5. That's what I was referring
to. So you need to look -- the two estimates need
to be consistent.
MR HO: Yes. I think you use a risk-free
rate of 2 per cent.
DR FLORES: Correct.
MR HO: So in total you would be using an
equity risk premium of 9.25 per cent, whereas
Duff & Phelps would recommend a total equity risk
premium of 8 per cent?
DR FLORES: If the beta was one, yes, but
if the beta is higher than one or lower than one it
would be --
PRESIDENT: Can you speak into the
microphone?
DR FLORES: Sorry. Yes, it would
depend on -- that would be the only case if the beta
parameter was equal to one.
MR HO: Let's see why Duff & Phelps don't
use the 7.25 per cent figure. We can see that if we
go over to the next page, and can you see two-thirds
[Page 114]
down the page there's the heading "Realised
Historical Stock and Bond Returns"?
DR FLORES: Yes.
MR HO: Now, just before we start looking
at the detail I just want to confirm with you in
broad terms what this is about. So one way to
estimate an equity risk premium is by looking at
historic stock and bond returns, isn't it?
DR FLORES: Yes.
MR HO: And the actual returns earned on
stocks over a long period of time are estimated, and
they're compared to the actual returns on a default
free security like a government bond?
DR FLORES: In general terms, yes.
MR HO: And then the difference on an
annual basis between the two returns is calculated,
and that is used as the historical equity risk
premium?
DR FLORES: Yes.
MR HO: And it shows you how much more in
percentage terms one would need to earn to make it
worthwhile to invest in equities as opposed to a
risk-free government security?
DR FLORES: Yes.
MR HO: So, against that background, we
[Page 115]
can just go on, then, to page 4, and we can see
there the Exhibit 3.4, and that's headed "Realised
Equity Risk Premiums", and that table encapsulates
the results of the basic exercise which we've just
been discussing over different time periods, doesn't
it?
DR FLORES: Yes.
MR HO: And if we look at the first
column, Length, at the 95 year length period, which
is the period between 1926 and 2020, we see in the
arithmetic average column the 7.25 per cent figure
you've used, yes?
DR FLORES: Yes.
MR HO: So your figure for ERP comes from
comparing, in every year from 1926 to 2020, the
difference in return between actual stock market
returns and US government bonds?
DR FLORES: Yes, and just to clarify why
1926, that's when you have the first point in which
you have reliable -- I think it's weekly data
continuously since that point until the present.
There's these additional rows in the table that go
back to 1900 and the 1800s and the 1700s. Those are
based on estimates. Those are not -- because the
data collection mechanisms were not as good in
[Page 116]
earlier centuries, so that's why no one uses those.
People sometimes want to use shorter
periods but, going earlier than 1926, it's good for
academic studies but it's not used in any actual
valuations.
MR HO: And if we then look further down
this page, we see the heading "World War II Interest
Rate Bias". Do you see that?
DR FLORES: Yes.
MR HO: Under that it says "Some observers
have suggested that the period including the 1940s
and the immediate post World War II boom years may
have exhibited unusually high average realised
return premiums due to the Fed's intervention in the
bond markets to control interest rates. We consider
the years 1942 through 1951 particularly problematic
as they reflected a period of government-imposed
stability in US government bond yields. During
World War II the US Treasury department (the
Treasury) decreed that interest rates had to be kept
at artificially low levels in order to reduce
government financing costs. This led to the
Fed's April 1942 public commitment to maintain
interest rates at prescribed levels on US government
debt, both long-term and short-term".
[Page 117]
So what is being said there that the
post-war period the US Treasury deliberately kept
the return on US Government debt artificially low,
didn't they?
DR FLORES: Yes, but the funny thing, if
you look at footnote 3, that comes from a study, the
United States in the 1940s from a paper The Journal
of Economic History from 1992. It's interesting.
Everything they say up until the 1940s you could
apply to the last ten years. The Federal Reserve in
the United States until very recently this year has
done exactly that. They have kept interest rates at
artificially low levels. So history has a way to
repeat itself, and that's why people, including
Professor Damodaran, say people do use the
historical average because you never know what's
going to happen in the future. If you look an
average of the last hundred years, chances are
you're going to capture things that will happen
again in the next hundred years. That's the
rationale for using the arithmetic average of
historical returns.
You can see in paragraph 228 of my second
report Professor Damodaran says "In the standard
approach ... historical returns are used".
[Page 118]
MR HO: Yes, well, this is a document
prepared by Duff & Phelps in 2020, so they're well
aware of events since the credit crunch, but they
still describe the use of the years 1942 to 1951 as
particularly problematic, don't they?
DR FLORES: Yes, based on a paper
published in 1992.
MR HO: And what it means is, if you use
data from that period to calculate equity risk
premium, you will end up with an artificially higher
ERP because when you minus the returns on government
bonds from stock market returns in those years,
you're using the artificially low returns which the
Treasury created, aren't you?
DR FLORES: But I do not agree that that's
an artificial ERP. As I told you, the experience
between 2008 and 2021 has been also artificially low
returns on government debt, so are we to exclude the
last 15 years of data? No. These have been actual
events that have happened, and trillions of dollars
have been transacted based on those low levels of
government interest rates.
So that's my point. It's like at some
point interest rates are going to be very high and
at some point interest rates are going to be very
[Page 119]
low. If you want to do a DCF valuation, you have to
take into account both possibilities. You cannot
eliminate the possibility that the European Central
Bank, the Federal Reserve of the US, the Japanese
Central Bank -- that at some point they will think
that for economic, financial, political reasons
interest rates have to be kept low.
MR HO: Well, let's just turn over the
page. We can see the significance of this point in
Exhibit 3.5. Can you see that if you exclude the
years 1942 to 1951, the risk premium drops to 6.26
per cent?
DR FLORES: Yes. Mathematically it is
correct.
MR HO: And then at the bottom of the page
we see the heading "Concluding on an ERP", do you
see that?
DR FLORES: Yes.
MR HO: And it says "What is a reasonable
estimate of the unconditional or long-term average
ERP for the US as of December 31, 2020? Valuation
is a forward-looking concept, not an exercise in
mechanical application of formulas. Correct
valuation methodology requires applying value
drivers reflected in today's market pricing. We
[Page 120]
need to mimic the market. In our experience, you
often cannot match current market pricing for
equities using the post-1925 historical arithmetic
average of one-year realised premiums as the basis
for developing discount rates".
So would you accept that Duff & Phelps'
advice is that valuation analysis -- I'm sorry.
Would you accept that Duff & Phelps'
advice is that valuation analysts cannot simply use
the long-term historical ERP as you have done?
DR FLORES: That's their opinion, yes.
I accept that that's what they opined. That doesn't
take away from the fact that many other valuation
practitioners, including myself, do apply and they
continue to apply the arithmetic historical average
of risk premium.
MR HO: In fact, as we see on the last
page of this document, we can see there Exhibit 3.7,
Duff & Phelps have summarised a number of ways of
calculating ERP, haven't they?
DR FLORES: Yes.
MR HO: And one of the ways they rely on
is Professor Damodaran's implied ERP, do you see
that?
DR FLORES: Yes.
[Page 121]
MR HO: And that is a reference to
Professor Damodaran's analysis which Secretariat
have relied on but which I understand you suggest is
excluded from consideration?
DR FLORES: Yes. Yes. I do not agree
with that methodology that he uses.
MR HO: So Duff & Phelps, whose numbers
you have relied on, they advocate using Professor
Damodaran as a source as well, and I put it to you
that you're simply wrong to ignore his analysis.
DR FLORES: You put it to me?
MR HO: Yes.
DR FLORES: What am I to do?
MR HO: Well, to respond if you agree or
disagree.
DR FLORES: No, I do not agree with you.
MR HO: All right.
DR FLORES: Do you want me to explain or
not?
MR HO: No, that's fine.
Would you accept that using the
7.25 per cent figure which Duff & Phelps calculate
is supported by no one, including Duff & Phelps
themselves?
DR FLORES: No, I do not accept that. In
[Page 122]
fact, look at paragraph 228 of my second report.
There I have an underlined sentence that Damodaran
himself says the historical premiums -- he
recognises that in the standard approach they are
used, and people use them and continue to use them,
so I'm not alone in using the historical arithmetic
approach.
MR HO: But Professor Damodaran's view is
that historical average premiums are in fact poor
predictors of the correct equity risk premium.
DR FLORES: The problem is that no one
knows what the correct equity risk premium is. No
one knows. And the way he does his implied thing is
he does a DCF of the US stock market, and he tries
to guess what the dividends that the US stock market
would yield, and the capital appreciation under a
bunch of assumptions.
Then he discounts that and says, well,
that means that the equity risk premium must be
4 per cent or 5 per cent. That academically is an
interesting exercise but doesn't have any more
grounding because, if you start changing the
assumptions he uses in forecasting what the yields
in the US stock market will be in the next decade,
if you change those assumptions, then his equity
[Page 123]
risk premium changes.
So that's why I do not think that's a
method that can be used.
MR HO: Yes, but what I'm saying to you is
that Professor Damodaran does not support the use of
historical average premiums, does he? His view is
that they are poor predictors of the correct equity
risk premium.
DR FLORES: Professor Damodaran recognises
that they are used in the marketplace, and I'm
trying to replicate not an academic exercise, I'm
trying to replicate how real investors in the real
world calculate discount rates.
MR HO: I'll just try once more. He
recognises that they are used but his view is that
they are poor predictors of the correct ERP.
DR FLORES: And I'll say what I said
before, that he can say the correct ERP. No one
knows the correct ERP. We know what the yield of
the ten-year Treasury bond is, you can just go and
search on your phones. That's an actual number
because there's thousands of people buying and
selling US government bonds they tell you exactly
with several decimal points what the yield of the
Treasuries is, there's no comparable source where
[Page 124]
you can get the right, the correct equity risk
premium. It's an estimate that you use in the
capital asset pricing model. It's all estimates.
Just to be clear, this would be a very
fruitful discussion, a very necessary discussion, if
we were in a case in which the termination of the
discount rate was essential to arrive at the right
damages number, but if you want -- for the purposes
of this hearing and this case --
MR HO: I'm so sorry to interrupt you but
we're quite short of time and I think we're now
straying outside an answer to my question.
DR FLORES: I would like to finish the
sentence -- very briefly.
PRESIDENT: Very briefly.
DR FLORES: I'm willing to concede and
accept the equity risk premium that they want
because, as I show you in slide 30, it doesn't
matter. You don't need to accept the way I usually
calculate discount rates. You only need to add a
little bit more to Mr Sequeira's discount rate and
the value evaporates. That's a key point for the
purposes of whether the DCF is reliable here or not.
I don't need to convince you of every
single point on the ingredients of the discount
[Page 125]
rate. You only need to do the sensitivity that if a
reasonable investor would have added 1 or 2 per cent
points to the discount rate that Mr Sequeira
calculates, no value.
MR HO: Thank you.
Can we move on now to look at the next
element of the discount rate which is in dispute,
and that's the country risk premium. In short, that
is an additional factor that you add to the discount
rate to reflect the risks of investing in a
particular country, isn't it?
DR FLORES: Yes, compared to a country
like the US or Germany.
MR HO: Yes.
So one of the points of disagreement
between you and Secretariat concerns an estimate of
the CRP for Mozambique from a report prepared by
Professor Fernandez. We can see that at C-299.
It's Core Bundle volume 3, tab 74. It should be tab
74, I hope.
Could we have a time check?
MS JALLES: Of course. Claimant has used
so far 1 hour and 27 minutes.
MR HO: Thank you.
So do you have that now, Dr Flores?
[Page 126]
DR FLORES: Yes.
PRESIDENT: Can I just say that Professor
Fernandez and myself, we are not relatives. It
happens. As with Mr Patel and the Claimants, it's a
very normal name in Spain.
MR HO: That's very disappointing,
Mr President. I was hoping there would be extra
credit for us!
So this is a copy of the report and, as we
see below the title, it's prepared by Professor
Fernandez, who's a professor of Finance at the IESE
Business School in Barcelona.
If we just turn on in this report to page
9, it's internal page 9 and page 9 of the pdf, we
can see this is not Professor Fernandez' first time
preparing a survey report like this on market risk
premiums for particular countries, can't we? He's
conducted a survey every year since 2020, is that
right?
DR FLORES: Yes, and in the interests of
disclosure, I'm one of the recipients, or one of the
participants in the survey.
MR HO: Right.
So Professor Fernandez has over a decade's
worth of experience conducting surveys like this,
[Page 127]
doesn't he?
DR FLORES: Yes. He does that every year.
MR HO: And I think you, by contrast, have
never performed a survey like this, have you?
DR FLORES: No, I haven't.
MR HO: So I think it's fair to say that,
between the two of you, Professor Fernandez has far
greater experience in conducting surveys like this
and analysing the results?
DR FLORES: Yes, because he conducts the
survey every year. He sends an email with a series
of questions. If I have time, I answer. If I don't
have time I don't answer. He's very -- if you delay
yourself a week, you are out. You need to respond
within a week when he sends it. So yes, he has a
nice mailing list. He sends the e-mail. You reply;
you don't reply. He has the experience of doing
that. More than experience I think he has a very
nice mailing list of valuation practitioners.
MR HO: Yes. If we go back to page 2 in
the report, you can see that below table 1 --
DR FLORES: Just -- if you go to -- you
see he has 15,000 e-mail addresses that he sends and
about 1600 people replied, so it's about 1 in 10,
more or less. My suggestion to him would be if he
[Page 128]
would give us a month instead of a week, maybe more
people would reply.
PRESIDENT: No one would reply because
everyone would forget! He knows what he does.
MR HO: Yes. So you can see there that
there's table 1 in the middle of the page and below
it it says "Table 2 contains the statistics of the
MRP used in 2021 for 88 countries. We got answers
for 92 countries, but we only report the results for
88 countries with more than 6 answers".
So where Professor Fernandez received less
than six answers, he excluded that country from the
report on the basis of insufficient data, didn't he?
DR FLORES: Yes.
MR HO: If we go onto the next page at the
very bottom, Table 2, at the very bottom we can see
Mozambique and he receives ten answers in the 2021
survey, didn't he?
DR FLORES: Yes.
MR HO: Now, you've not referred, in
either of your reports, to any academic analysis
which suggests that a sample size of ten responses
is inadequate for the purposes of a survey about
country risk premium, have you?
DR FLORES: I have not. I don't think
[Page 129]
that such an analysis exists, but if you go to the
top of the table, you'll see that there's countries
like the US -- if you can scroll up a little bit?
MR HO: Yes. Can you scroll up?
DR FLORES: Right. Look at that. US,
1700 people respond. No one would dispute that that
is a meaningful, like, number when you have so many
people replying. Spain, because his mailing list
includes a lot of professors and practitioners in
Spain, also has a lot of respondents, but once you
start straying away from the biggest countries, then
you get very few responses.
And one thing you can see from year to
year is that those countries at the bottom of the
table appear and disappear because one year you get
five responses, it doesn't appear, the other year
you get eight responses and then it appears in the
table, so clearly you are at a much less reliable
sample than when you have hundreds of responses.
MR HO: I think just to be clear, the
table is in alphabetical order except for the USA
and Spain that we see at the top, so you can see for
example that Italy has 65 and Jamaica has 9 and
Japan has 29, so it's not a table organised by
responses.
[Page 130]
DR FLORES: I did not mean bottom of the
table --
MR HO: I see. I'm sorry.
DR FLORES: Bottom from more responses to
fewer responses.
MR HO: I understand what you mean.
Now, you've not referred to any market
practice which suggests that a sample size of ten
responses is inadequate for the purposes of a survey
about country risk premium either, have you?
DR FLORES: I have -- yes, I have not
referred to that because I am not aware that it
exists.
MR HO: Now, would you accept that, given
the relative experience between yourself, who has
never conducted a survey like this, and Professor
Fernandez, who has over a decade's worth of
experience, the reality is that there's no good
reason why Professor Fernandez's assessment of what
an adequate sample size is should be ignored in
favour of your view?
DR FLORES: Well, yes, I think there are
good reasons, and I think his experience in
conducting these surveys does not extend necessarily
to a good empirical determination or if six is the
[Page 131]
right number or not. I actually -- I will ask him
the next time I talk to him why did he choose six.
It's a good question. I would have chosen a higher
number, and he does not explain in his annual papers
whether he did any economic analysis or statistical
analysis to put this boundary of six.
I will ask him and when I get this answer
I will e-mail it to you.
MR HO: We can see in the table that the
average country risk premium for Mozambique is 10.7,
and the next column is the median of the responses,
and that's a figure of 10.8 per cent. Do you see
that?
DR FLORES: Yes.
MR HO: If the median is close to the
average, that means the data contains limited
outliers, doesn't it?
DR FLORES: Yes.
MR HO: So the majority of the responses
are all around the average figure?
DR FLORES: Yes.
MR HO: This, therefore, is a case where
the majority of the respondents have selected about
the same figure and that increases confidence that
it's a reliable and accurate figure, doesn't it?
[Page 132]
DR FLORES: No, and I give you a country
example. Say that I'm working in arbitration where
it's very important to get this number, and
I receive the survey and I forward it to ten of my
colleagues at Quadrant, and because we all think
alike we all say 20 per cent and we are the only ten
respondents because nobody else has provided an
estimate -- well, let's not say Mozambique, let's
say Swaziland, and there's only ten respondents, and
the ten respondents are colleagues of mine and we
all have said the same number. You're going to get
a very well defined with very little variation
because we all have said the same number. But
that's the danger.
When you have very few respondents, you
don't know whether there can be some manipulation of
the other. Where you have hundreds of respondents,
manipulation will be much, much more difficult, so
that's why you have to be very careful. The fact
that there's not much variation doesn't tell you
much.
PRESIDENT: I wonder whether that is so
easy because I think the survey must be started by
Professor Fernandez, so you would have to get your
20 -- to do the manipulation, you have first to
[Page 133]
manipulate Professor Fernandez to include the 20 in
his database.
DR FLORES: No, because there's a sentence
at the bottom that says please feel free to forward
this to any of your colleagues. So that's -- it is
a -- I think it's nice that he does this exercise.
It does provide a lot of qualitative comments.
There's a line you can type whatever you think about
what would be the right number and so on, but it is
not a well defined survey in which you get like 20
per cent has to be from academic world, 20 per cent
from investment banking, 20 per cent from
practitioners like me.
It's not like that. It's an open-ended
survey that anyone who replies, within the week --
within the one week -- then that would get included.
PROFESSOR TAWIL: Mr Flores, but you don't
have any element to indicate there was manipulation.
DR FLORES: No.
PROFESSOR TAWIL: This is a theoretical
projection.
DR FLORES: Absolutely, yes, there is no
basis whatsoever, but the possibility of that
happening is higher when you have responses of, yes,
like six, ten, 15.
[Page 134]
PROFESSOR TAWIL: But that could happen
with any number in any survey you see. I mean,
unless you have 1800 answers or 2,000 answers. But
I mean you don't know, reading any survey, I mean if
there was a manipulation.
DR FLORES: No, correct. I don't know.
But, for example, when you have Germany 287 at the
very top of what's being displayed now, it would be
much harder to provide agreed upon answers than when
you have ten, 12, nine.
PROFESSOR TAWIL: Understood.
DR FLORES: But I'm not making any
allegation that anyone has manipulated anything.
PROFESSOR TAWIL: Thanks.
MR HO: Thank you. Let's move on to next
area of disagreement on discount rate, and that
concerns the pre operational risk premium and in
particular the duration over which that applies.
So, just to set the scene, Secretariat's
position is that a 2 per cent pre operational risk
premium to account for things like a delay in
construction starting should apply during the
construction period, but you say that the 2 per cent
pre operational risk premium should apply generally.
Is that fair?
[Page 135]
DR FLORES: To be clear, in the first
estimation of the discount rate they did not apply
any pre operational risk. I did apply it, and then
in response Mr Sequeira agreed with me, but only
partially.
MR HO: That's fine, and I'm just
identifying what the current area of disagreement is
and, as I understand it, the current area of
disagreement is Secretariat say apply it until the
project is operational; you say apply it throughout
the lifetime of the project. Is that right?
DR FLORES: Correct.
MR HO: And let's see, I think the basis
for you suggesting that it should apply throughout
the lifetime of the project is a study by Atias and
Bancel, and we can see that at QE-55, page 2, or in
Core Bundle, volume 4, at tab 104.
DR FLORES: By the way, the basis is not
this source that you're showing. Your question said
the basis for applying it throughout the life. I'm
not basing that on this. I'm basing it on basic
economic principles.
MR HO: Well, let's just look, then, at
paragraph 220. If you just keep that open, could
you look at paragraph 220 of your second report?
[Page 136]
DR FLORES: Yes.
MR HO: Or actually, so we're clear, let's
just pick it up at 219, that's on page 78,
I believe.
So in paragraph 219 you say, "Versant" --
that's Secretariat -- "disagrees on how the 2
per cent operational premium should be accounted for
in the discount rate. According to Versant, after
the project is built, it ceases to be pre
operational, hence the premium should be applied to
the construction period only".
And then you go to 220, you say:
"Versant's methodology is in contrast with the study
by Atias and Brancel.
So I had understood you to be saying that
Secretariat are wrong in their approach because it
is inconsistent with what is suggested by Atias and
Brancel. Is that right?
DR FLORES: No, just to be clear.
I attach Atias and Bancel to my first report for the
proposition that an estimate of pre operational risk
is 2 per cent.
Then Versant accepts that source for the 2
per cent. So even though they said, well, that
2 per cent was a credit for the renewal energy
[Page 137]
industry, here we're not talking about renewable
energy, that is true, but he still goes with the 2
per cent, Mr Sequeira, so there is no more dispute
about the magnitude of the adjustment. 2 per cent.
We are on the same page. But then he says yes, but
I'm only going to apply it for the first five years,
and then I say no, you have to apply it, as I said
in my first report, for the duration of the project.
MR HO: Yes. And the reason for that is
because you rely on this study by Atias and Brancel?
DR FLORES: No. No, no, no. I rely on
that study for quantifying the magnitude, which is 2
per cent.
MR HO: Right. So, just so we're clear,
my understanding is that Secretariat do not accept
the 2 per cent from the Atias and Brancel study.
They simply say we agree that a 2 per cent pre
operational risk premium should be applied, but
they're not taking that from the study. They're
saying that, because it's to reflect things like
construction risks, it only applies until the
project is operational.
Now, you are saying -- at least I had
understood you to be saying -- that you take the
2 per cent from the Atias and Brancel study and you
[Page 138]
apply it, as Atias and Brancel suggest, over the
lifetime of the project because this is to reflect
the risk of a greenfield project.
But have I misunderstood you?
DR FLORES: Yes. Yes. First, if they
don't take the 2 per cent from the same source
I took it, where are they taking it from? They're
not providing any other source that would support 2
per cent than the one I added, which is the Atias
and Brancel paper, so they are agreeing with my
quantification, which is 2 per cent.
For the second point, I don't need the
paper from Atias and Brancel because, let's think
about that. Why do we apply a pre operational risk
premium to the discount rate? Because we're trying
to assess from the point of view of today, the
valuation date, what are the risks involved in the
cash flows that I have projected for the future.
So let's say it's a 30 year project.
Let's look at the risk associated with the cash flow
in ten years from now when the project will be
operative. I say that I do the DCF projection, and
I say I'm going to receive free cash flow from year
ten in the amount of $1 million, and I need to
assess the value of that $1 million ten years from
[Page 139]
1 now into these terms.
2 What do you think is more risky? If this
3 $1 million that I'm forecasting is for a company
4 that today is in operation? Or whether I'm
5 forecasting a cash flow ten years from now for a
6 company that I'm assuming that ten years from now
7 will be in operation, but today doesn't even exist?
8 Even though I'm making the assumption for ten years
9 from now that the company will be in existence then,
10 the company, it's less certain that the company will
11 make it to year ten. It may never make it to year
12 ten.
13 That's why the cash flow that I'm
14 projecting for a company that is not operating today
15 has to be higher risk and, hence, higher discount
16 rate. That's where the premium applies to the
17 entire projection, not just the three years when you
18 think that the projects will be built. Otherwise,
19 you would be overestimating the value of cash flows
20 that are more risky, because you didn't even know
21 whether the company will actually be taken to
22 operation stage.
23 MR HO: So you apply a 2 per cent figure
24 to reflect the fact that the company may never be
25 operational, and that's why it applies over the
[Page 140]
1 lifetime of the project?
2 DR FLORES: Exactly.
3 MR HO: But, ex hypothesi, if the project
4 is forecast to be operational in the model, I don't
5 then understand why you apply a discount rate to
6 assume it won't be.
7 DR FLORES: Well, because you can make the
8 assumption, but an assumption doesn't give you
9 certainty.
10 MR HO: Right. And how is this risk not
11 encapsulated by any of the other factors in the
12 discount rate?
13 DR FLORES: Because these other factors
14 already apply to firms that today are operating.
15 MR HO: Right. I understand.
16 So your 2 per cent -- so you do at least
17 rely on the study for the 2 per cent figure, so I
18 think it's probably then just worth us having a look
19 at the study together so we can understand it a bit
20 more.
21 So do you still have that with you? I
22 think it's behind that tab. Yes. So everyone has
23 it, it's QE-55, Core Bundle volume 4, tab 104.
24 So let's see what this says, and we can
25 pick it up about halfway down the page. I'm sorry,
[Page 141]
1 more like a quarter of the way down the page.
2 Do you see there's a paragraph which says
3 "In a recent research we asked whether factoring in
4 a specific greenfield risk would be justifiable for
5 projects"? Do you see where I'm reading from,
6 Dr Flores?
7 DR FLORES: Yes.
8 MR HO: "Would be justifiable for projects
9 involving the construction of new infrastructure.
10 In order to answer this question we sought to
11 establish whether companies specialising in
12 greenfield projects were perceived as being more
13 risky than companies in the same sector that did not
14 invest in this type of project. If this is the
15 case, and all other things being equal, greenfield
16 companies should have a higher weighted average cost
17 of capital than others. Assuming that investors are
18 diversified and only pay the systematic risk, the
19 beta of greenfield companies should be higher than
20 companies that only replace or upgrade existing
21 assets".
22 So what the authors were investigating is
23 whether investors view greenfield companies as
24 riskier investments, and their theory was that if
25 they did, then all other things being equal, those
[Page 142]
1 greenfield companies should have a higher weighted
2 average cost of capital, is that fair?
3 DR FLORES: Yes.
4 MR HO: And in essence they wanted to
5 compare the weighted average cost of capital of
6 similar greenfield and non greenfield companies to
7 see if they could identify the difference as a
8 greenfield risk?
9 DR FLORES: Yes.
10 MR HO: So let's see how they went about
11 that task.
12 The report continues, "The only sector in
13 which we were able to identify such firms is the
14 energy sector, and, more specifically, the wind farm
15 and energy transportation segments of the energy
16 sector. Firms in these two segments operate in an
17 environment that is homogeneous from a regulatory
18 point of view, regulated prices, et cetera, and
19 their risks are comparable at most levels, with the
20 exception of the greenfield risk".
21 So we can see that this study is focused
22 only on companies in the wind farm and energy
23 transportation segments of the energy sector, can't
24 we?
25 DR FLORES: Yes.
[Page 143]
1 MR HO: Then if we go a little bit further
2 down they explain that they found three wind farm
3 companies and four firms specialising in energy
4 transport. Do you see there's a paragraph "We
5 identified three listed pure players on the wind
6 farm market", and then who those people are, "and
7 four firms active in energy transportation".
8 Do you see?
9 DR FLORES: Yes.
10 MR HO: So, in total, their sample size is
11 seven companies?
12 DR FLORES: Yes.
13 MR HO: And then if we go to the
14 penultimate paragraph we see it says, "There are a
15 lot of limits to this research and it can only be
16 seen as an initial attempt to measure the greenfield
17 risk. Firstly, our results are based on the study
18 of a very small number of listed pure players.
19 Secondly, the construction risk for wind farms is
20 not necessarily comparable to the construction risk
21 of another infrastructure in another sector. For
22 example, the construction of an oil rig is a very
23 different sort of project from that of developing of
24 a wind farm. Whether this risk premium should be
25 generally applied to all greenfield projects is thus
[Page 144]
1 a question worth asking. Finally, there is
2 generally always a wide margin of error when
3 estimating the parameters required for computing the
4 cost of capital".
5 So it's fair to say the authors themselves
6 recognise the study has a lot of limits?
7 DR FLORES: Yes.
8 MR HO: Do you agree?
9 DR FLORES: It's totally fair to say that,
10 yes.
11 MR HO: And one of the limits of the study
12 is the small sample size. We saw a moment ago in
13 the context of the country risk premium, that you
14 thought a sample size of ten was too small, but here
15 we have an even smaller sample size, don't we?
16 DR FLORES: Well, it's not mixed concepts.
17 There we were talking about survey responses. Here
18 we're not talking about survey responses. But
19 I agree, yes. This is I think a very ingenious
20 academic research to do something that everyone
21 understands. It's more risky to invest in a project
22 that doesn't exist than a project that exists,
23 everyone knows that, but how to quantify it is a
24 more difficult question to do, so I think I give a
25 lot of credit to these authors for doing that
[Page 145]
1 research. They say further research will be needed.
2 Absolutely. I don't think this is the last word
3 that will be written on pre operational risk. But
4 we have to give them credit to that.
5 However, the advantage the Tribunal has
6 here is that these authors conclude 2 per cent.
7 I used 2 per cent and Mr Sequeira agrees to use
8 2 per cent, so we're on the same page. The only
9 issue is whether it applies for the entire duration
10 of the cash flow projection, or only for the first
11 few years. That's the only issue remaining.
12 MR HO: I understand but that's why I want
13 to put this to you because we'll be saying something
14 about that in closing.
15 Now, another limit of this study is that
16 it is based on wind farms and energy transportation.
17 It's not an attempt to study what the risk premium
18 would be for infrastructure projects like railways,
19 is it?
20 DR FLORES: It is not, absolutely.
21 MR HO: And we can see from the top of the
22 page that this is a study from September 2009. Can
23 you see that?
24 DR FLORES: Yes.
25 MR HO: So a further limit on this study
[Page 146]
1 is that it's considered conditions over a decade
2 before the valuation date for the ex post DCF?
3 DR FLORES: Yes, I agree with everything
4 you are saying, but the point is that the only thing
5 I took from this paper is a figure, 2 per cent,
6 which is not disputed by Mr Sequeira.
7 MR HO: Yes, but what is disputed is the
8 period over which it applies, and, as I understand
9 it, this project -- this document is suggesting that
10 because there's a greenfield risk, you can apply it
11 over the lifetime of the project.
12 DR FLORES: No, no. I'm not relying on
13 this paper. This paper agrees with me. But even
14 without this paper, I will continue making the same
15 point. It's undeniable that the cash flow
16 projection in year ten is more risky if today the
17 company doesn't exist.
18 MR HO: All right. I think we've looked
19 at that sufficiently.
20 The final point of disagreement on
21 discount rate is whether it's appropriate to add an
22 additional risk premium, either on the basis that
23 we're valuing a small cap company or for
24 illiquidity, and, as I understand it, you are now
25 suggesting that an additional risk premium is
[Page 147]
1 appropriate on the basis of illiquidity, is that
2 right?
3 DR FLORES: To be more precise, it's an
4 additional risk premium to capture everything that's
5 not captured by the capital asset pricing model,
6 which includes illiquidity, it includes size, and it
7 includes also marketing perfections that are not
8 contemplated in a capital asset pricing model.
9 MR HO: Right. All right. Let's look at
10 an article from Professor Damodaran. That's at
11 C-302. It's in Core Bundle volume 3 at tab 76, so
12 it may be in the bundle that you have there.
13 76. Now, while we're getting that,
14 Professor Damodaran is a very well known and
15 respected author on financial valuation, isn't he?
16 DR FLORES: Yes.
17 MR HO: And on page 1, can you see there's
18 the heading "The Basis" at the bottom of the page?
19 It's sort of by the second hole punch.
20 DR FLORES: Yes.
21 MR HO: And here Professor Damodaran
22 identifies the historic rationale for small company
23 premiums, and he says, if we look at the last line
24 in that paragraph, he says: "In summary, looking at
25 returns from 1926 to 2014, the smallest cap stocks
[Page 148]
1 (in the lowest decile) earned 4.33 per cent more
2 than the market, after adjusting for risk. This is
3 the strongest (and perhaps) only evidence and it is
4 reproduced in data services that try to estimate
5 historical risk premiums (Ibbotson, Duff & Phelps,
6 et cetera). This historical premium has become the
7 foundation for both valuation and investment
8 practice".
9 So, in Professor Damodaran's view, the
10 strongest and perhaps only evidence for small cap
11 premium is the historic data, isn't it?
12 DR FLORES: That's what he writes, yes.
13 MR HO: And we see on page 2 --
14 DR FLORES: By the way, I notice that what
15 you have highlighted is the foundation for valuation
16 and investment practice. He's a professor, he's a
17 very well respected academic person. Sometimes he
18 has views that deviate from what actual people do in
19 the actual world, because he's just teaching classes
20 to students. We are trying to value real companies.
21 MR HO: Yes. Well, let's see if he has a
22 good reason for teaching these things to his
23 students.
24 If we see at the bottom of page 2 the
25 heading "The problem with the Historical Premium",
[Page 149]
1 and in this section Professor Damodaran identifies a
2 number of defects with the historic rationale which
3 is said to justify small company premiums, so we'll
4 look at some of those together. The first one on
5 page 3 you can see there's a paragraph 1 and it says
6 "Trend lines and time periods" and what he says is:
7 "Small cap stocks have earned higher returns than
8 large cap stocks between 1928 and 2014 but the
9 premium has been volatile over history, disappearing
10 for decades and reappearing again. While the
11 premium was very strong prior to 1980, it seems to
12 have dissipated since 1981. One reason may be that
13 the small cap premium studies drew attention and
14 investor money to small cap stocks, and in the
15 process led to a repricing of these stocks. Another
16 is that the small cap premium is a side effect of
17 larger macroeconomic variables ... and that the
18 behaviour of those variables has changed since
19 1980".
20 Now, you've not suggested, let alone
21 demonstrated in your reports, that Professor
22 Damodaran's analysis of the historic data in this
23 paragraph is wrong, have you?
24 DR FLORES: No. No, no, I have not.
25 MR HO: And the data shows that between
[Page 150]
1 1981 and 2014, ie over 30 years, there has been no
2 premium attached to small cap shares?
3 DR FLORES: The way he analyses the data,
4 then there's no -- you wouldn't see a premium.
5 However, other people have done other analyses
6 controlling for other factors, and they do see that
7 the premium continues to exist.
8 MR HO: Let's look at number 2. That's
9 headed "Microcap, not small cap premium".
10 It says, "Microcap, not small cap premium"
11 -- are you with me, Dr Flores?
12 DR FLORES: Yes.
13 MR HO: "Even over the long time period
14 that provides the strongest support for existence of
15 a small cap premium, one study finds that removing
16 stocks with less than $5 million in market cap
17 causes the small firm effect to vanish. In effect,
18 what you have is microcap premium, isolated in the
19 smallest of stocks, not just small stocks".
20 What I want to ask you is you again have
21 not suggested, or let alone demonstrated in your
22 reports, that that analysis is wrong, have you?
23 DR FLORES: No, I have not done that in my
24 report.
25 MR HO: We'll look at just one more
[Page 151]
1 together. If we go over the page to page 4, can you
2 see at the top there's a paragraph 4, "The January
3 effect". What he says is, "One of the most puzzling
4 aspects of the small cap premium is that almost all
5 of it is earned in one month of the year, January,
6 and removing that month makes it disappear. So
7 what? If your argument for the small cap premium is
8 that small cap stocks are riskier, you now have the
9 onus of explaining why that risk shows up only in
10 the first month of every year".
11 And you have not picked up Professor
12 Damodaran's challenge and explained in your reports
13 why the small cap premium only appears in January,
14 have you?
15 DR FLORES: No. There's plenty of papers
16 that have rebutted this idea of the January effect.
17 I did not include them in my report.
18 MR HO: Now if we move on in the document
19 to page 6, you'll see towards the top of the page
20 there's the heading "The illiquidity fig leaf", and
21 what Professor Damodaran is doing here is dealing
22 with the suggestion that the small cap premium can
23 be justified as a proxy for illiquidity, and what he
24 says is "Looking at the data, the only argument
25 left, as I see it, for the use of the small cap
[Page 152]
1 premium is as a premium for illiquidity, and even on
2 that basis it fails at one of these four levels".
3 I just want to look at some of those with
4 you. Let's take the second one. What he says is:
5 "If illiquidity is what you are adjusting for in the
6 small cap premium, why is it a constant across
7 companies, buyers and time? Even if your defence is
8 that the small cap premium is an imperfect (but
9 reasonable) measure of the illiquidity premium, it
10 is unreasonable to expect it to be the same for
11 every company. Thus, even if you are valuing just
12 privately owned businesses (where illiquidity is a
13 clear and present danger), that illiquidity should
14 be greater in some businesses than in others and the
15 illiquidity (or small cap) premium should be larger
16 for the former than the latter. Furthermore, the
17 premium you add to the discount rate should be
18 higher in some periods ... than others and for some
19 buyers ... than others ...".
20 Now, what I want to ask you is you've made
21 no attempt to tailor the small cap premium which you
22 now say is a proxy for an illiquidity premium to the
23 specific business market sector and time period, the
24 subject of the ex post DCF, have you?
25 DR FLORES: I have not.
[Page 153]
1 MR HO: We'll just look at one more point.
2 The third point: "Even if you can argue that
3 illiquidity is your rationale for the small cap
4 premium and that it is the same across companies,
5 why is it not changing over the time horizon of your
6 valuation ...? In any valuation, you assume through
7 your company's cash flows and growth rates that your
8 company will change over time and it is inconsistent
9 (with your own narrative) to lock in an illiquidity
10 premium into your discount rate that does not change
11 as your company does. Thus, if you are using a
12 30 per cent expected growth rate on your company,
13 your 'small' company is getting bigger (at least
14 according to your estimates) and presumably more
15 liquid over time. Should your illiquidity premium
16 therefore not follow your own reasoning and decrease
17 over time?"
18 What I just want to ask you is you've not
19 decreased your small cap premium over time, have
20 you?
21 DR FLORES: I don't call it a small cap
22 premium, but the premium I call additional risk
23 premium, I do not change it over time.
24 MR HO: Thank you. Just two or three
25 final topics, I think.
[Page 154]
1 DR FLORES: Can I say one just thing about
2 this?
3 MR HO: Yes.
4 DR FLORES: Can you turn to page 7,
5 because all of this can be shortcircuited very
6 easily. If you can scroll to page 7, please. Look
7 at what it says after the bolded heading. "It is
8 true that the small cap premium is established
9 practice at many appraisal firms, investment banks
10 and companies." And it says "you would think that
11 analysts would reconsider their use of small cap
12 premiums, but there are three powerful forces that
13 keep it in ...".
14 The discount rates that I calculate when
15 I do arbitration evaluations are not academic
16 discount rates. It is true Professor Damodaran is
17 very against any of these kind of premiums -- you
18 can read the article, you can see his passion, and
19 if you have seen his videos on the internet, he's
20 very passionate when he talks about this issue --
21 but he's an academic.
22 What I'm trying to replicate is not an
23 academic, I am not trying to replicate how Professor
24 Damodaran likes to calculate discount rates. I'm
25 trying to replicate what appraisal firms, investment
[Page 155]
1 banks and companies do in real life, and that's why
2 I think you need to apply an additional risk premium
3 because it is applied in real life, regardless if
4 there is a January effect or there is no January
5 effect.
6 MR HO: Well, Dr Flores, it's more than
7 that, isn't it? It's not just that he's an
8 academic; he's pointed out reasons why you are
9 mistaken to apply that premium, and, indeed, we can
10 see that in the bit you've highlighted. If you look
11 at paragraph 2, "Inertia". "The strongest force in
12 corporate finance practice is inertia, where much of
13 what companies, investors and analysts do reflects
14 past practice. The same is true in the use of the
15 small cap premium where a generation of analysts has
16 been brought up to believe ... that it is the right
17 adjustment to make. ... That inertia is reinforced
18 in the legal arena ... by the legal system's respect
19 for precedent and general practice. You may view
20 this as harsh, but I believe that you will have an
21 easier time defending the use of a bad, widely used
22 practice of long standing in court than you would
23 arguing for an innovative better practice".
24 And that is what you're doing, isn't it?
25 You're trying to defend the use of a bad but widely
[Page 156]
1 used practice?
2 DR FLORES: Yes.
3 MR HO: Very well. Let's move on then.
4 Can I talk to you now about the market
5 capitalisation of a company?
6 To work out a company's market cap, one
7 takes the total number of shares in a company and
8 multiplies them by the share price of those shares,
9 is that right?
10 DR FLORES: It would be the shares
11 outstanding, yes.
12 MR HO: Right, OK, yes. Yes, I see.
13 So a company's share price is critical to
14 working out market cap, isn't it?
15 DR FLORES: Yes.
16 MR HO: Now, I'd like to discuss with you
17 some of the factors which can affect the company's
18 share price. The management --
19 DR FLORES: But, just, I'm a little bit
20 lost. What are we -- what topic are we talking
21 about now?
22 MR HO: Well, we're talking just at the
23 moment about what factors affect a company's share
24 price and in turn how that affects market cap.
25 DR FLORES: But in the context of where in
[Page 157]
1 my report?
2 MR HO: Well, we're talking about that in
3 relation to the cross-check that you rely on for
4 ITD.
5 DR FLORES: I see.
6 MR HO: Now, one of the factors which
7 affects a company's share price is the management of
8 the company, isn't it, because the management of a
9 company has a significant impact on the company's
10 attractiveness to investors and, therefore, its
11 share price?
12 DR FLORES: It -- yes and no, because
13 there's companies with very bad management that
14 markets can expect that the owners of the company
15 will get rid of the bad managers and will put in
16 better managers in a way that the share price today
17 may already be reflecting that things cannot be
18 mismanaged forever.
19 MR HO: Yes, but equally you can have
20 companies which have very bad management where the
21 expectation in the market is that they won't be
22 replaced, and then the share price will reflect
23 that?
24 DR FLORES: Yes. I mean, that wouldn't be
25 very efficient, but I mean if the owners of the
[Page 158]
1 company want to continue having bad managers
2 forever, so be it.
3 MR HO: The share price of a company will
4 therefore, to an extent, reflect not just the value
5 of the company's assets but the market's assessment
6 of management's ability to exploit those assets
7 profitably, won't it?
8 DR FLORES: Again, I would not agree with
9 that completely.
10 In the short term perhaps, but eventually
11 if you go by market fundamentals, investors will
12 normally agree that sooner or later the companies --
13 a company cannot get mismanaged forever. That's a
14 fundamental belief of efficient markets.
15 MR HO: Share prices are also affected by
16 investor confidence and sentiment, aren't they?
17 DR FLORES: Yes.
18 MR HO: If a particular sector or company
19 is seen as hot or in vogue, shares can trade at
20 elevated levels based on those sentiments?
21 DR FLORES: I'm sorry?
22 MR HO: If a particular sector or company
23 is seen as particularly hot or trendy or desirable,
24 then shares can trade at elevated levels based on
25 those sentiments?
[Page 159]
1 DR FLORES: Yes. Again, over the long run
2 the share price should reflect the fundamentals.
3 You can deviate for a while but not forever.
4 MR HO: So shares can be undervalued or
5 overvalued relative to the true market value of the
6 company's assets based on investor sentiments or
7 beliefs about a particular company or industry or
8 sector, can't they?
9 DR FLORES: Sometimes they can, yes.
10 MR HO: A company's market cap would also
11 be affected by whether it faced legal or regulatory
12 difficulties as a result of particular assets it
13 owns, couldn't it?
14 DR FLORES: Potentially it could, yes.
15 MR HO: So if one or more of a company's
16 businesses were loss-making, that would depress a
17 company's share price perhaps significantly if large
18 losses were being made in some of its businesses?
19 DR FLORES: Yes, usually the value of a
20 company is the sum of all the businesses it has, and
21 if you have like ten businesses that make a lot of
22 money and ten businesses that make very little
23 money, the market capitalisation would reflect the
24 aggregate of all of those individual valuations.
25 MR HO: So the market cap wouldn't have
[Page 160]
1 anything to do necessarily with the -- I mean you
2 can't simply look at the market cap and then work
3 out what the value of profit making assets owned by
4 the company are, because the market cap is being
5 affected potentially by loss-making assets. Would
6 you agree with that?
7 DR FLORES: I mean potentially, yes, if
8 you have good assets and bad assets, the market cap
9 would be an average of all of those.
10 MR HO: The market cap of a large company
11 doesn't simply reflect, in a proportional way, the
12 fair market value of a given asset which the company
13 owns, does it?
14 DR FLORES: No, you cannot derive the
15 value of one single company -- one single business
16 or project from an entire big conglomerate. Yes.
17 MR HO: A penultimate topic, I think.
18 Now, in the past ten years --
19 DR FLORES: By the way --
20 MR HO: Yes.
21 DR FLORES: You ask these questions. Does
22 this relate to --
23 MR HO: Don't relate what they relate to,
24 Dr Flores. You just worry about answering.
25 DR FLORES: Yes.
[Page 161]
1 MR HO: In the past ten years or so, you
2 have given expert evidence in numerous
3 investor-State arbitrations. Are you able to give
4 us a rough figure on the number of investor-State
5 arbitrations you've given expert evidence in?
6 DR FLORES: In what period?
7 MR HO: Over the past ten years, let's
8 say. I'm not holding you to it but just roughly.
9 DR FLORES: I would say it's -- I recently
10 started working on my 100th case and I'd say about
11 two thirds investment cases, one-third commercial
12 cases.
13 So maybe, yes, about 50 to 60 maybe.
14 MR HO: And in those 50 to 60 -- again
15 just roughly -- in how many of those arbitrations
16 was the party who was instructing you a State or a
17 State entity as opposed to the investor?
18 DR FLORES: I think it's almost all of
19 them. Not all of them but almost all of them.
20 MR HO: Almost. All right.
21 Let's look now at what you say about the
22 ex ante interest rate. Now, you have proposed a
23 short-term risk-free rate, for example the yield on
24 six month or one year Treasury bills, and
25 Secretariat say US prime plus 2 per cent?
[Page 162]
1 DR FLORES: That's correct.
2 MR HO: A fair summary?
3 I don't know if you heard this, but in his
4 direct presentation, and just to give the reference
5 for the transcript it's Day 5, page 1159, lines
6 10-17, we'll get that up on the screen for you now,
7 Dr Flores but let me just read it in the meantime,
8 what Mr Sequeira said was, he said "I should say
9 that if you look at data on awards, if you look at
10 the last five years of awards from 2016 to 2021, of
11 over 90 awards that have been issued, I think only
12 four awards have issued a risk-free rate of
13 interest".
14 I understand -- but you'll tell me if I'm
15 wrong -- that from a previous case, you may have
16 some familiarity with those statistics, but what
17 I wanted to ask you is whether you have any basis
18 for believing that a risk-free rate has been awarded
19 more commonly by tribunals in the last five or
20 six years?
21 DR FLORES: I want to be very careful
22 here.
23 MR HO: Yes.
24 DR FLORES: Mr Sequeira and I are involved
25 in a highly confidential arbitration so what you
[Page 163]
1 just said worries me. I don't know what
2 understanding you have but I'm worried, and I don't
3 want to say anything that relates to this other
4 highly confidential arbitration.
5 MR HO: That's very fair. Then we will
6 just put in it general terms. Are you aware of
7 tribunals awarding a risk-free rate of interest more
8 commonly than Mr Sequeira suggested in his direct
9 presentation yesterday?
10 DR FLORES: Yes. I don't know exactly how
11 he has come up with this number because, for
12 example, a tribunal awarding interest at the LIBOR
13 rate, that is not the US Treasury rate that
14 I recommend, but LIBOR rate and US Treasury rates
15 are very similar.
16 So if you were to add the Tribunal to have
17 awarded interest at LIBOR on top of the ones that
18 have awarded one year US Treasury yield, you
19 probably would get a different number than what he
20 mentioned yesterday.
21 MR HO: Right. And do you believe that if
22 you did that you would find a significant number of
23 awards awarding a risk-free rate, or do you accept
24 that that's actually a very small minority?
25 DR FLORES: I guess I -- I don't know.
[Page 164]
1 MR HO: Fair enough. You say that one of
2 the reasons why using US prime rate is inappropriate
3 is because some companies can borrow below US prime,
4 and we can see that at paragraph 164 of your second
5 report. That's at page 60, I believe. 61 if you're
6 using the electronic version.
7 And if we just pick up paragraph 164 about
8 four lines down, can you see that you say, "The
9 actual rates at which lenders will lend and
10 borrowers will borrow funds will depend on the risk
11 profiles of the borrower and of the economic
12 activity in which the funds will be employed. For
13 example, a well-established reputable company can
14 finance the purchase of equipment at interest rates
15 significantly below the US prime rate as there is
16 little risk that the company will not be able to
17 repay the loan".
18 And we see that ends with footnote 258,
19 and if we look at footnote 258 we can see that the
20 evidence you rely on for the suggestion you've made
21 there is QE-87.
22 Do you see that?
23 DR FLORES: If this is -- it's one of the
24 documents I rely on.
25 MR HO: I think it's the document.
[Page 165]
1 I can't see any others referred to in footnote 258.
2 DR FLORES: Well, in this footnote, yes,
3 but I think my arguments about how to calculate pre
4 award interest will be on this footnote.
5 MR HO: Well, let's look at that document,
6 shall we, QE-87? So for you that will be Core
7 Bundle volume 5, tab 107.
8 PRESIDENT: Before we do that, can we just
9 clarify, because I have this doubt, are we speaking
10 of pre award interest or post award interest or
11 both?
12 DR FLORES: Here the discussion is about
13 pre award interest. It applies only to the ex ante
14 valuation in which the date of valuation
15 is July 2013, and then Mr Sequeira says, and I agree
16 with him, if an ex ante valuation were to be used,
17 then it would be reasonable to add interest to that
18 until the current time, so we are talking about pre
19 award interest.
20 PRESIDENT: Yes. Can we extend the
21 discussion to post award interest, which seems to be
22 a topic which we have discussed very little? Can we
23 extend the whole discussion to post award interest,
24 or would that be a completely different topic?
25 DR FLORES: I would give this answer. In
[Page 166]
1 general I think it's the same idea, that you have to
2 compensate for the passing of time, and that doesn't
3 end on the date the Tribunal issues an award with
4 damages. It ends at the day of payment of such an
5 award.
6 Now, I do recognise that after the award
7 is issued -- so between the date of valuation and
8 the date the Tribunal issues an award, there is no
9 risk. All your coal prices can go higher or can be
10 lower in the last several years. Once you say X
11 dollars, X dollars is X dollars, and it's not
12 affected by whether Mozambique defaulted on its debt
13 five years ago or if there was a big flood in
14 Mozambique.
15 So all of the risks, lending, borrowing,
16 business risks, do not affect anything that happens
17 until the date of the award. After the date of the
18 award, it's true other risks can appear, so
19 Mr Sequeira in his presentation he says -- right, in
20 slide 33 of his presentation --
21 PRESIDENT: Let's have a look. Yes.
22 DR FLORES: You see on the right column
23 when he responds to my Dr Flores column, number 1 he
24 says a damages award is exposed to risks and
25 uncertainty as to whether or when the award will be
[Page 167]
1 paid and how much will be collected.
2 I agree that that risk can exist after
3 that point, but using the prime rate is not the
4 answer because the prime rate doesn't reflect
5 anything having to do with how likely Respondent is
6 to comply with the Tribunal's award within 30 days
7 or 60 days or 90 days.
8 So from a practical perspective and an
9 economic perspective, I usually recommend continuing
10 to apply the same interest rate both for pre and
11 post award interest.
12 PRESIDENT: Let's -- why don't you
13 finish --
14 MR HO: I will, Mr President. We can make
15 submissions about that in closing, about the right
16 interest rate, but I won't do that now.
17 So, just to remind ourselves where we
18 were, Dr Flores, I had shown you paragraph 164 of
19 your report where you were suggesting that
20 well-established reputable companies can finance the
21 purchase of equipment at interest rates
22 significantly below the US prime rate, and that was
23 a reason why Secretariat are wrong to use that.
24 The document you had referred to in
25 support of that is this one, and that's the one
[Page 168]
1 we're going to look at now, just to recap.
2 So this is an article from the website
3 home.loans, isn't it?
4 DR FLORES: Yes.
5 MR HO: And that is a consumer finance
6 website?
7 DR FLORES: Yes.
8 MR HO: And we can see the article is
9 headed "Prime mortgage. A complete guide", so this
10 is an article for consumers about what prime rate
11 mortgages are?
12 DR FLORES: Yes.
13 MR HO: Is home.loans known as a serious
14 academic resource relied upon by valuation
15 professionals?
16 DR FLORES: No, I don't think it is, but
17 it's just making the very simple point about what
18 prime rate is. I thought it had a very easy -- a
19 very clear definition, and that's why I used it.
20 MR HO: All right. Let's go over the
21 page, and over the page we can see --
22 (Discussion off the record).
23 We can see over the page the bit of the
24 article you rely on. We have the heading "What are
25 the details of the prime rate?" And then there are
[Page 169]
1 two paragraphs. I want to read the second.
2 "It's important to note that the prime
3 rate is an index, not a law. It's possible to find
4 a loan or credit card with an interest rate less
5 than the current prime lending rate. Lenders will
6 sometimes offer below prime rate loans to highly
7 qualified customers as a way of generating business.
8 Furthermore, below prime rate loans are relatively
9 common when the loan product in question is secured.
10 This is the case with mortgages, home equity loans,
11 home equity lines of credit, and car loans".
12 So what is being said here is that loans
13 or credit cards will sometimes be offered to
14 customers as a way of generating business, is that
15 right?
16 DR FLORES: Yes.
17 MR HO: And the customers being referred
18 to on this consumer finance website are obviously
19 private individuals, aren't they? All that this is
20 saying is that financial institutions may offer cut
21 rate interest products to attract new consumers?
22 DR FLORES: Yes, but let's be clear, the
23 prime rate is a consumer rate. It's a US-based
24 rate. We don't have the prime rate in Europe or the
25 prime rate in Japan. We're talking about the US
[Page 170]
1 prime rate. And it's the rate -- if you see the
2 percentages where this rate is applied, it's home
3 loans and credit cards. That's where the US prime
4 rate is used for.
5 And the fact is that businesses, most of
6 them, when they negotiate lending, they don't do it
7 by reference to prime, they do it by reference to
8 LIBOR, and that's why it's primarily a consumer
9 rate, and that's what -- yes, it's banks dealing
10 with individuals offering rates.
11 MR HO: There's no discussion in this
12 article of businesses, let alone large multimillion
13 dollar businesses based outside of the US, being
14 offered below prime lending rates, is there?
15 DR FLORES: No, business based outside of
16 the US will never be offered any prime rate because
17 it's only for lending purposes within the US.
18 MR HO: But they're not being offered
19 comparable rates which are below prime, are they?
20 DR FLORES: Yes, they are.
21 MR HO: Well, there's no discussion of
22 that in this article, is there?
23 DR FLORES: No. This article is focusing
24 on US consumers borrowing at the prime rate.
25 PROFESSOR TAWIL: Sorry, can I make a
[Page 171]
1 follow-up question?
2 MR HO: Yes, of course.
3 PROFESSOR TAWIL: I understand LIBOR is no
4 longer being calculated.
5 DR FLORES: It's still being calculated
6 but it is true that in the next few months it will
7 be stopped being calculated. I think
8 it's June 2023. But there are replacement rates if
9 you want to do US dollars. There's something called
10 SOFAR, which is the rate that in the US will replace
11 the LIBOR. It's calculated by the Federal Reserve
12 bank of the United States.
13 PROFESSOR TAWIL: Thanks.
14 MR HO: Thank you. Final topic,
15 Dr Flores --
16 PRESIDENT: Because we have been going on
17 for more than an hour and a half, so if you could
18 really make it the last topic.
19 MR HO: Yes, I will, Mr President.
20 Hopefully we'll be done in the next five minutes.
21 Now, I think you'd agree with me that CFM
22 is a 20 per cent partner in the TML consortium,
23 which is the consortium carrying out the project,
24 aren't they?
25 DR FLORES: I'm sorry. You said that
[Page 172]
1 I have agreed with you?
2 MR HO: I'm asking do you agree with me
3 that that is the case?
4 DR FLORES: I think it is, yes.
5 MR HO: And the TML consortium as the
6 entity carrying out, or in your view not carrying
7 out, the project would have the most up-to-date
8 information on the status of the project, wouldn't
9 they?
10 DR FLORES: That, I do not know. I mean
11 being a minority shareholder doesn't give you as
12 much access to information as when you are
13 management of the company.
14 MR HO: No, apologies. My first point was
15 that CFM is a 20 per cent partner in the consortium,
16 and what I'm putting to you now is the consortium
17 itself, the whole consortium, they are the people
18 carrying out the project or, in your view, not
19 carrying it out, and they obviously have the most
20 up-to-date information on the status of the project,
21 don't they?
22 DR FLORES: You're referring to TML?
23 MR HO: Yes.
24 DR FLORES: I assume TML -- I assume the
25 management of TML has the more up-to-date
[Page 173]
1 information. I do not know for fact, but I assume
2 that's the case.
3 MR HO: And are you aware that, on the
4 11th of August 2022, Mozambique State television ran
5 a feature where Jose Fonseca, a member of TML's
6 executive committee stated amongst other things that
7 conditions are in place to move ahead with the
8 Chitima-Macuse rail port project?
9 DR FLORES: I have aware of that source.
10 MR HO: And are you aware that he also
11 said that the project infrastructure work was a
12 priority because it's linked to a faster financing
13 process? We've already had approval from the Bank
14 of Mozambique, we've already had approval from
15 public entities, and therefore we will move forward
16 with the port operation?
17 DR FLORES: That, I do not recall that --
18 those words that you're talking about.
19 MR HO: Well, Mr President, this is
20 another one of those documents -- oh, it's admitted.
21 My apologies.
22 Well, in that case, then, perhaps we can
23 just show you that, Dr Flores. I understand it's at
24 C-405, and as if by magic I think a video will now
25 start playing.
[Page 174]
1 PRESIDENT: We had expected that for the
2 final post-hearing, but I'm sure that Dr Flores will
3 love to see the video.
4 MR HO: Something interactive to close
5 with, Mr President. (Pause)
6 Mr President, one option may be we'll see
7 if they can sort of immediately sort out the
8 problem, but if it looks like it's taking longer we
9 can take the break now and then come back after the
10 break when the video is ready.
11 PRESIDENT: Yes, let's make a break.
12 Let's make a break, a five-minute break, and let's
13 come back at 13.20.
14 MR HO: Thank you, Mr President.
15 (Short break from 1.11 pm to 1.21 pm)
16 PRESIDENT: Very good. We resume the
17 hearing, and we continue with the projection of the
18 video.
19 MR HO: Thank you. Just before we play
20 it, Mr President, just so we're clear, this is
21 C-405, this is a video from the Mozambican state
22 television agency. There will be subtitles in
23 English. Those subtitles have been put there by the
24 Claimant. I don't think there's been any dispute
25 about them yet but, if there is, that's where
[Page 175]
1 they've come from, and no doubt we'll be told about
2 them in due course.
3 So, play.
4 (Video played)
5 MR HO: Dr Flores, what I want to put to
6 you in light of that video is that your comments
7 this morning in your direct presentation that in
8 your view there would never be any project are
9 wrong. Mr Fonseca's comments there show quite
10 clearly that the project is going to move ahead.
11 Would you agree or disagree with that?
12 DR FLORES: I disagree with your proposal.
13 Can I explain?
14 MR HO: Yes.
15 DR FLORES: Yes. What we have is the
16 financial statements of ITD, the -- yes, the
17 Italian-Thai Development, the company in Thailand,
18 that they own a 60 per cent interest in this
19 project, and that's where you have to go for the
20 actual hard-quoted figures, and they tell you how
21 much they have spent, how much they are spending,
22 and in what they are spending.
23 You saw images there in the video of a
24 train. Just, I assume no one's confused, but so the
25 record is clear, that's not the train in this thing,
[Page 176]
1 and the railways where they were cutting, those are
2 stock images from other projects. There is no rail,
3 there is no lines, and there's no construction.
4 They did show images, which I understand
5 to be of an actual port that's being built. That's
6 fully consistent with the financial statements when
7 they say that's been recharacterised and we want to
8 do the general cargo sea port, and they said there's
9 some families being resettled, and the financial
10 statements also talk about those activities.
11 I understand in recent times they have completed the
12 feasibility -- no, the environmental study for the
13 new port, the general cargo port, that is going
14 forward. And you see in the video they give a date,
15 they are hoping it will be in place by August 2023.
16 That I'm not sure is going to happen or not because
17 we're already in December.
18 But yes, I do think the general cargo port
19 will become a reality, if not in 2023, maybe in
20 2024, and we know that there is financing in place
21 for that general cargo port. But we're talking
22 about $25 million. I have seen no evidence
23 whatsoever of financing having been agreed for the
24 entire railway going up to the mines. There's no
25 evidence of that whatsoever, and the financial
[Page 177]
1 statements, as I show you in slide 15, show that
2 that will only go forward once the economics
3 justify -- these are the financial statements
4 from June -- as of June 30th of this year, which
5 were published actually in mid August, a few days
6 after that video.
7 So we have financial statements from a
8 publicly traded company in Thailand telling us in
9 mid August, a few days after that video, that the
10 phase 2, the deep sea port and the railway, will
11 happen whenever, and, if you notice, that's fully
12 consistent with the video. The video said, yes,
13 whenever -- we don't have a calendar but we are
14 looking at financing and so on.
15 I understand that this gentleman shown in
16 the video, yes, his job is at stake, right? If they
17 don't go forward at all, then what's he going to do?
18 He's probably spent there many years, but one thing
19 I wish is, year one is economics, and unless they
20 can come up with 3 billion-dollar in financing, that
21 will never happen. And everything I have told you
22 in my presentation, I do believe that that will not
23 happen. The economics are no longer there.
24 MR HO: Sorry, Dr Flores, can I clarify
25 just one point? The financial statements that
[Page 178]
1 you're referring to, I think that's QE-100, they
2 state the position as at 30th of June 2022, don't
3 they?
4 DR FLORES: Yes, but the auditor's
5 comments are dated August 15.
6 MR HO: So the statements in the document
7 that you refer to from ITD come from the 30th
8 of June 2022, whereas this video is
9 from August 2022.
10 DR FLORES: Yes, but remember, in the
11 paragraph to the right in slide 15, that's written
12 by the independent auditor of the company, and she's
13 expressing her view as of August 15. If she had
14 known in the meantime that -- you know in financial
15 statements there's this section called Subsequent
16 Events, things that have happened after the closing
17 of the statements, if she had learned that the
18 billions of dollars had already been secured and the
19 money was flowing and the whole railway was about to
20 get built, she would not have any reason to put the
21 emphasis that she had to put as of August 15.
22 MR HO: Very well. One moment,
23 Mr President.
24 I think that's all the questions we have.
25 Thank you very much. Thank you very much for
[Page 179]
1 bearing with me, Dr Flores.
2 DR FLORES: Thank you.
3 PRESIDENT: Very good. Thank you.
4 Mr Brown?
5 MR BROWN: Thank you, Mr President.
6 I won't take long, but I do have a few follow-up
7 questions.
8 PRESIDENT: Of course.
9 Re-examination by Respondent
10 MR BROWN: Dr Flores, we spent some time
11 earlier this morning with questions being asked of
12 you about the components of the discount rate. Do
13 you recall that?
14 DR FLORES: Yes.
15 MR BROWN: Did any of the questions that
16 you received regarding the discount rate, have those
17 now caused you to change any of your conclusions
18 regarding the discount rate?
19 DR FLORES: No. No, no.
20 MR BROWN: I think you also received some
21 questions regarding the capitalisation, the market
22 capitalisation of ITD.
23 DR FLORES: Yes.
24 MR BROWN: Let's just get a little context
25 here, if we can for a moment. Can we turn to your
[Page 180]
1 slide 25 in your presentation, please, and we'll
2 need the screen for Respondents, please. Just so we
3 have the context, Dr Flores, does slide 25 reflect
4 your reasonableness check using the ITD market
5 capitalisation?
6 DR FLORES: Yes, it does.
7 MR BROWN: And I think the questions that
8 were asked of you were asked suggesting that perhaps
9 the market capitalisation was affected by maybe
10 negative pressure on the ITD market capitalisation?
11 Do you recall that?
12 DR FLORES: Yes.
13 MR BROWN: Can we actually turn to
14 Secretariat's slide 24 for just a moment? If we
15 could blow up the area of the slide that's the last
16 bullet point there that says ITD's market cap
17 consistently decreased since 2015?
18 DR FLORES: Yes.
19 MR BROWN: I just want to make sure we get
20 a couple of data points off this slide, please.
21 First of all, what's the date of the first
22 of the two analyst reports that Mr Sequeira
23 identifies and quotes in this slide?
24 DR FLORES: That is the 4th of June of
25 2021.
[Page 181]
1 MR BROWN: And what's the date of the
2 second of the two articles -- or, sorry, analyst
3 reports that Mr Sequeira identifies in this slide?
4 DR FLORES: It's 8th of September 2020.
5 MR BROWN: What was the date that you
6 used, do you recall, with regard to analysing the
7 market capitalisation of ITD for the purposes of
8 your reasonableness check, Dr Flores?
9 DR FLORES: I think it was the valuation
10 date that Mr Sequeira uses in his ex post analysis.
11 MR BROWN: Maybe to help, can I turn you
12 to page 26, internal page 26 of your report,
13 Dr Flores, which is in the record at RER-9?
14 DR FLORES: Yes.
15 PROFESSOR TAWIL: Sorry, which report?
16 MR BROWN: Yes, it's RER-9. Dr Flores'
17 second report.
18 PROFESSOR TAWIL: The second?
19 MR BROWN: Yes.
20 Dr Flores, do you see on this chart where
21 the date from 2020 would exist?
22 DR FLORES: It would not be here. It
23 would be to the left, because this begins
24 in January, the first business day of January 2021,
25 so 2020 would be to the left.
[Page 182]
1 MR BROWN: And what does this chart
2 reflect, by the way, as it was put together?
3 DR FLORES: This reflects the market
4 capitalisation of ITD during the period around
5 Mr Sequeira's valuation date.
6 MR BROWN: I think the second date that
7 was reflected in Mr Sequeira's observations about
8 the market capitalisation was June 4, 2021, is that
9 true?
10 DR FLORES: Yes.
11 MR BROWN: What actually was happening
12 with the market capitalisation of ITD on June 4,
13 2021?
14 DR FLORES: It exploded. I mean you can
15 see we start the year at a capitalisation of about
16 $200 million, and then around May and June 2021, by
17 that time when we get to early June, it has more
18 than doubled, the market capitalisation, from less
19 than $200 million to almost $500 million.
20 MR BROWN: Mr Sequeira testified yesterday
21 based upon the chart that you have in figure 1 from
22 your second report. Is it true, Dr Flores, that
23 ITD's market cap consistently decreased since 2015?
24 DR FLORES: No, that's clearly incorrect.
25 In fact, as of the date of the first report he cites
[Page 183]
1 of 8 September 2020, the market capitalisation was
2 around $175 million, so it went from $175 million --
3 it is true that that source, which I added to my
4 report -- by the way, for the purposes of saying,
5 look, people when they analyse ITD, guess how many
6 paragraphs they spent discussing the project
7 Mozambique? Zero paragraphs. The project in
8 Mozambique is not even discussed when people talk
9 about ITD.
10 What they did talk what's going on in
11 Thailand, what's going on in Myanmar, what's going
12 on here, there -- no discussion whatsoever of
13 Mozambique. That's the purpose for which I put this
14 report.
15 Now, QE-78, it is true it says at that
16 moment in time the company had some problems, but
17 those problems were clearly resolved. By the time
18 we get to Mr Sequeira's valuation date, the company
19 that was valued at $175 million had exploded in
20 value to over $400 million.
21 MR BROWN: I have one other quick topic to
22 do.
23 I'm going to direct your attention to a
24 document that was handed to you this morning.
25 Claimant's Exhibit 395 entered into the record this
[Page 184]
1 morning?
2 DR FLORES: Yes.
3 MR BROWN: I don't believe we have that
4 document electronically, so I wonder if I could get
5 a bit of co-operation from opposing counsel to
6 redisplay Exhibit C-395, please?
7 MR HO: No problem. We'll do that now.
8 MR BROWN: Thank you.
9 I wonder if you could maybe just display
10 the part just below the abstract of this article,
11 please? Right there is fine, thank you.
12 First of all, in the abstract, Dr Flores,
13 it says, "This article presents results from the
14 first statistically significant study of cost
15 escalation in transportation infrastructure
16 projects".
17 Let me pause there.
18 Were you relying on the statistically
19 significant results of this particular document in
20 drawing any conclusions that you drew in your
21 reports?
22 DR FLORES: No. The specific numerical
23 numbers, regardless of whether they are
24 statistically significant or not, I did not rely on.
25 I relied on the qualitative discussion that these
[Page 185]
1 authors provide.
2 MR BROWN: Let's take a look at one of the
3 qualitative discussions in this particular document.
4 Can we go to the bottom of this same first page?
5 At the end of the abstract, this document
6 states, "The policy implications are clear. In
7 debates and decision making on whether important
8 transportation infrastructure should be built, those
9 legislators, administrators, investors, media
10 representatives, and members of the public who value
11 honest numbers should not trust the cost estimates
12 and cost-benefit analyses produced by project
13 promoters and their analysts".
14 Do you see that?
15 DR FLORES: Yes, I see that.
16 MR BROWN: Is that consistent with the
17 qualitative information that you were gleaning from
18 Professor Flyvbjerg's work?
19 DR FLORES: Yes, that's absolutely
20 correct. Remember, the whole point is to stress
21 test any DCF projection you make, and if you take
22 into account what these authors say, you tend to
23 have people that are too optimistic. The costs are
24 low and the revenues are going to be very big, you
25 need to do some correction for that, and that's why
[Page 186]
1 I did in my report where I said look, just a 22
2 per cent correction on costs eliminates all value.
3 MR BROWN: I have no further questions,
4 Mr President.
5 PRESIDENT: Is there any further question
6 for you, Mr Ho?
7 DR FLORES: No, thank you, Mr President.
8 PRESIDENT: Any question from you?
9 Dr Perezcano, any question? No?
10 DR DANIEL FLORES and MR KIERAN SEQUEIRA
11 Questions by the Arbitral Tribunal
12 PRESIDENT: I have just -- can we come,
13 since we have Mr Sequeira with us -- just remain
14 seated there, if you don't mind, sir -- and that is
15 the question of interest, because the treaty refers
16 when dealing with the expropriation, with the
17 calculation of the expropriation, but I think it's
18 the only place where it deals with interest, it says
19 fair and equitable rate, fair and equitable rate
20 until the date of payment. And my question I think
21 to both of you is whether prime plus 2 in your case,
22 and in your case I think it was the short-term
23 US Treasury rate, where you think that these are for
24 the purposes of this article fair and equitable
25 rates.
[Page 187]
1 So maybe I give -- if this is agreeable to
2 you, Dr Flores -- to Dr Sequeira first the floor and
3 then you can comment on that. Is that OK?
4 DR FLORES: Yes.
5 PRESIDENT: Please.
6 MR SEQUEIRA: Thank you. This wording
7 "fair and equitable rate" I would say is not as
8 common a wording I see in most treaties. You
9 typically see "commercial rate", "reasonable
10 commercial rate". I have construed, at least this
11 is my personal interpretation, it to be somewhat
12 similar, what's reasonable, what's commercial is
13 also what is fair and reasonable, so I would view
14 them to be generally intending to achieve the same
15 objective, is to calculate a reasonable commercial
16 rate, and so on that basis I would say that that's
17 the way in which we have come up with the prime rate
18 and the premium over prime is something that is
19 commercial, that is widely available in the market.
20 And, with your permission, I would like to
21 briefly comment on the pre versus post award
22 interest issue which you brought up as well.
23 I can do that separately, if you want, but
24 it relates to this issue.
25 PRESIDENT: Let's -- yes. I do have --
[Page 188]
1 when you say "prime", isn't prime related to a
2 specific bank? So isn't that the prime of Citibank?
3 MR SEQUEIRA: No --
4 PRESIDENT: If I want to see LIBOR, there
5 is a web page which gives me the LIBOR rate. How
6 would you calculate the prime rate?
7 MR SEQUEIRA: So you're right that prime
8 rate can vary from bank to bank, but the rate that
9 is normally used as a benchmark is a rate published
10 by the Wall Street Journal. The Wall Street Journal
11 does public a US prime rate which is usually used as
12 the standard benchmark. It is usually reflective of
13 the broader arrangement of prime rates that are
14 applied by banks across the country. And I would
15 say -- I know there was some discussion about the
16 prime rate applying to consumers. That is not
17 correct. The prime rate is widely used as a
18 benchmark for commercial loans as well.
19 I ran my own company for a few years. We
20 were benchmarked -- our rate was benchmarked off the
21 prime rate. We paid a premium over prime. So it is
22 used for mortgages as, well, so I agree it is used
23 for consumers, but it's widely used for businesses.
24 Particularly small, mid-sized businesses are
25 benchmarked off of prime.
[Page 189]
1 PRESIDENT: And your proposal was prime
2 plus a premium. You said I think a 2 per cent
3 premium. That was your proposal?
4 MR SEQUEIRA: That is correct. And,
5 again, the 2 per cent premium is based on our
6 judgment and there are some awards that use the same
7 logic, but it's based on the concept that prime rate
8 is available to typically the most creditworthy
9 businesses, so the vast majority of companies, like
10 my company back in the day, did not get prime rate.
11 We paid a premium over prime rate. So it's a
12 judgment as to how much the premium should be.
13 We have applied 2 per cent. You might
14 think it's 1 per cent or zero or 3, but that is
15 based on our judgment as to what is the reasonable
16 premium over prime that reflects a widely available
17 rate in the market.
18 PRESIDENT: And the premium would be based
19 on the credit rating of Mozambique?
20 MR SEQUEIRA: It could, although I would
21 say that if you would apply the credit rating of
22 Mozambique it would be a much higher premium over
23 prime, so that would reflect a more -- prime plus 2
24 per cent would be a more creditworthy rating than
25 what would be for Mozambique, which is like a CAA on
[Page 190]
1 Moatize or a much higher premium to that.
2 PRESIDENT: Very good.
3 Let us clear this up, and then we speak
4 about the other point pre and post.
5 Dr Flores?
6 DR FLORES: Yes. Brief points.
7 One, I agree with Mr Sequeira that this
8 phrasing of a fair and equitable rate, it's not very
9 common in the work we do. For practical purposes
10 what Mr Sequeira has done is to use what he always
11 uses, and what I have done is to do what I always
12 use, right?
13 So, for practical purposes, having this
14 wording has not changed the way we have calculated
15 interest rates, either of us. So that's the
16 practical purpose or import of that.
17 Then, as to the point about where prime is
18 used, I do agree that small businesses sometimes do
19 borrow at prime rate, but not businesses when they
20 are talking about hundreds of millions of dollars.
21 In fact, my company also has a line of
22 credit which we don't use right now based on the
23 prime, but I will tell you we're paying prime --
24 well, if we were to borrow the rate we will have
25 access to is prime plus zero, and this is a very
[Page 191]
1 small company in Washington DC with just 20
2 employees.
3 So if you are talking about large
4 international investors, I think they can do better
5 than Quadrant Economics as to interest rates.
6 So it was basically those two points.
7 PRESIDENT: Very good. So the pre and
8 post, you wanted to say something?
9 MR SEQUEIRA: Yes. It's important because
10 I wanted to react in part to what Dr Flores said.
11 The first question is should you apply the
12 same rate as a pre award interest rate and a post
13 award interest rate, and on that point I would agree
14 that if you're looking the goal is a reasonable
15 commercial rate, I agree with Dr Flores, the clock
16 keeps ticking until you get paid, so it would be the
17 same rate, the same reasonable commercial rate that
18 you would apply, but I don't think the logic applies
19 under Dr Flores as well where he says that a damages
20 award is risk-free until the date the award is
21 issued, and then he agrees that from that point on,
22 from the date of the award, there is some risk
23 because the counterparty is the Respondent, right?
24 So in this case it would be Mozambique.
25 So under his logic, from the point of the
[Page 192]
1 date of a damages award, you should be using
2 Respondent's cost of debt, right? Not his risk-free
3 rate. He says you should take the risk-free rate
4 all the way to the date of payment. That would be
5 fundamentally incorrect based on his own logic where
6 you would switch from the date of award to a
7 post-award interest rate that equals the
8 Respondent's cost of debt, which is far higher than
9 the US risk-free rate.
10 So I just want to point out that
11 inconsistency. We keep it the same throughout, but
12 under his logic you would need to switch, and that
13 would be a much higher rate, much higher than the
14 prime plus 2 per cent that we are proposing across
15 the board.
16 PRESIDENT: Do you continue agreeing with
17 Dr Sequeira on this point?
18 DR FLORES: No. So in general, yes, and I
19 think for our practices we've never recommended
20 different interest rates, but what he says, let's be
21 clear, when we talk about the Respondent's cost of
22 borrowing, he's referring to the rate that
23 Mozambique has to pay when they issue sovereign
24 bonds, right?
25 Now, the rate that Claimant -- that
[Page 193]
1 borrowers ask Mozambique from those borrowings, it's
2 because those borrowings are unsecured debt, so as
3 you know, many countries they stop paying bonds and
4 then -- you know Argentina and other countries --
5 and then good luck getting your money back from the
6 borrowings to the lending in government bonds,
7 right?
8 Whereas an arbitral award, it's different
9 than a sovereign bond, and neither he nor I have
10 done the research to say, look, this is how much
11 risky -- what's the risk differential between a
12 sovereign bond and a secure award, which is secure
13 by the treaty, by international law, by this
14 convention, that convention, and all the enforcement
15 mechanisms that exist.
16 So you have to ask, then the question
17 would be, would you rather have, say, a $1 million
18 award, or would you rather have a $1 million
19 sovereign bond? So the risk is different.
20 So he's not correct to say you would have
21 to apply the Respondent's cost of borrowing.
22 MR SEQUEIRA: Can I just react to that
23 very quickly? I know we are almost at the end.
24 PRESIDENT: Yes, of course.
25 MR SEQUEIRA: That logic -- I usually
[Page 194]
1 would not react to that but that's I think
2 fundamentally wrong because what he's saying is that
3 it's better to have a damages award in hand than to
4 have a sovereign bond of a country, so, in other
5 words, that same logic is saying that the sovereign
6 bonds are more risky than a damages award against a
7 state.
8 And in that case states should rather
9 default on their debt first and pay all their
10 damages awards, investor-State awards, where would
11 be -- that would be the logical extension of what
12 he's saying, which I most fundamentally disagree
13 with. The Tribunal can form its own view on this,
14 but that's just fundamentally wrong.
15 PRESIDENT: I think it's just two ways of
16 viewing the same economic issue, and I don't think
17 there is an answer, a clearcut answer. It's a very
18 interesting question on what is the logic of default
19 interest. Very good.
20 So I think this finalises our -- I see our
21 court reporter almost falling dead, and our
22 interpreters are on the floor, so we are off the
23 record now.
24 (The hearing was adjourned at 1.50 pm)
25