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Looking Forward: Energy Transition and Resource Mobilisation

Illicit Financial Flows, Extractive Sectors, and the Energy Transition: Building State Capacity to Finance the SDGs

Flux financiers illicites, secteurs extractifs et transition énergétique : Renforcer la capacité des États à financer les ODD
Flujos financieros ilícitos, sectores extractivos y transición energética: Creación de capacidad estatal para financiar los ODS
Philippe Le Billon

Abstracts

States play a crucial role in the capture and allocation of commodity revenues shaping development outcomes. This chapter examines their capacity to address illicit financial flows and better finance development programmes, focusing on energy transition revenues. It first reviews the main findings about state capacity to harness commodity revenues to reach key Sustainable Development Goals. It then explores the complex interplay between state capacity, commodity-based financial flows, and development processes in the context of the energy transition. Highlighting the diversity of state capacities among commodity-dependent countries and possible energy transition trajectories, the chapter discusses opportunities and challenges resulting from changes in the volume, type and price volatility of commodities, and associated illicit financial flows associated with the energy transition. State capacity must anticipate and respond to shifts in dependence on fossil fuels to energy transition minerals and renewable energy production in order to avoid repeating illicit financial flow patterns associated with the ‘resource curse’ and poor development outcomes.

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1. Introduction

  • 1 This chapter focuses on mineral extraction for the energy transition. On illicit financial flows in (...)

1As the energy transition unfolds, trillions of dollars in investments and revenues will be generated from commodity sectors associated with renewable energy production and widespread electrification (G20, 2022). This expected windfall raises major concerns given the relatively poor developmental outcomes of previous commodity booms in many countries (Carbonnier and Mehrotra, 2022; IGF, 2023). High demand for energy transition minerals (ETMs) increases the number of mining projects in jurisdictions with weak governance and puts pressure on authorities and companies to fast-track projects (TI, 2022). As this chapter suggests, the prevention of illicit financial flows (IFFs) within energy transition sectors, including the extraction of ETMs, represents a significant challenge for sustainable development in the coming decade.1 Integrity and fairness within mineral sectors and fiscal structures are also essential if climate mitigation is to rest on a resource-intensive ‘green transition’ as corruption, tax evasion and unfair revenue distribution increase conflict risks around ETM projects (Clark, 2023; Kellas, 2023).

2Both the Millennium Development Goals (MDGs) and the Sustainable Development Goals (SDGs) have emphasised the role of fiscal policy and domestic resource mobilisation in global development efforts (Addison, NiñoZarazúa and Pirttilä, 2018). The SDGs require significant public expenditures to reduce poverty and improve healthcare, education, gender equality and environmental sustainability. Public investments are also needed for climate adaptation and accelerating the energy transition. Meanwhile, the debt levels of most countries have sharply increased and aid donors have encouraged lower-income countries to increase domestic resource mobilisation, including through revenues from primary commodity sectors. Many countries are seeking to develop ETM sectors in the hope of benefiting from high commodity prices and capital investments as well as to diversify their economies through downstream mineral processing and manufacturing (e.g. electric batteries).

3Launched in 2015, the SDGs came at the tail end of a decade-long ‘commodity super-cycle’ resulting in large part from the rapid growth of infrastructure and manufacturing sectors in China. Hopes of long-term growth fuelled by high commodity prices, major investments in extractive projects, and resource-backed loans had just been dashed by a commodity bust that resulted in debt crises for countries such as Ecuador or Ghana, thereby significantly reducing state capacity and forestalling key investments in SDGs (Ampofo et al., 2021; Kharas, Prizzon and Rogerson, 2014).

4As much of the resource curse literature notes, there is a risk that resource-dependent countries have lower incentives to collect domestic revenues compared to other countries, a pattern also observed for foreign aid dependence (Crivelli and Gupta, 2014). This not only affects revenue availability during commodity busts, it also undermines good governance principles—such as the taxation–representation nexus—as top-down flows of external revenues reduce incentives for governments to invest in domestic tax enforcement and for citizens to pay their taxes (Mohtadi et al., 2019; Moore, 2004). The fallout can include lower state capacity in crucial areas for the SDGs, as well as greater volatility in revenues available for public services. More importantly for this chapter’s focus, high dependence on resource rents is also associated with greater capital flight—some through IFFs such as corruption and tax evasion—further undermining revenues required to build state capacity, deliver services, and achieve the SDGs (Ndikumana and Sarr, 2019).

5The growth of renewable energy sources in the global energy mix and the associated electrification of many economies is expected to have wide-ranging impacts on commodity producers, in part as a result of the overall size and distribution of energy-related resource revenues. While the transition will be increasing revenues for ETM producers and decreasing them for fossil fuel producers, especially for coal and eventually oil or even natural gas (yet often considered a longer-term ‘transition fuel’ displacing coal in electricity generation). According to the IMF (2021), fossil fuel production generated 70 trillion US dollars in revenues between 1999 and 2018, whereas production of ETMs only generated about USD 3 trillion; but under a Net Zero by 2050 scenario, ETMs could generate USD 13 trillion and fossil fuels only USD 19 trillion in the period 2021–2040. As a result, there may be a greater risk of IFFs for ETMs given the opportunities associated with massive investments and new rents, as well as fossil fuel producers seeking to squeeze as much wealth out of a declining sector. Still, there remains much uncertainty about the pace of the energy transition and the evolution of revenues for different commodities, as well as their impacts in terms of IFFs and SDGs (Hansen, 2022). One possible scenario is that renewable energies will be added to continued global demand for fossil fuels, resulting in a process of ‘energy addition’ rather than ‘energy transition’ (Newell et al., 2020). Such a scenario could result in hard-to-manage dependence on fluctuating revenues for many fossil fuels and ETMs. Despite COP 28’s call to ‘transition away’ from fossil fuels, many ETM producers—including Brazil, Gabon and Mozambique—are still pursuing fossil fuel production projects in an attempt to diversity and maximise revenues.

6Many other impacts associated with booming ETMs are expected to resemble those of minerals in general (De Jong, Sauerwein and Wouters, 2021), with key issues including social and environmental impacts (Owen et al., 2023) as well as the capture and allocation of revenues (Carrasco and Madariaga, 2022; Månberger and Johansson, 2019). Several studies have already pointed at the many conflicts associated with ETM projects (Church and Crawford, 2018; Lèbre et al., 2020), with local communities often denouncing the ‘sacrificing’ of their territories for the sake of a ‘green transition’ primarily benefiting resource companies and privileged consumers of ‘green goods’ such as luxury electric vehicles (Deberdt and Le Billon, 2024; Dunlap and Riquito, 2023; Zografos, 2022). Some of the main differences that ETM projects may have in comparison to ‘classical’ mineral projects potentially include: (i) a high concentration of production for some ETMs, such as cobalt (70 per cent of global mining occurs in the Democratic Republic of the Congo (DRC)) or lithium (90 per cent originating from Australia, Chile or and China); (ii) greater competition between project investors backed by home countries that are competing geopolitically, which may increase the bargaining power of host countries in the licencing process but also the risks of corruption (Fitzgerald and Salomon, 2022); (iii) a risk of lax regulations and weak enforcement seeking to accelerate the pace of project approval and development, with an increased risk of negative social and environmental impacts, as well as IFFs associated with poor monitoring and auditing of inflated production costs for example (Aggarwal-Khan, 2022); and (iv) inadequate host country expertise on ETMs, including for mineral extraction, processing, and trading audits (Deberdt and Le Billon, 2023).

7This chapter engages with the imperative to strengthen state capacity to reduce IFFs out of energy transition commodity sectors in order to achieve the SDGs. The first section provides an overview of relations between state capacity, commodity sectors, and IFFs, focusing on conditions undermining the ability to finance the SDGs. The second explores challenges and opportunities associated with the energy transition and implications for policies seeking to reduce IFFs in commodity sectors. Before concluding, the third section outlines a range of policy recommendations for strengthening state capacity and preventing IFFs in order to achieve a broad set of SDGs.

2. Commodity Sectors, State Capacity, IFFs and the SDGs

8Narrowly defined, IFFs refer to money that is illegally earned, transferred, or used across borders. More broadly, the term encompasses transactions ‘that are deemed non-ethical, even if not illegal in the assessed jurisdiction’ (see Musselli and Bürgi Bonanomi, 2020, 1). Several broad categories are often recognised: tax-motivated IFFs including through trade mis-invoicing, abusive transfer pricing, and other practices eroding the tax-base and shifting profits to low-taxation jurisdictions; corruption IFFs including bribery and embezzlement; illegal resource extraction and trading IFFs such as illegal mining; and criminal IFFs such as theft, racketeering and money laundering. Practices within these categories can occur alone or in different combinations, with various impacts on developmental outcomes (Kolstad and Søreide, 2009; Robbins, 2000).

9Commodity sectors are often more prone to IFFs due to their high value, their limited transparency and oversight, as well as incentives and opportunities for corruption and tax evasion (Andersen et al., 2017). Weak state capacity creates opportunities for corruption, tax evasion and other types of IFFs, such as trade mispricing and abusive transfer pricing whereby companies shift profits to low-tax jurisdictions. IFFs deprive countries of vital revenue needed to fund public services and reduce poverty, exacerbate inequalities and political instability, and contribute to environmental degradation and social harms, including conflicts. As a result, many governments and international organisations have promoted measures to address IFF risks in commodity sectors, such as greater transparency in revenue management (e.g. the Extractive Industries Transparency Initiative (EITI)), revised contracts, improved monitoring and reporting systems and stronger anti-corruption laws and enforcement mechanisms (Le Billon, 2011; Igbatayo, 2019). Whereas this study focuses on IFFs occurring in revenue collection, IFFs also take place through revenue allocation that more directly affects SDG-related projects and activities.

10Relations between state capacity, commodity sectors, IFFs and the SDGs are complex and multifaceted. On the one hand, commodity sectors can provide a significant source of foreign exchange and revenues for governments, which can be used to fund development programmes and promote economic growth (WEF, 2016). In addition, commodity sectors associated with the energy transition can increase access to affordable and clean energy (SDG 7), provide decent work and economic growth (SDG 8) and contribute to climate action (SDG 13). Nevertheless, commodity sectors can seriously undermine SDGs through greater demand for water, increased pollution, and labour abuses, thus negatively affecting food security (SDG 2), good health and well-being (SDG 3), clean water and sanitation (SDG 6), decent work (SDG 8), life below water (SDG 14) and life on land (SDG 15). Table 10.1 summarises governance risks for ETMs and potential impacts on SDGs.

Table 10.1 Governance risks and potential SDG impacts.

Risks for local stakeholders

Risks for mineral-rich countries

– More exploration and mining for transition minerals may encroach on conservation areas and Indigenous and land-connected peoples’ territories. SDG 3, 11, 14, 15

– Pressure to approve mining projects may limit time for community consultations and impact assessments. SDG 3, 11, 16

– Water-intensive mining methods may contribute to water scarcity and could have adverse impacts on communities, especially on women and girls. SDG 3, 5, 6, 14, 15

– Rising commodity prices may trigger more unregulated or illegal artisanal and small-scale mining (ASM). SDG 8, 12

– Local government capacity constraints in remote regions may hinder effective planning for sustainable development outcomes. SDG 1, 2, 3, 4, 5, 10, 11

– Lack of robust, public geological data may hinder competition in the development of transition minerals. SDG 9, 10, 12

– Regulation may lag behind developments in the market for transition minerals, causing governance gaps. SDG 8, 12, 16

– Fast-tracking contracts and licenses may increase corruption risks. SDG 10, 12, 16

– Local content policies and state participation may enable favouritism and corruption. SDG 8, 12, 16

– Opaque tax structuring across transition mineral value chains may result in lost revenue for governments. SDG 1-12, 16

– Price volatility may lead to unpredictable revenue flows and macroeconomic planning challenges. SDG 8, 16

– Export-oriented mining policies may fail to realise potential for mineral beneficiation and value addition. SDG 8, 16

– Rushed public procurement for low carbon energy and transport infrastructure may open new channels for corruption. SDG 8, 12, 16

Risks across transition mineral value chains

Risks to the energy transition

– Rising mineral prices may drive smuggling and other illegal activities. SDG 8, 12, 16

– Smelters and refineries may be unable to meet environmental, social, and governance (ESG) standards due to production pressure and soaring energy costs. SDG 3, 6, 7, 8, 12, 14, 15

– Commodity trading deals increasingly involving state-owned enterprises (SOEs) may be at heightened risk of corruption. SDG 16

– Tightened due diligence regulations may disadvantage high-risk producer countries. SDG 10

– Governance weaknesses may disrupt the supply of transition minerals needed for low-carbon energy technologies. SDG 7, 13

– Transition mineral strategies may lead to a decarbonisation divide between mineral producer and consumer countries. SDG 10

– Geopolitical rivalries may weaken cooperation on the energy transition. SDG 7, 13

  • 2 The SDGs: No poverty (SDG 1), Zero hunger (SDG 2), Good health and well-being (SDG 3), Quality educ (...)

Note: Risks directly associated with IFFs are set in italics.2

Source: Sturman et al. (2022).

11To a large extent, the impacts of commodity sectors on SDGs will depend on the quality of state governance and the capacity of states to create conditions and to enforce rules enabling the maximisation of positive impacts and prevention or remediation of negative ones. Weak state capacity to ensure financial integrity can contribute to conditions enabling IFFs and more broadly undermine long-term inclusive economic growth (Sharma and Mishra, 2022). The United Nations Economic Commission for Africa, for example, has concluded that key elements of the MDGs, such as halving rates of poverty, could not be achieved in African countries in part because of IFFs (UNECA, 2015; see also Igbatayo, 2019). Similar concerns exist for the SDGs, as IFFs can negatively affect poverty reduction (SDG 1) and quality education (SDG 4), while increasing inequalities (SDG 10) and—in a feedback loop—undermining ‘accountable and inclusive institutions promoting peaceful and inclusive societies’ (SDG 16).

12Poor governance can also negatively affect the impact of commodity sectors on a broad set of SDGs, including those relating to environmental quality (Elmassah and Hassanein, 2022). Using a data set for 26 African countries over the period 1990–2016, Tiba and Frikha (2019) confirm institutional quality can reduce the adverse effect of the resource curse, including on SDGs. The study stresses the importance of reducing corruption levels, including through greater accountability, as well as reinforcing state institutions building human capital. In another study, Barbier and Burgess (2023, 1) observe net welfare changes associated with the 17 SDGs for 99 emerging market and developing economies (EMDEs) over the 2000–2019 period and conclude that ‘long-term progress towards the SDGs in EMDEs hinges on improved management of natural capital and the environment, as well as more effective governance’. They note that this, in part, relies on improving the management and distribution of resource revenues.

2.1 Commodity Sectors’ Vulnerability to IFFs

  • 3 For detailed case studies of IFF risks along gold and cocoa value chains in Ghana, see Brugger and (...)

13Commodity sectors, especially extractive ones, are generally considered vulnerable to IFFs (Anderson, 2014; Gillies, 2019; Kolstad and Søreide, 2009). This vulnerability can notably result from (i) control by political elites enabling discretionary actions facilitating IFFs, including the blurring of public, shareholder and personal interests in national companies; (ii) limited competition and long-term contracts in commodity sectors resulting in fewer checks and balances compared to more competitive industries; and (iii) inadequate domestic regulations and/or ineffective enforcement combined with complex technical and financial international processes creating opportunities for manipulation in the absence of sound contracts and robust auditing capacity (Le Billon, 2011; Pasculli, 2020). Various stages within commodity project cycles and nodes within commodity supply chains are particularly exposed to specific types of IFFs. For example, initial negotiations over contracts for mineral extraction can lead to high level corruption, while mine construction can increase risks of local over-invoicing to inflate tax-deductible costs and petty corruption to facilitate equipment imports and licences. Mining operations can involve transfer pricing to reduce apparent profitability, and commodity trading can facilitate tax evasion through trade mispricing (Fotoyi, 2021; Nesvetailova et al., 2021).3

2.2 State Capacity and Commodity Sectors

  • 4 Shaped in part by historical legacies, state capacity requires sustained investment in education, i (...)

14State capacity generally describes a government’s ability to design policies, enforce laws, and address the needs and aspirations of its citizens, including through the collection and allocation of public revenues (Besley and Persson, 2010; Savoia and Sen, 2015).4 Strong state capacity is required to ensure effective fiscal policies, create transparent and accountable revenue collection systems, and manage revenues to ensure positive developmental impacts from commodity sectors (Akintayo, 2021). This encompasses institutional, administrative, and technical expertise components requiring a skilled workforce and sound bureaucratic processes capable of establishing transparent, accountable revenue collection systems, independent regulatory agencies overseeing commodity sectors, and legal and regulatory frameworks that can promote SDGs (Collier et al., 2010). Greater capacity can, for example, better define and enforce clear property rights, sustainably manage resources, capture and distribute revenues, prevent conflicts, and enforce labour, socio-environmental, or financial standards. In contrast, low capacity can lead to overexploitation, labour abuses, low revenues and environmental degradation, fuelling tensions and undermining the pursuit of SDGs.

15 When put to good use, state capacity positively correlates with many development indicators (Besley et al., 2022). Yet there are many challenges to building up state capacity for the public good, including legacies and ongoing predatory forms of (neo)colonialism often associated with resource sectors (Acemoglu, 2003; Igwe and Amadi, 2020), clientelistic or patrimonial networks seeking to maximise benefits for incumbent elites (Fergusson, Larreguy and Riaño, 2022), and foreign governments and companies pursuing weak regulatory contexts (Fergusson, Molina and Robinson, 2022; TI, 2021). Whereas some states have strengthened their capacities for revenue capture, they have not had strong incentives to develop capacity for revenue redistribution in order to achieve inclusive development objectives (Anderson, 2014). In Angola, for example, Amundsen (2014) explains that domestic ruling elites have protected and buttressed institutions of extraction—such as a strong state oil company and financial capacities enabling the extraction of oil rents from foreign companies’ extraction—but have sidelined and impaired institutions of redistribution to prevent regime change and wealth redistribution. Whereas Angola has not actively pursued ETM production, another oil rentier state, Gabon, has vigorously promoted the growth of its manganese production in order to better prepare for ‘post-oil’ future development. Gabon has also actively promoted investments in ‘climate-smart’ conservation through forest-based carbon sequestration. While these activities can assist with decarbonisation and economic diversification, they also risk undermining the rights and traditional livelihoods of local populations through forced displacement and resource access loss (Ali et al., 2023). Among other petrostates, Venezuela serves as a ‘cautionary tale for resource-dependent economies that may also undergo post-oil transitions in the future due to shifting global conditions but likewise lack the necessary state capacity to respond and adapt’ (Rosales and Clark, 2023, 1).

16 Countries relying heavily on commodity sectors face specific challenges, including ‘resource curse’ effects potentially degrading the quality of institutions and increasing the macroeconomic instability associated with commodity boom-and-bust cycles (Le Billon and Good, 2016; Loayza et al., 2007). Mobilising commodity sectors for development bears specific challenges due to the often remote location of resource extraction sites, which require costly infrastructure development, with commodity-related infrastructures creating IFF risks of their own (Adam and Fazekas, 2023). Many commodity-rich areas have long been marginalised and although new mines’ ETMs can contribute to local economic growth, it is often difficult to promote inclusive development through local employment and revenue spending, given the frequent influx of migrants into new mining areas and limited local absorptive capacities (Svobodova et al., 2022). Local resentment against commodity schemes can also increase the risk of community-level conflicts and further reduce positive development outcomes, especially as prior consultation processes for ETMs may be expedited and perceived to be imposed on local communities for the benefit of distant elites and consumers (Conde and Le Billon, 2017; Dunlap and Riquito, 2023; Owen et al., 2023). Finally, concentrating state capacity building around commodity sectors may unintentionally undermine economic diversification as efforts and talent get too focused on these activities and increase the risk of continued exposure to hard-to-manage commodity dependence risks, such as external price shocks (Le Billon and Good, 2016; but see Meierding, 2022).

17Beyond state capacity, the effective financing of SDGs and inclusive development outcomes also depends on the capacity of other actors, including alliances of local, regional and international organisations. Such capacity includes the ability to circulate and act upon information pertaining to commodity revenue flows, including tax evasion and corruption. International financial cooperation and anti-corruption organisations can play a major role in this regard, including those in the home countries of extractive companies (Villeneuve, Mugellini and Heide, 2020; Williams and Le Billon, 2017). The strengthening and protection of independence for non-state actors indirectly participating in commodity revenue governance, including civil society and the media, is crucial, and may require a mix of training, arm’s-length financial support, the guarantee of political rights, and even physical protection (Arsenault and Le Billon, 2022).

2.3 Harnessing the Energy Transition for Sustainable Development?

18Conceived as an energy transition from fossil fuels to alternative sources of energies paired with widespread electrification, the decarbonisation of economies will demand massive amounts of ETMs for the deployment of alternative energies and associated networks, products and services (Hund et al., 2023). Core ETMs include cobalt, graphite, lithium, manganese and nickel for battery storage, aluminium and copper for electricity networks, and rare earth elements for electric vehicle (EV) motors and wind turbines. A GIZ/Econias report estimates that ETM-related government revenues in the coming two decades will mostly accrue from copper (44%), lithium (22%) and nickel (20%) (Born, Heerwig and Steel, 2023). Most ETMs have long been exploited, but their growing importance and revenue implications increase stakes around associated financial flows. The risks of IFFs for ETMs are generally similar to those experienced for other mineral sectors (e.g. corruption, abusive transfer pricing), but can be exacerbated by the rapid pace and competitive character of these sectors, as well as by more opaque or oligopolistic trading markets (e.g. for rare earths and cobalt, see Klinger, 2018; IGF, 2023).

19Governments and corporations are deploying hundreds of billions of dollars to secure their places in this new ‘green tech economy’ (Allan, Lewis and Oatley, 2021). The transition will also require the reconfiguration of diverse economic sectors, as land and water are reallocated to ETM mines, biofuels, dams, solar panels, wind farms or transmission lines (Huber and McCarthy, 2017). Although the likely pace of this transition and its impacts on fossil fuel production remain debated and geopolitical events may again send prices soaring, government oil revenues should structurally be facing downward pressure from a progressive decline in demand from high-income countries due to growing numbers of EVs, rising production costs as the complexity of extraction increases, and a likely reduction in investments in new fossil fuel projects.

20There are concerns that a rush for ETMs may undermine good governance principles, infringe rights, and exacerbate social inequalities (Clark, 2023; Owen et al., 2023; Sturman et al., 2022). Among the most prominent examples of this is the ‘lithium rush’, which has seen numerous projects being proposed across nearly all regions of the world. Allegations of corruption have, for example, been made regarding vested private interests of local governors in Argentina, bribery and political financing by lithium companies in Chile, the acquisition of the Uis lithium mine in Namibia by Xinfeng Investments, and the development of the Manono deposit in the DRC (FARN, 2023; Global Witness, 2023). In Zimbabwe, artisanal miners were reportedly violently evicted from the Sandawana mine to facilitate a takeover by ‘companies with close ties to Zimbabwe’s ruling ZANU-PF party and the military, including entities facing US or EU sanctions’ (Global Witness, 2023, 2-3). In Portugal, Prime Minister Antonio Costa resigned following a corruption probe into the awarding of lithium mining licences (Shaw, 2023). Concerns are particularly acute for countries with weak state capacity as they are more likely to lack the necessary institutional frameworks and technical expertise to address environmental, social and financial challenges. For example, most of the world’s ETM projects are taking place within or in close proximity to the lands of Indigenous peoples and peasant communities, ‘with adverse conditions for human rights-compatible permitting, consultation, and consent’ (Owen et al., 2023, 203).

21The energy transition creates more competition over access to mineral resources, as countries and companies seek to secure mineral supplies for ‘green technology’ sectors. Competition can give producers a stronger negotiating position vis-à-vis investors regarding fiscal terms and requirements for local content or value-added activities. Yet there is also competition among producers as commercial deposits of some ETMs, such as lithium, abound and there are concerns over possible oversupply (Kumar, 2023). Attempts to achieve or maintain a dominant position can lead to what political scientist Eduardo Gamarra calls ‘geostrategic corruption’, which some critics see as being systematically employed by Chinese companies (cited in Saavedra, 2023). Key state capacities for the ability of countries to address IFF risks (see Table 10.2) and harness commodity sectors to meet the SDGs in an energy transition context are discussed below (see Musselli and Bürgi Bonanomi, 2021).

22Much of the fiscal capacity of the state primarily relates to the set of regulations and contracts it can position to maximise revenues and development outcomes. With many new investments taking place and greater competition between companies (but also between producing countries), the energy transition offers a renewed opportunity to reform investment and mining laws, which could increase rents and minimise the negative impacts of the sector. These reforms need to account for the capacity of the state to maintain or improve its regulatory reach. While countries with relatively weak capacities should aim to strengthen them, they should first establish easy-to-enforce rules to reduce IFF risks, such as withholding taxes and the use of referenced commodities (Musselli and Bürgi Bonanomi, 2021). However, the large number of proposed transition projects risks stretching the licencing process capacity of the host government, with a greater risk of corruption accompanying the speeding up and securing of such projects—especially as the competitive context between firms as well as between countries can erode integrity standards, promote regulatory shortcuts, and more generally create a ‘resource rush’ mentality enticing bad behaviours (Sahla and Salomon, 2022).

23States require the capacity to undertake mineral valuation and auditing for both mining and trading operations. The undervaluation of minerals and overvaluation of mining costs—including procurement and services—are two of the basic practices behind IFFs in extractive sectors (Hubert, 2017; OECD, 2016). This requires human, legal and technical resources, which can now include tools such as smart containers and blockchain technology (Chuah, 2023; Okazaki, 2018). This can be challenging when the extraction of ETMs is new in the country, or when the scale of operations changes (e.g. through a new, large-scale, industrial or a small-scale mining rush; see Maconachie and Conteh, 2021). For example, many ETMs are by-products—or ‘subsidiary materials’—of base metals mining operations (Nassar, Graedel and Harper, 2015); being able to detect and tax ETMs has become increasingly important as they have gained value in the context of the energy transition. To build capacity, states can invest in human capacity and information technology (Hemling, Rossing and Hoffjan, 2022), subcontract ore concentration assessments to trusted external laboratories and auditors, leverage international technical assistance, learn through regional exchanges, and require arm’s-length training and equipment from investing companies. Technical and regulatory changes can include disaggregated trade data reporting, with new categories according to ore grades and by-product contents (Carbonnier and Mehrotra, 2020).

24Depending on the type of contracts involved, much of state revenue may come from commodity sales contracts. Maximising revenues relies on the selection of buyers and the characteristics of such contracts. IFFs can occur through the biased or corrupt selection of buyers, as well as due to unethical contract characteristics with regard to their duration, terms of trade, and redress mechanisms (Porter and Anderson, 2021). States need to have the capacity to assess the best possible buyers and establish fair and enforceable contracts. Again, the energy transition may pose specific challenges, as the processing and refining of many ETMs and the manufacturing of related products are concentrated, especially in Chinese firms with low levels of transparency in sales contracts (Ali et al., 2022; Church and Crawford, 2018).

25Curtailing IFFs requires a capacity to exchange information and cooperate with other domestic and international agencies—such as anti-corruption agencies and fiscal and customs organisations—that hold important data for IFF detection and accountability (Ebire and Daniels, 2022). This rests on adequate regulations and integration into relevant networks, as well as on appropriate human capacity including legal skills. Several international initiatives can facilitate this exchange of information, including the Global Forum on Transparency and Exchange of Information for Tax Purposes, the Oslo Dialogue, and the Financial Action Task Force. Capacity is used for accounting and data matching skills and to implement accountability mechanisms at fiscal and judicial levels. Information exchange can be crucial to the detection of transfer pricing and to identifying and tracking down beneficial owners (Westenberg, 2018).

26 The energy transition has significant implications for state capacity to manage commodity sectors’ revenue flows for development purposes. Countries that are heavily reliant on the production of fossil fuels may face a significant drop in annual income in the case of an effective transition towards ETM-based renewable energy sources. IFFs can exacerbate these challenges as patterns of fossil fuel and other mineral rent mismanagement may also be repeated for ETMs. Table 10.2 outlines some of the major risk factors of IFFs in resource sectors. Challenges are expected to be particularly acute for countries with weak state capacity and/or a poor record of resource revenue management, as they will lack or misuse the institutional frameworks and technical expertise necessary to effectively manage the transition and prevent IFFs. Table 10.3 highlights the main ETM producers and their relative ‘score’ in terms of the SDGs, vulnerability to IFFs, criminality within non-renewable resource sectors, quality of resource governance, and perception of corruption level. While such indicators need to be interpreted with caution, Table 10.3 suggests that most countries face serious issues across multiple dimensions, with the partial exception of Australia and Chile. The countries most at risk include the DRC and Myanmar, followed by Mozambique, Madagascar and Zimbabwe, suggesting that historical legacies of colonialism, civil strife and prolonged resource dependence undermined state capacity and integrity.

Table 10.2 Risk factors of IFFs in extractive sectors.

Decision to extract

– Insufficient resources and information to assess the country’s reserves

– Political discretion and poor governance

– Specific risk factors associated with environmental and social impact assessments and land tenure

– High-risk investment

Awarding of mineral rights

– Non-transparent and asymmetric negotiation and contracts

– Inadequate legislative, regulatory and governance framework of the licensing process

– Lack of host governments’ technical, human and financial resources to manage contract negotiations

– Political interference and public-private collusion

– Opacity in the process of reallocation of a licence or contract to a third party

– Opacity and discretion in bidding processes

Absence of an open and competitive bidding process

– Opaque and complex financial and commercial arrangements

– Nature of the market with high entry costs and limited number of competitors

Extraction operations and regulation

– Opacity and discretion in the procurement of goods and services

Patronage, cronyism, clientelism, and favouritism

– Lack of competition

– Ill-designed local content requirements setting unrealistic targets

– Uneven, irregular, and non-transparent enforcement of local content requirements

– Vague criteria for the evaluation of waiver applications

– Lack of, weak or inadequate internal procedures for book and record-keeping and monitoring

– Sudden fluctuations in consultancy fees

– Lack of adequate control and metering capacity on production, storage, and transportation

– Lack of a coherent framework for measuring and monitoring the country’s subsoil wealth

– Lack of transparency regarding the process of privatisation or selling of shares

– Lack of, or inadequate due diligence procedures governing relationship with suppliers
– Inadequate corporate internal rules, procedures merging and acquisitions transactions

Revenue collection

– Inadequate legislative and regulatory framework for revenue collection

– Weak technical, financial, and human capacity in revenue administrations

– Lack of revenue collection related data transparency and access

– Inadequate tax-related corporate strategy and procedures

– Opacity of commodity trading transactions

– Opacity over ownership and governance structures of key actors involved in commodity trading

– Lack of transparency on commodity-trading related data

– Lack of or insufficient corporate due diligence

Revenue management

– Lack of a coherent, consistent, and disciplined fiscal policy framework

– Weak governance and mismanagement of natural resource funds

– Lack of clear, transparent, and consistent rules governing revenue transfers

– Lack of co-ordination and asymmetries of information between national and sub-national governments
– Lack of human, technical and financial capacity of subnational governments

Revenue spending and social projects

– Insufficient capacity for budget planning and execution

– Lack of transparency of public procurement processes

– Inadequate control and monitoring by central authorities

– Mismanagement of extra-budgetary allocations

– Inadequate energy subsidy system

– Lack of transparency and asymmetry of information about social expenditures made by companies

– Mismanagement and misallocation of social expenditures
– Weak governance of social development
funds

Source: adapted from OECD (2016).

Table 10.3 ETMs and relevant indicators.

Table 10.3 ETMs and relevant indicators.

Sources: SDG score (dashboards.sdgindex.org/rankings); IFF: IFF Vulnerability Tracker from Tax Justice Network (https://iff.taxjustice.net/​#/​); Criminality: Criminality in non-renewable resources from the Global Organized Crime Index (ocindex.net); RGI: Resource Governance Index from the Natural Resource Governance Institute (resourcegovernanceindex.org); CPI: Corruption Perception Index from Transparency International (transparency.org/en/cpi/).

27To sum-up, the mobilisation of ETM revenues for SDGs presents classic challenges associated with extractive sectors, but also opportunities to improve mineral revenue management and promote economic diversification through downstream value addition (IGF, 2023). The rapid growth in demand for ETMs as well as their (geo)political dimensions currently sets this category of minerals apart. Still, lessons learned around reducing corruption and other IFFs—and their implications for the SDGs—apply to ETMs (Igbatayo, 2019), with some progress having been made, for example, in terms of corruption prevention, identification of beneficial ownership, and the fight against abusive transfer pricing (Chowla and Brown, 2023; Makinde and Le Billon, 2023; NRGI, 2022).

3. International Instruments to Reduce IFFs in Relation to the Energy Transition

28So far, the main relevant anti-IFF instrument has been the EITI, which includes an inclusive multistakeholder governance model and elaborate compliance standards to bring greater integrity in natural resource revenue flows (Le Billon, Lujala and Rustad, 2021). Launched in 2003, the EITI has helped to disclose trillions of dollars in revenues from about 56 countries—mostly low- to middle-income countries that are also aid dependent (Rustad, Le Billon and Lujala, 2017). The EITI (2023) recognises that the energy transition will have ‘a transformative impact on the extractive industries and global economy […] expos[ing] producer countries to new risks and opportunities, requiring governments of resource-rich countries to make important decisions about the management of their natural resource wealth’. The EITI already covers disclosure for ETM sectors in participating countries (Sturman et al., 2022) and is considering options for increasing transparency and preventing corruption in renewable energy sectors (Zinnbauer and Trapnell, 2023). Of particular relevance to IFFs, the EITI’s standards require greater disaggregation and information on beneficial ownership, which can be useful to prevent or track down illicit flows (Markle, 2022).

29At least two other international instruments are also relevant to IFF risk reduction, even if their primary goal is to ensure reliable ETM supplies in a competitive geopolitical context. Announced in June 2022, the US-led Minerals Security Partnership (MSP) brings together a number of Organisation for Economic Co-operation and Development (OECD) countries and mineral-rich countries to strengthen their ETM supply chains and reduce their dependence on China. The MSP’s stated goal is to ‘ensure that critical minerals are produced, processed, and recycled in a manner that supports countries in realizing the full economic development potential of their mineral resources’ (US Department of State, 2022). Bringing together public and private investments, the MSP is expected to increase transparency and promote high ESG standards throughout critical minerals’ supply chains. A key market for ETMs, the European Union has also passed a new regulation (PE-CONS 2/23) deploying due diligence policies specifically requiring ‘battery business structures to have instruments in place to fight corruption and bribery’. While addressing IFFs is only a secondary objective for each of these instruments—and could conflict with their broader objective of securing supply independence from China—they can still provide leverage for curbing IFFs by directing attention to poor governance and corruption risks, and by providing the foreign assistance and corporate due diligence that could reduce them.

4. Conclusion

30The energy transition presents both challenges and opportunities for states to accelerate progress on the SDGs. Countries mining ETMs should, in principle, benefit from the energy transition through greater revenues and economic diversification. Yet there are many concerns about the realised effects of the transition revenue windfall on development outcomes, in part due to IFFs. To benefit from the energy transition, ETM producers need to carefully consider their development strategies, governance structures and organisational competences in order to maximise revenues and inclusive development outcomes, while avoiding repeat patterns of negative social and environmental impacts frequently associated with extractive sectors.

31Attracting foreign direct investment, moving up along the value-added ladder, and efficiently capturing and allocating revenues for inclusive development are critical dimensions if ETMs are to contribute to the SDGs. In this regard, ETM producing countries should not only increase their anti-IFF capacity, but also develop policies and capacities promoting domestic processing – rather than simply exporting ETMs as raw materials – as illustrated by Zimbabwe’s use of a ban on raw lithium exports to force investment into local processing (Chingono, 2023). Measures to integrate value-added activities within the domestic ETM supply chain should, however, avoid forestalling investments, as in the case of the long-delayed development of Bolivia’s lithium sector (Obaya, 2021). By forming regional or commodity trade blocs and collaborating on commodity governance, producing countries can address some of these issues, even though experiences among members of the Organization of the Petroleum Exporting Countries (OPEC) show the challenges and limits of cooperative behaviours (Colgan, 2014). Thus far, a majority of ETM initiatives have been led by high-income countries. Yet, some producers with lower income levels have considered the benefits of greater cooperation, including Argentina, Bolivia and Chile for lithium (Mares, 2022). In addition, efforts to build state capacity should also consider the indirect ways through which IFFs influence the operations of ETM sectors in order to minimise environmental impacts and enhance the overall well-being of citizens, and thereby help achieve the SDGs. Finally, efforts are required to increase the capacity of actors other than states, including civil society alliances, to ensure that the energy transition contributes to inclusive development in commodity producing countries. Further research could include the use of investigative approaches to ETM supply chains with poor disclosure, the assessment of key barriers to anti-IFF capacity building and implementation, and the evaluation of due diligence processes associated with ETM-related companies and financial intermediaries.

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Notes

1 This chapter focuses on mineral extraction for the energy transition. On illicit financial flows in renewable energy sectors, see, for example, Ren, Hao and Wu (2021), Sovacool (2021) and Williams (2022).

2 The SDGs: No poverty (SDG 1), Zero hunger (SDG 2), Good health and well-being (SDG 3), Quality education (SDG 4), Gender equality (SDG 5), Clean water and sanitation (SDG 6), Affordable and clean energy (SDG 7), Decent work and economic growth (SDG 8), Industry, innovation and infrastructure (SDG 9), Reduced inequalities (SDG 10), Sustainable cities and communities (SDG 11), Responsible consumption and production (SDG 12), Climate action (SDG 13), Life below water (SDG 14), Life on land (SDG 15), Peace, justice, and strong institutions (SDG 16), Partnerships for the goals (SDG 17).

3 For detailed case studies of IFF risks along gold and cocoa value chains in Ghana, see Brugger and Engebretsen (2019).

4 Shaped in part by historical legacies, state capacity requires sustained investment in education, infrastructure and public services (Maseland, 2018; Uslaner, 2017, Von Hau, 2012; for conceptual discussions of state capacity, see Cingolani, 2013; Hendrix, 2010; Hanson and Sigman, 2021).

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List of illustrations

Title Table 10.3 ETMs and relevant indicators.
Credits Sources: SDG score (dashboards.sdgindex.org/rankings); IFF: IFF Vulnerability Tracker from Tax Justice Network (https://iff.taxjustice.net/​#/​); Criminality: Criminality in non-renewable resources from the Global Organized Crime Index (ocindex.net); RGI: Resource Governance Index from the Natural Resource Governance Institute (resourcegovernanceindex.org); CPI: Corruption Perception Index from Transparency International (transparency.org/en/cpi/).
URL http://journals.openedition.org/poldev/docannexe/image/6668/img-1.png
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Cite this article

Electronic reference

Philippe Le Billon, Illicit Financial Flows, Extractive Sectors, and the Energy Transition: Building State Capacity to Finance the SDGsInternational Development Policy | Revue internationale de politique de développement [Online], 17 | 2024, Online since 27 May 2024, connection on 16 June 2024. URL: http://journals.openedition.org/poldev/6668; DOI: https://doi.org/10.4000/11q9g

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About the author

Philippe Le Billon

Philippe Le Billon is a professor with the School of Public Policy and Global Affairs at the University of British Columbia (UBC). Before joining UBC, he was a research associate with the Overseas Development Institute (ODI) and the International Institute for Strategic Studies (IISS). He holds an MSc, MBA and DPhil (Oxford). His research topics include geographies of violence, the political ecology of primary commodities, and linkages between the environment, development and security. He has published widely on natural resources governance, the political economy of war, and environmentalism. He is the (co)author or editor of Wars of Plunder: Conflicts, Profits and the Politics of Resources (OUP, 2014), Oil (Polity, 2017), Corruption, Natural Resources, and Development (Elgar, 2017) and Environmental Defenders: Deadly Struggles for Life and Territory (Routledge, 2021).

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