Thursday, June 10, 2010

"Resource companies will leave Australia only when there are no more minerals and energy to extract"

Ian Verrender, who is less polite than I am, in today's Herald:

"Enough is enough. If one more person looks me in the eye and talks about sovereign risk and the new resources tax, I swear I'll strangle them.

Let's get it straight. Even by the loosest definition, modifying the tax system in the manner proposed by the federal government does not in any way endanger the national ability to repay debt.

Nor will it endanger the ability of resources companies to meet their commitments.

And that, dear reader, is the definition of sovereign risk.

As with many developed nations, Australia has become more exposed to sovereign risk as the global banking system was bailed out with taxpayer funds, the consequences of which are playing out at this very moment in Europe.

In our case, taxpayers underwrote $100 billion of offshore borrowing for our big banks, lifting our risk profile.

But raising the rent for a bunch of tenants profiteering on the back of resources they do not own does not increase sovereign risk. It is simply an owner exercising ownership rights...

Joseph Goebbels, the master of propaganda, noted: 'If you tell a lie big enough and keep repeating it, people will eventually come to believe it.'

And so we have the current scare campaign, being waged by a sector of the economy that has suddenly found itself in the midst of a boom, the likes of which it could never have imagined possible, not even in the wildest dreams of the most optimistic of speculators, less than a decade ago.

Earnings have grown in spectacular fashion, at a pace few have scarcely believed. And there is almost universal agreement this trend will continue.

The old cumbersome state-based royalty system, calculated on the volume of dirt rather than dollars, has meant that the overall profit share from mining has turned dramatically in favour of resources companies. For the proof, see the bottom line of their annual accounts.

Not surprisingly, with the stakes so high, truth has been cast aside. The ever more hysterical arguments from industry spokesmen are so intellectually bankrupt, so bereft of reason, they defy description.

The truth of the matter is this. The big resources companies certainly pay large licks of tax. But they do not want to pay more. They want to capture the windfall gains for themselves, for the executives to pay themselves ever bigger bonuses and their shareholders ever greater returns.

That is a perfectly understandable and legitimate argument. That is the essence of capitalism. That is what companies are supposed to do. That is what executives are paid to do. It also is the reason Xstrata is headquartered in Zug, Switzerland, a nation not ordinarily known for its mining potential.

But you won't get too far using that logic in argument such as this.

And so, from the industry's viewpoint, the focus is on employment, while the profit side of the equation has been cleverly shoved into the background. Listen to the rhetoric. They don't refer to a Resources Super Profit Tax. Instead it has been modified to the far more politically charged Resources Super Tax.

The other great lie in this debate is the notion that the new tax is retrospective. Look up the definition. Don't worry, I'll do it for you.

'1. Directed to the past; contemplative of past events'.

The new tax applies to future earnings. It does not impose penalties or an impost on past earnings and cannot be considered in any way retrospective.

But the argument has been twisted: because it applies to projects that are already in operation, this somehow means it is retrospective.

Apply that argument to personal income tax. If a pay rise catapults you into a higher tax bracket, try arguing that you shouldn't have to pay because you've had the same job for years and that it should apply only to new employees.

The reason the new tax applies to existing mines, particularly the Pilbara iron ore deposits being exploited by BHP Billiton and Rio Tinto, is that they yield fabulous riches to the operators. Development costs were written off decades ago when iron ore prices were a mere fraction of current levels.

Well-funded fear campaigns, bolstered by arguments such as these, have become regular events over the years within the mining industry.

The gold tax was supposed to wipe out gold mining in Australia, leaving thousands unemployed as miners rushed offshore. Indigenous land rights legislation in the wake of the Mabo decision was going make Australia a laughing stock.

In both cases, the threatened mining exodus failed to eventuate.

Why? The answer is simple. Australia has world-class resources. It has first-class infrastructure. It has a highly educated population. It has a transparent government and efficient bureaucracy. It is located geographically within the fastest growing economic region on earth.

Resource companies will leave Australia only when there are no more minerals and energy to extract.

The federal government could be accused of many things in this debate: naivety, poor presentation, insufficient consultation.

And while Ken Henry's resources super profits tax is ''elegant'' from a structural and economic viewpoint, you have to wonder why on earth the federal government simply didn't extend the resources rent tax that has been operating for decades on our offshore petroleum industry.

Politically, that would have been far simpler to sell. And we might have had a debate based on logic rather than fear."

Related Posts

. Wednesday column: No way back, no way out - the miners don't want a deal

. Who wins? Who loses? This is worth reading

. Henry: "Frankly there is more than enough investment in train in the mining sector"

. Three of the best things written about the Resource Super Profits Tax


Matt C said...

What rot.

The ability of the government to honour its debt is credit risk not sovereign risk.

This tax clearly can endanger mining companies' ability to meet their commitments. Indeed, it could do that even if you believe the Treasury's theory.

Let's say I borrowed $100 billion at 10% to invest an expect to earn 112 the next year.

The government now taxes $6 of my profit (assuming 6% bond rate). The 40% rate on that $6 is 2.40.

I need to pay the bank back $110 but now I only earn 109.60.

That's sovereign risk and it's before company tax applies.

Peter Martin said...

What if the prices for the things you sell doubled?

Marek said...

Peter can you out up some worked examples of how the tax works? My understanding(using the example above)is that the company would have a deduction of $106mil for rspt purposes and therefor pay no rspt

Anonymous said...

The definition of sovereign risk is that a future government may not honour its liabilities. To the extent that a future government may not honour the 40% tax credit sovereign risk exists. Similarly, the fact that the current government wishes to impose a tax on retrospective investments implies sovereign risk relative to past government decisions.

Anonymous said...

The RRT cannot be the same as the PRRT because offshore oil/gas wells don't pay royalties

carbonsink said...

Adam Carr says Rudd will cave today on RSPT

Mind you, Adam also thinks that booming Chinese exports to Europe in May is entirely plausible. Adam is a data-driven man after all, as long as that data isn't US Non-Farm Payroll data, which he still hasn't mentioned.

Anonymous said...

Doubled? They said the price of iron ore (IIRC) had gone up 900% since the beginning of the last mining boom, on Four Corners last Monday. The only risk here is that the mining industry might not make as much of a killing.

Peter Martin said...

Doubled this year.

carbonsink said...

What if the prices for the things you sell halved?

The sustainability of Chinese growth is the big issue in commentary today. Tony Boyd (Chanticleer) of The Australian Financial Review offers an interesting canvass of prominent pundits. He lines up on one side of the room “... the sceptics and short sellers who are predicting a dramatic crash caused by the bursting the of country’s property bubble. The sceptics ... include US hedge fund manager Jim Chanos, Gloom Boom and Doom report author Marc Faber, Harvard professor Kenneth Rogoff and eccentric UK hedge fund manager Hugh Hendry. On the other side of the room are an eclectic mix of believers in the China growth story including Reserve Bank of Australia governor Glenn Stevens, former Prime Minister Paul Keating, global fund manager Hamish Douglass and the author of a new book on China’s Communist Party, Richard Macgregor.”

According to Boyd, “...the hedge funds that seek to make money from the next crisis wherever it occurs have been talking their books all year.” Faber, says Boyd, argues, “...China’s growth is a ‘bubble’ and that its official economic growth numbers cannot be trusted. Rogoff agrees that economic data from China is so poor that it makes it hard to evaluate what is going on in its inflated property sector ... but it must have business cycles.”

Boyd is non-committal but ends with Douglass, suggesting his may be the best of the views: Douglass “... rejects the idea that China is a train wreck waiting to happen [but] thinks a slowing economy and decline in fixed investments, and slowing in the European economy – which takes 40 per cent of China’s exports – will have ramifications for commodity prices. He predicts commodity prices will fall by 50 per cent over the next eighteen months ...

This column will simply add that it could not have put it better itself, and will note that a 50 per cent drop in Australia’s key exports may leave the miners profitable, but will hammer Australia.

John Garnaut's investigations suggest Chinese iron ore prices will more likely halve than double, but hey, what would John Garnaut know about China?

Peter Martin said...

They have doubled. If they halve they will go back to oooh.. where they were in February.

(Which is four times higher than when most of the mines were set up)

Bernard S. Jansen said...

"Resource companies will leave Australia only when there are no more minerals and energy to extract."

Then why not implement a 95% tax? The mining companies are only profiteering from resources that belong to the Australian people. The companies will stay until they've taken all of the resources, regardless of the tax rate, so let's just throw them a 5% bone and reap the rewards.

Better still, why don't we kick out the mining companies and have mining performed by a new federal government department? We have a "transparent government and efficient bureaucracy", so a government-owned mining operation would make more money for the people than those foreign-owned profiteers baying their executives big bonuses.

carbonsink said...

That would be February 09, not February 2010.

Iron ore spot prices bottomed out in the mid 70s. If they halve (from $144 today) they'll be where they were at the depths of the GFC.

I'm not suggesting the miners won't be profitable at those prices, but a global economic environment where iron ore prices halve, is not a happy environment for the Australian economy.

But never mind ... it can't happen. Don't listen to Garnaut. Glenn knows best.

Peter Martin said...

Dear Bernard, You raise an important point.

(By the way here's Ken Henry before the Senate Committee: "I do not want to make too much of this, but other countries—take Norway, for example—have managed to attract very substantial amounts of private capital investment while taking 95 per cent of the profits.")

Let's use a 50% RSPT to consider the idea.

A mine that previously had, say, a 12% return on capital would find the government putting up half the capital and getting half the return. The total return and the return on capital would still be 12%.

Sure it would only get half as many dollars back, but if it wanted to open 2 mines instead of 1 it would get the same number of dollars back for the same capital invested.

(Naturally there is a lot simplified here; we are assuming capital markets work well or that the idea I proposed gets up. We are also ignoring the existing royalty charges which will be rebated, leaving the mine better off)

So yes - the RSPT would work at 95 per cent. Australia would go well down the queue of destinations to be mined, but it would still be mined in due course, still with a 12% rate of return in the example above (except that the rate of return might have gone up by then).

Now to your last paragraph, which is the crux of the argument for the RSPT. The government doesn't want to manage mines. I don't want the government to manage mines. It is not good at that sort of thing. The beauty of the RSPT arrangement is that it lets the people who are good at running mines run them. The government comes in as a shareholder, but a shareholder without a vote. Nifty, eh? I can think of a few chief executives who would be rather pleased to have such a shareholder.

Sean said...


With your view (above), have you spoken to mining executives, fund managers and other project financiers to see if they agree?

Peter Martin said...

I haven't spoken to executives. I have spoken to their representatives.

They don't engage on the maths. It is what it is. They could hardly disagree with it. It isn't a "view".

They just say that in the real world things aren't like that, as I acknowledged above.

My Wednesday column addressed these concerns.

As for having a silent shareholder imposed, putting up 40% of the costs and taking 40% of the profits, of course they don't like it - because they are making (or believe they will make) certain profits.

If they were uncertain about the profits however, it would be attractive.

But with mining as it is at the moment...

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