Wednesday, June 09, 2010

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

I've come up with a way out - something designed to give the mining companies what they say they want while giving the government what it wants.

But there's no point. The mining companies don't really want what they say they want. Not yet. Not by a long shot. Not while there is a chance of toppling the government.

Their behaviour makes sense on two levels. Most simply, no-one likes paying more tax. Company directors are required to maximise after-tax returns. But more profoundly, if Australia's proposed super profits tax can be stopped before it starts it won't be mimicked worldwide. Governments far more cash-strapped than Australia's are waiting to see what happens. If Rudd wins, India, Canada, Peru, Chile and the nation that's hosting the World Cup might follow, making mining less profitable all over.

But still incredibly profitable. The Treasury official who consulted with Australia's miners David Parker told a Senate committee last week that some of the projects whose numbers he examined had "a payback period of less than six months... that is, they return all their capital in less than six months - and they have an internal rate of return in excess of 400 per cent".

Treasury believes that if all of such a project is worth doing, so too would 60 per cent of it after that government had imposed itself as a 40 per cent partner. The (smaller) investment would be recouped just as quickly at just as sharp a rate of return.

So what's the miners (stated) gripe? It is that the government isn't actually planning to put up 40 per cent of the costs as a genuine partner would. It is promising to come up with them in time by subtracting them from future tax payments (or the tax payments of other mines owned by the same company).

To the extent that it delays coming up with the 40 per cent it will compensate the miners it eventually pays by giving them interest, calculated at the government bond rate.

Ken Henry says the bond rate is the right one because what the government is offering is mathematically the same as a AAA rated government bond.

It is not called a bond because then the government would have to deal with Barnaby or Andrew Robb or someone firing up a debt truck and going on about the debt that will be left to our children (notwithstanding the quick payback period of many mines).

But Henry reckons it is the same and any half-decent financial institution can make it so. As he put it to a group of economists last month, "the people we call financial engineers can translate theory into practice at the speed of light".

It is not particularly difficult financial engineering. The Bendigo Bank will advance me money against the proceeds when I eventually sell my house and is prepared to wait.

But Andrew Forrest of Fortescue Mining has told the stock exchange a government guarantee is "of little value to banks and project financiers".

"Who believes that companies could fund 40 per cent of an investment on the strength of some future unbudgeted government tax credit," he asks.

I'm suggesting the government short-circuit the argument and set up a company that would do just that.

For a fee this off-balance sheet government authority will come good with 40 per cent of a mine's development costs upfront, relying for the bulk of its income on the tax receipts the government will send its way when they arrive and borrowings at the government bond rate.

The bonds it issues would be popular. Amongst banks and super funds there's a shortage of AAA-rated investments.

Miners may well choose not to use the authority and avoid paying the fee. The big ones are awash with cash and wouldn't need it. But they wouldn't be able to claim they couldn't get finance.

In reality this complaint matters little to most miners (although if it does matter I have solved their problem).

What worries them much more is a higher average tax rate that would still leave them extraordinarily profitable and spread worldwide.

And given that that is the point of the super profits tax it is hard to see how the government can satisfy them. And in any event it is hard to know who to satisfy. Many of the mining companies scarcely talk to each other let alone like each other. Who would the government reach agreement with? If it found negotiating with the Coalition over the emissions trading scheme impossible it would find this worse. As soon as it gave one company what it said it wanted another would disown the "deal".

There's nothing fundamentally wrong with what the government is proposing - nothing to negotiate away except the tax itself.

And just as there is a lot at stake for the miners worldwide, there is a lot at stake for government - for the idea of government.

If our government can't pull this off, can't exercise its sovereign right to introduce economic reform in the same way as have other governments when they reduced tariffs, taxed offshore petroleum and taxed goods and services, it will have diminished what is seen as possible.

The Hawke and Howard years will be seen as high water mark for what Australian governments used once to be able to achieve.

There's really no way out and not much of a way back.

Published in today's SMH and Age

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