No risk and so much to gain

“A well-designed rent-based tax is less likely to distort investment and production decisions … essentially, the Government is a silent partner whose share in the project is determined by the tax rate.” (Henry Tax Review, pg 222.)

While Treasury Secretary Ken Henry might have been aiming at an economic purist’s form of resource rent tax, with no distortion of investment and production decisions, that is not what the Rudd Government has imposed.

The economic “seamless wonder” of the cheekily dubbed “Resources Super Profits Tax” fails completely to recognise the risks inherent in the mining industry and the way that both investors and companies will respond to a change in incentives.

The basics of the tax are as follows:

As of July 1, 2012, a new tax will be levied at 40 per cent of profits on all existing mining projects, once companies have covered the cost of the project and the cost of capital, set at the long-term bond rate.

The quid pro quo on this arrangement is that the government, our industry’s generous “silent partner”, also undertakes to return to investors 40 per cent of the tax value of losses. That is, when project losses are greater than project costs in any given year, this can be transferred to other profit making projects, or carried forward to the following year to offset future RSPT. The RSPT tax losses are only refunded when the project is closed.

The two big questions the government should be asking itself are:

• Will the new tax adversely affect the ability of mining companies to raise capital for Australian based projects?
• Will the new tax adversely affect the attractiveness of Australia as a destination for exploration and mining investment by large miners?

If the answer to either of these questions is “Yes”, then the government has - to cite the most commonly invoked cliché in relation to this tax - killed the goose that laid the golden egg, or at best plucked, clipped and even seasoned the goose while expecting it to continue to live a highly productive and happy life.

Will the new tax adversely affect the ability of mining companies to raise capital?

The answer to this question is: most probably, yes. Investors generally do not pick mining stocks, particularly small to medium sized miners without the diversified assets of a BHP-B or Rio Tinto, because of the inherent romance of the industry. These stocks are risky. They are risky because of the fluctuation of commodity price cycles, and the sudden adverse affect these fluctuations can have on projects. As we saw in 2008, these fluctuations result in exploration programs put on hold and mines closed or put on care and maintenance. During this time, the value of shares plummeted and dividends became a distant memory.

Moreover, due to the inherently variable nature of Australia’s geology (or any geology for that matter) there is significant technical risk at each stage of development. A mining operation is not like an off-the-shelf manufacturing plant. It requires successful completion of exploration, mining and mineral processing phases, each of which carries considerable risk. An exploration program will be revised and reconsidered with each new set of results. The method of extraction utilised in the course of mining operations will be designed around the properties of the orebody, which will vary throughout. Further, ensuring the processing plant is capable of delivering to customer specification often requires costly trial and error.