Rush to mine tax raises longer-term growth risk

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This was published 13 years ago

Rush to mine tax raises longer-term growth risk

By Elizabeth Knight

Every business that extracts mineral resources in Australia has been put on notice that it will soon have a new business partner - the Australian government.

It's not a traditional joint-venture model - because this usually entails both partners bringing either money or assets into the project or company. It's partnership Kevin Rudd-style.

The government will receive tax on as much as 55 per cent from the owners of the resource project's profit and in return will underwrite some of the riskier start-ups and even allow those that never make a profit to recoup 40 per cent of the capital they invest.

It's not a fair trade as far as the mining industry is concerned. Indeed, the economics are tilted so heavily in the government's favour that attempting to call it a partnership would be an insult to just about any relationship.

The government cannot (and is not trying to) deny that this will cost the Australian resources industry dearly. This cost to the industry was ratified by the sharemarket, which has wiped more than $10 billion off the value of listed players since the announcement on Sunday that the government planned to impose tax on super profits of the industry.

The proceeds will be handed back to the people via various means - mainly through superannuation.

Thus it has been branded as socialism by many - even the China-based research firm GaveKal Dragonomics dubbed the planned tax increase a decision by Australia to "pull a mini-Chavez" (referring to Venezuela's President Hugo Chavez's penchant for nationalising resource assets), that could threaten Australia's economic performance.

"We would have thought that the sports-mad Australians would be the first to know that you should not mess with a winning team," the GaveKal report said.

The government has justified the move as a means to capture the riches that mining companies are making by extracting mineral resources from Australia's natural reserves, by saying that it is more equitable to give a larger portion of the spoils of the mining boom to the community.

But crimping the level of profits that such a cyclical industry makes in boom times can have a downside. In the current boom the industry is experiencing it is not all that evident, but if the government stays true to its promise to underwrite the downside of unprofitable ventures, the plan could get ugly at some later stage.

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It will be interesting to see what happens if some stand-alone mining project in which a company has invested, say, $1 billion, falls over and the owners lose their shirts.

Will the government be all right with reimbursing $400 million spent by the owners? It is more likely that this will be the point at which the government will abandon this part of the joint-venture relationship.

It is not unusual for some sectors to have imposed on them some degree of regulation in their pricing or rates of return, but these are generally confined to low-risk infrastructure or utilities assets.

Mining is different. It is not just cyclical; it carries plenty of risk. Limiting the rate of return on resource projects will change the economic dynamics of investment decisions. Undoubtedly billions of dollars of projects either will be abandoned or will become marginal when these changes take effect. And the value of potential new projects will fall.

According to Macquarie Equities analysis, the net present value of the ''next generation'' of iron ore developments in the Pilbara will be reduced by more than 30 per cent should such a resource super profit tax come into effect.

Despite the government's guarantee to recoup 40 per cent of the investment in failed projects, fewer of the smaller companies will be prepared to take risks on start-ups or expansion.

Mining projects have long lead times and are capital-intensive in the early stages. Carrying risk over a cycle requires some commensurate level of return.

One of the big complaints of the industry is that the super profit tax kicks in after accounting for a meagre 5.7 per cent of deductible capital expenditure - the equivalent of the risk-free bond rate. This stacks up very poorly against a mining company's cost of capital, be it debt or equity.

In other words, funding mining investments reflects risk but the government's capital shield does not.

Thus the super profit that the government proposes to tax is not really all that super. The underwriting of failed projects is not sufficient to offset a naked grab for revenue.

Even the most conservative commentary acknowledges that the new tax kicks in at a level that is too low. By setting the level so low, the government is taking a step towards nationalising the profits from this industry without taking ownership of much of the risk.

While the move will not worry most voters, who would rather have better access to the spoils of the mining industry, the new tax does run the risk of applying a brake to the industry's longer-term profit growth. (None of this will be evident until well after Rudd and Wayne Swan have left the political arena).

Once these changes come into force Australia will have to take the mantle as the highest taxer of mining profits. Our Asian customers hate the idea because they believe it will put further pressure on prices.

It brings with it some risk that the governments of other mineral-extracting countries will follow this lead.

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