See those storm clouds gathering?
Over the Pit of Despair?
I wonder how Greens’ supporters will respond, when they wake up and discover the truth.
That their party’s deal with Labor on the mining tax will have the opposite result of what they were told.
I wonder what will they say, when they discover that the Minerals Resource Rent Tax (MRRT) will not result in the kind of wealth redistribution that was touted, a “fair share of our mineral wealth for all Australians”.
That instead, it will result in the Big 3 multinational mining companies … getting bigger. And richer. And more powerful.
And the government’s budget digging even deeper into the red.
When PM Gillard and Treasurer Swan went behind closed doors with the Big 3 miners to thrash out a hasty “fix” to former PM Rudd’s Resource Super Profits Tax (RSPT) debacle, thinking folks knew it would not end well.
Except for the big miners, that is.
Rather than scoring a vital goal for her “decisive” new leadership before the 2010 election, the secretive deal always looked more likely to result in yet another decisive Labor own goal.
And indeed it has.
Especially after Gillard and Swan again went behind closed doors, this time with the Independents and Greens, to thrash out a political deal to secure passage of the legislation in the parliament.
Late last month, after the new MRRT legislation passed the lower house, mining correspondent for The Australian Andrew Burrell belled the cat:
FEWER than one in 10 iron ore and coal miners operating in Australia will earn enough profit to start paying the $11.1 billion minerals resource rent tax from next year, according to Gillard government estimates.
A spokesman for Wayne Swan said yesterday he could not provide the names of the “estimated 20 to 30″ companies that were likely to pay the MRRT in 2012-13 because it was impossible to say how many companies would earn more than the annual profit threshold of $75 million.
“We haven’t got a precise list,” the spokesman said.
“But we have said the vast bulk of MRRT will be paid by the big three (BHP Billiton, Rio Tinto and Xstrata).”
Mr Burrell went on to reference the PM’s ever-changing claim for how many miners will be impacted under her revised grand design.
A claim most noteworthy not for its credibility.
But for its familiarity.
A remarkable familiarity to her “1,000 biggest” / “500 biggest” / “more like in the order of like, 400 biggest polluters” claim.
And the “half a million” / “300,000” jobs creation claim.
And the “4%” / “3.25%” projected GDP growth claim.
And the “3.5bn surplus” / “1.5bn surplus” projected budget outcome claim.
Big Labor government claims that are always being revised … downward:
Julia Gillard said last year that 320 iron ore and coal miners operating in Australia could be eligible to pay the MRRT — down from 2500 under the original resource super-profits tax that applied to all commodities.
In a deal with Tasmanian independent MP Andrew Wilkie on Monday, the government agreed to raise the profit threshold for the tax from $50m to $75m.
Mr Wilkie revealed the move would restrict the number of companies paying the MRRT to fewer than 30.
But this failed to quell criticism from junior miners, which claim the design of the tax still favours the established miners.
It remains unclear how the government will raise $11.1bn in the first three years of the MRRT.
Billionaire miner Andrew Forrest added to the confusion last week when he estimated that his iron ore company, Fortescue Metals Group, would largely avoid paying the tax for at least five years thanks to the substantial writeoffs available to all big producers.
Many in the industry also doubt whether BHP, Rio and Xstrata will face big MRRT liabilities, particularly in the early years of the mining tax.
This is because the design of the tax allows iron ore and coalminers with existing operations to price their assets using today’s inflated market values and claim potentially massive deductions…
Glyn Lawcock, a top-rated mining analyst at UBS, said it was impossible to predict with accuracy how much MRRT companies would pay from next financial year because it was difficult to calculate a company’s market value, which was used to determine MRRT liability.
When asked whether he believed the government could raise $11.1bn over three years, he said: “I scratch my head a little bit at that.”
It certainly is a head scratcher. Especially when one takes the time to carefully review the Treasury department’s Minerals Resource Rent Tax Bill 2011 document.
Recently a mining industry chief executive walked your humble blogger through this document. And explained that there is a very good reason why there has been little except “token noise” from the mining industry over the GilSwan MRRT, in stark contrast to the spirited fight put up against the original Rudd RSPT.
It is because in his words, “big miners will pay nothing for years, and small miners will pay nothing at all”.
But there’s more. In having the details explained to me, an even bigger flaw dawned.
A key insight, that mainstream economic commentators have not cottoned on to.
The clever accountants and lawyers for the Big 3 appear to have conned GilSwan into creating a tax mechanism that not only allows the Big 3 to defer paying any MRRT for years. It is a “tax” that acts as a financial incentive for the Big 3 to increase their monopoly, by gobbling up their smaller competitors and getting MRRT write-offs for doing so.
To understand how, let’s work through the details of the Treasury department’s document (emphasis added):
• New investment will be given generous treatment in the form of immediate write‐off, rather than depreciation over a number of years. This allows mining projects to access the deductions immediately, and means a project will not pay any MRRT until it has made enough profit to pay off its upfront investment.
Sounds good if you are a start-up miner or explorer, right? No doubt this idea was sold to GilSwan by the Big 3 as being “necessary” to encourage future mining investment, given that the MRRT places Australia at a competitive disadvantage versus other nations that do not have an MRRT.
But it’s also an obvious loophole that immediately dawned on your humble blogger. One that favours the Big 3 miners, who have the deepest pockets.
What happens if a big multinational miner such as BHP, Rio Tinto, or Xstrata buys out a smaller mining company, such as a junior explorer or a company with proven but unrealised in-ground reserves? It would appear they can claim the cost of that “new investment” as an immediate tax write-off, thus offsetting any MRRT they might otherwise be obliged to pay with respect to their other mining projects.
As you will see in a moment, this is no mere speculation by a sceptical blogger with an eye for detail.
It is exactly what the mechanism allows.
But it gets better for the big miners.
What if that smaller miner or junior explorer that they have now bought out, is presently making losses? Remembering that all do, typically for the first 5-10 years of the mine’s life:
• The MRRT will carry forward unutilised losses at the government long term bond rate plus 7 per cent.
Buy up a smaller, loss-making mining company. And claim the value of their unutilised losses against your other MRRT obligations.
Can’t believe that GilSwan (and the “bozos” in Treasury) could be this stupid?
• The MRRT will provide transferability of deductions. This supports mine development because it means a taxpayer can use the deductions that flow from investments in the construction phase of a project to offset the MRRT liability from another of its projects that is in the production phase.
No use to a small mining company with only one project. But manna from heaven to a large multinational miner with multiple projects.
Buy up a junior explorer, or a mining company that has proven reserves but has not yet begun/completed construction on the project. Claim 100% of the costs against your MRRT liabilities from other, active producing projects.
Thanks to the MRRT, the initial ‘new investment’ in swallowing up a junior mining company, and the ‘unutilised losses’ of that junior mining company, and the construction costs of taking that newly-acquired mining company’s project to production stage, all these now become tax-minimising assets to a hungry Big 3 multinational looking to take over their smaller, up-and-coming (Australian-owned) competitors.
But there’s still more:
• The MRRT will recognise the particular characteristics of different commodities, by applying a taxing point close to the point of extraction, and using appropriate pricing arrangements to ensure only the value of the resources extracted is taxed.
The Big 3 miners were very clever indeed in negotiating this “deal” with GilSwan.
As my mining industry source pointed out to me, the point of extraction is the point of lowest value of the ore; the grade is far below “shipping grade”, and so its value is far below the actual market value. He cited the example of copper ore.
At the point of extraction, the ore may only comprise 1% copper. The value of the ore at this point is around $20 per tonne.
But when subsequently processed into a 25% copper concentrate, the value is around $1,387 per tonne.
And the cost to the mining company of processing the raw 1% copper ore into 25% copper concentrate?
“About $30 per tonne.”
When the Big Miners insisted on the tax being applied “close to the point of extraction”, they took advantage of GilSwan’s abject ignorance of real-world business. An ignorance that has been all too often seen in their many other policy calamities – think ceiling insulation, school halls, computers in schools, subsidised Toyota hybrids, green schemes, set-top boxes, and the daddy of them all, the no cost/benefit analysis NBN.
You should not be surprised, dear reader. Not when our World’s Greatest Treasurer has an Arts degree, zero business experience, and has never worked a real job in his life.
Which explains, of course, why we are paying him $262,000 per year. And why we are about to increase his salary by $84,000 per year. And why we have spent $75,440 in 6 months on empty RAAF VIP “ghost” flights to ferry him about.
This ignorance of how things work in the real world is borne out even more starkly however. Not only have GilSwan agreed to impose the mining tax “close to the point of extraction”, (ie) at the ore’s lowest value, far below its value-added market value. They have also agreed to a 25% extraction allowance:
• The MRRT will provide a 25 per cent extraction allowance to further shield from tax the important value add and capital that mining companies bring to mineral extraction.
“Further shield” it?! When they are already applying the tax “close to” the point of its lowest value?!
Ignore if you can all the other write-offs and deductions for a moment. What this “extraction allowance” really means is that GilSwan have not only agreed to tax the ore at or near its lowest value. They have also agreed to an effective tax rate of only 22.5%. Not the headline 30%.
In other words, this so-called “super profits tax” will be applied at 25% less than the standard company tax rate that even my own small business has to pay!
But where the now-familiar Labor descent into complete farce reaches its denouement, is when we get to the Treasury department’s modelling:
How the MRRT works
The following example is intended to illustrate how the MRRT will apply to iron ore and coal projects, commencing after 1 July 2012.
The example presents outcomes for a single project company with an equity financed mine that operates for 5 years. The company is assumed to invest $1 billion in the first year of the project. Over the life of the project the pre‐tax rate of return (revenue less operating and investment costs) is 50 per cent.
Click to enlarge
As my mining industry source assured, the modelled assumptions are beyond fantastic.
They are positively delusional.
The Treasury assumes this fairytale mining company begins to show “Revenue” of $520 million at Year 2 (see table). In the real world, a start-up mining project typically absorbs 5-10 years of losses before they even begin productive operations. My mining industry source pointed out that he has never heard of any mining company ever going from zero revenue to half a billion in a single year.
The Treasury also assumes this fairytale company has Year 2 operating expenses of 25% of revenue, and 25.5% at Year 6. Again … unheard of figures.
Back to the modelling:
The MRRT is levied at a rate of 30 per cent of the operating margin (revenue less operating and investment costs) less the MRRT allowance and the extraction allowance. The MRRT allowance is calculated as the value of unused losses uplifted by an allowance rate equal to the long term government bond rate plus 7 per cent…
When we look at Year 4 in the example, the year in which Treasury has modelled the first MRRT “profit” (an inconceivable $436m), we find another problem. It is unclear whether Treasury has modelled “Revenue” as being Company revenue, or, as the “extraction point” value of the ore. If, as appears likely, the modelled “Revenue” figure is actually Company revenue, then on this point alone Treasury’s modelling is gravely flawed. Company revenue has nothing to do with the value of the ore at the “extraction point”. Meaning, the Treasury figures are nonsense.
Indeed, my mining industry source described them as “totally made up and have no resemblance to reality”.
Rather like Treasury’s modelling for “green jobs” (see one of 2011’s most popular posts, Barnaby Bamboozles Chief Of Climate Change Modelling Unit … Again).
Back to the MRRT modelling:
State royalties are assumed in this example to be equal to 7.5 per cent of sales revenue and are credited against the MRRT liability to produce the net MRRT liability. Where royalty payments exceed the MRRT liability in any one year, the balance is uplifted at the allowance rate to be offset against future MRRT liabilities…
We’ve left the issue of how the MRRT impacts on the payment of State mining royalties until now, to avoid complication. This is already a source of political angst between the governments of the mining states, and the Federal government. For the purposes of our look at the modelling, however, it’s pretty simple. The GilSwan grand plan grants a 100% credit for State mining royalties paid by the mining company.
In summary then, the MRRT is essentially calculated as follows:
MRRT 30% x Operating Margin (ie, Revenue calculated “close to Extraction Point”, less Operating costs)
less 100% write-off of construction costs
less write-off of unutilised losses
less 100% write-off of construction costs of acquired companies/projects
less write-off of unutilised losses of acquired companies/projects
less write-down of “market value” of existing assets over 25 years, OR
less write-down of “current written down book value” of existing assets (less the value of the resource) at an accelerated rate over 5 years
less Extraction Allowance (25%)
less 100% State Royalty credit …
It all begs the question … from where is the government’s claimed $11.1bn in MRRT revenue ever going to come from?
Treasurer Swan has claimed that “the vast bulk of MRRT will be paid by the big three”.
But in reality, given all the write-offs and concessions, the big miners will pay nothing for many years. If ever.
As Fortescue’s Andrew Forrest has affirmed.
So then, of GilSwan’s originally alleged “2,500 mining companies” in Australia, just who exactly are these “estimated 20-30” (small) iron and coal miners who will be earning profits of $75m per annum from July 2012?
Especially given that the boom in commodity prices has now peaked … and plummeted?
Others are asking the same question:
“Is this for real?
“Firstly, what 2500 companies are mining in Australia? There is NO WAY the number is that high unless one counts every Pty Ltd quarry and sand pit and borrow pit. Even then, it is an extraordinary figure and I cannot believe for one minute that it is real.
“But secondly, Gillard says only 320 iron and coal companies were captured under the MRRT. Really? Are there really 300-plus coal companies? Because as far as I know, there are only about 14 iron ore companies. And if you believe those figures to be true (i.e 320 dropping to around 30) that means that there are 290 iron ore and coal mining companies that are operating at an annual profit of between $50m and $75m since that is the only difference between MRRT Mk 1 and MRRT Mk 2. This is patently absurd.”
The broader point here is that there is just not a whole lot in the sustaining rhetoric of the MRRT that stands a cold hard reality check. Yet the government continues to represent the tax as a great leap forward in the commonwealth’s chase for a fairer share of the resources boom.
As colleague David Uren made clear in his insightful dismantling of a tax “so compromised by its bastard birth that it puts the commonwealth budget at risk and cannot be considered an economic reform”.
Uren observed that a 20 per cent fall in commodities prices would wipe out the government’s MRRT revenue and leave it stumping up for the $4.5bn of recurrent spending commitments that were supposed to be funded from the fairer share.
And folks I am here to tell you that this is exactly the scenario that the government is facing.
The sustained retreat of iron ore and coal prices means that big mining is now some months past peak cashflows.
With the China bubble deflating, iron ore and coking coal spot prices are currently trading around 30% below their 2011 peaks:
Source: RBA Chart Pack, Dec 2011 | Click to enlarge
At least the Coalition is aware of the budget risk. Even if they too appear not to have twigged to what is a blindingly obvious extension of logic – that the MRRT is designed to help the Big 3 multinationals increase their profits, and their monopoly:
“There are serious question marks over who will pay what and when under Labor’s mining tax deal,” Shadow Assistant Treasurer Mathias Cormann said.
“FMG says it won’t pay any MRRT for a number of years given the tax design features favouring larger miners,” he said.
“There are credible suggestions that the big three miners who had exclusive access to the Prime Minister and the Treasurer to design the mining tax behind closed doors won’t pay any MRRT for years either.
“No wonder the big three say they are happy with the MRRT, while the smaller local miners are not.
“Wayne Swan has consistently refused to release the commodity price and production volume assumptions used to estimate MRRT revenue claiming that they’re based on commercial-in-confidence data provided by the big three miners.
“So not only are the big three miners allowed to design the tax to suit their needs, they’re also the only ones allowed to know the governments mining tax revenue assumptions. That’s just not good enough.
“Even on the government’s own figures, the mining tax package is a fiscal train wreck in the making.
The Great Big Mining Tax … that isn’t.
As my kind mentor concluded:
“This bill was drafted BY miners, FOR miners”
“I think the miners and their accountants outsmarted Gillard and Swan, and bamboozled them with mining jargon”
“The miners in reality love it.”
Greens’ supporters … welcome to the Pit of Despair.
“What did this do to you? Tell me. And remember, this is for posterity so, be honest. How do you feel?”