Wednesday, July 28, 2010

Market risk of Resource Rent Tax

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The coal market consultants Wood Mackenzie have come out in defense of the mining industry over the resource rent tax. From the outset one must consider that Wood Mackenzie is a consultant to government and the mining industry, though most of their business is with the private sector, so some bias is possible. But I actually agree with them for reasons I will add. Appreciate that coal and iron ore are low value, high volume businesses requiring a great deal of investment (i.e. capital intensive).

As a prior coal analyst with Barlow Jonker (which was years later taken over by Wood Mackenzie), I can say there is a tendency for people to reflect only on the short term market for commodities. The reality is that commodity prices went very high in the 2000s, but we must remember they went so high because of the under-investment in the 1980s-90s. Higher prices have sparked a rash of new, small projects, so its possible that prices could stay low. This government intervention strikes me as a govt-orchestrated attempt to curtail the development of new capacity in order to keep prices high. Good for Australia it could be argued, but at whose expense? Certainly to the benefit of Fortescue, BHP and Rio Tinto.

In the long term the market could go either way. Coal and iron ore are common commodities. We must also remember that China has a great deal of it as well. We must also acknowledge that the global seaborne coal and iron ore supply curve tends to get flatter as the market expands. That makes competitition very intense. We can also expect that the last commodities boom will result in a lot of new players, who will keep prices down.

I recall studying the Carbocol SA Cerrejon de Norte coal mine in Colombia when I was an analyst. At the time, everyone thought that coal prices were going to $100/tonne in the 1980s. Instead they went closer to $25/tonne, and resulted in mines going broke. Carbocol was nationalised by the Colombian govt, much like the Australian govt plans to expropriate the profits from Australian miners. The legacy was that Colombia lost investment credibility, and the mine was loss-making for a decade. It never recovered its capital. The same risk exists if the Australian govt takes on a commercial risk in order to profit from mining. It might even become a mining industry rort like the tax credits for the wine and timber industry. Of course a strong China and India augers well for prices, though who knows what could happen in the next 10 years. Do we want the government accepting that commercial risk? Its your money, their lack of accountability.

The very idea of government basing its budgetary spending on voltatile commodity prices is grounds for concern, though in fairness, we tend to see commodity prices offset by a weaker $A....so on that basis the government is pretty safe, so commodity price changes will be ameliorated by balancing exchange rate movements; particularly as high household debts will pin interest rates at a low level.

It is clearly suspicious that the Gillard government is unwilling to disclose its commodity price-forex assumptions underpinning the claim that the tax will pull in $10.5 billion in its first two years.

According to the SMH, the head of coal supply research at Wood Mackenzie, Gero Farruggio, said that as the MRRT was a profit-based tax, government revenue would become more sensitive to price fluctuations. ''A return to the low prices of just a few years ago will see no additional government revenue flowing from MRRT, with some companies benefiting from a reduction in the corporate tax rate from 30 per cent to 29 per cent,'' he said.

Really though he is ignoring the exchange rate impact, and I suspect the exchange rate will offset it. Pragmatic arguments like these ought not however be the basis for moral-political decisions. Otherwise lets just kill all politicians and retarded kids, and we will add $2000 per capita to GDP in the first year and heaps more when we finally eradicate the oppressive arbitrary laws of political middlemen who create no value.

Gero Farruggio also said ''Indonesia dominates the ranking tables, with the largest thermal coal production and lowest average cash cost - in contrast to Australia. It has moved to reduce the level of government take from coal production".
We must remember however that Indonesian export coal will principally find local markets in future, so that is a domestic cost. Export sales could be expected to become less significant, and maybe for the government, security of supply considerations might justify a higher tax. Not legitimately, but that is what governments do....justify expropriation. Stuff those who are impacted.
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Author
Andrew Sheldon
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