TAX NEWS - June 2010

Australia Tax: Resource tax will cause mining project funds to dry up

MY company is Australia's largest resource industry-focused corporate finance advisory group and we are deeply concerned about the misinformation coming from the federal government about the proposed resource super-profits tax.

Many of our clients are junior, small-capitalisation or emerging miners. These are companies that have made mineral discoveries and have subsequently developed a mine, or plan to develop a mine in the near future. They are collectively a big employer within the resources sector.

We do a lot of detailed financial evaluation of client mining projects in Australia and internationally to help them with development, financing and acquisition decisions. As you can imagine, after the RSPT was announced we did a review of its impact and concluded very quickly that the majority of mines brought into operation over the past 20 years in Australia would not have been developed if the tax had been in place.

The buffer required for project finance would have been insufficient and the equity returns would have been too low for investors.

We trust our judgment but so do our clients and it would be correct to say that every single project we've been working on in Australia since the tax was announced has come to a halt. Fortunately for us, 70 per cent of our work is offshore so we are not so badly affected, but it is clear the effects of the tax will be far greater than anything the government has expected, for a number of simple reasons.

Raising funds from investors for exploration and subsequent project development is hard work.

Debt funding is certainly not available at anywhere near the government bond rate.

Parties providing funding are typically looking for a blended return of 15-25 per cent per year. Very few banks provide funding to mining as it is considered too risky.

Most Australian superannuation funds also specifically preclude investment in junior miners and exploration companies as the risk/return ratio is not considered attractive enough. It is typically only when an operation is up and running that institutional investors will look at putting their money in.

There's a rough rule of thumb among mining project financiers that they won't back a project that will not produce 2.5 times the original investment, in free (post-tax) cashflow, over the life of the mine. Clearly a tax aimed at reducing that free cashflow will reduce the chance of any project passing that financier test.

They have no interest in backing mines that are likely to fail, of the sort whose losses the government has said it will underwrite at 40 per cent. The mines won't fail in most cases, because the financiers won't back them. So neither the explorers nor the financiers have any interest in that safety net provision, which appears to be the basis of the tax.

Most investors in exploration and development companies are individuals, betting (hoping) that in among the losers there will be a discovery that makes them multiple returns on their investment.

When they get it right, the successful outcome is the establishment of companies such as Fortescue Metals, Mincor, Independence, Western Areas, etc.

However, for every junior that succeeds there are dozens that don't. The many individuals who have taken risks and lost money have been entirely forgotten in the government spin campaign targeting supposed billionaire miners. Our work has given us a hands-on working knowledge of the tax regime of most of the competing destinations for resource investment dollars.

Australia's mining royalties and taxes are currently slightly higher than most of our competitors (ABARE's numbers show this to be the case).

However, as one client put it, this is offset by the lower political risk, and the country having a relatively mining-friendly environment.

The new mining tax rate will make Australia uncompetitive. If the tax is implemented the government will enjoy a quick sugar fix from existing operations but it will result in resource investment dollars migrating to other markets (we have already had Canada's largest mining stockbroker call on us looking to redirect dollars).

Exploration expenditure will decline and new mine developments within Australia will not take place. Over time, the industry will wither.

This is a very real threat and not the stuff of big mining company misinformation, as portrayed by the government.

This would be a great tragedy because Australian mining technology and knowhow is considered to be the best in the world.