Richard Karn: A Bridge Too Far. . .to the Left?
Source: Brian Sylvester and Karen Roche of
In the midst of a boots-on-the-ground survey of Australian precious
and specialty metal projects,
The Emerging Trends Report's
Managing Editor, Richard Karn, took time between mine site
visits to share his insights about the controversial Resource Super
Profits Tax that's pending Down Under with
The Gold Report.
The Gold Report:
As an American involved with the Australian mining industry, can
you give us an overview of the Rudd government's proposed Resource
Super Profits Tax (
Certainly, but from the outset keep two things in mind. First, the
tax scheme is very complicated. Some details are murky and seem to
conflict with others in a number of ways. Secondly, the mining
industry itself has argued for streamlining the existing system,
which entails companies paying as many as six or seven different
state or territory royalties on the minerals they extract.
Apparently, they were prepared to pay a higher tax for a simpler
system. They did not, however, expect the tax reform the Labor
government wants to implement, which the Conservative Party is now
calling Prime Minister Kevin Rudd's "great big new tax."
Sounds like a case of "be careful what you wish for."
Exactly. In essence, the RSPT has been derived from aspects of the
Henry Tax Review and, if passed, it will apply to all existing and
future non-renewable resource projects beginning July 1, 2012.
Who is Henry?
Treasury Secretary Dr. Ken Henry chaired the review panel formed
when the Rudd government established Australia's Future Tax System
Review in May of 2008 to examine Australia's tax and transfer
Without getting into every nut and bolt, what is the RSPT basically
It has four basic tenets. First, profits derived from Australia's
non-renewable resources in excess of the rate of return from the
10-year bond (currently 5.7%) will be taxed at 40%. Let me point
out that this is in addition to the existing 30% corporate tax and
The tax will not be collected on individual mining projects
until the project becomes profitable; in the event of a loss on the
project, the federal government guarantees to credit mining
companies for 40% of the extraction costs-but not until the
government has determined that the expenditures could not be
carried on to another project.
Current state and territory royalty arrangements would remain in
place, which mining companies will be required to continue to pay,
but the federal government will issue rebates of a corresponding
amount to offset the royalties. When RSPT takes effect, the rebate
probably would be sufficient to offset the royalty rate; but
there's nothing to prevent states and territories from increasing
their royalties in the future.
How would they use the tax revenues?
The federal government expects to make about A$12 billion over the
first four years after the tax is introduced and plans to direct
the revenues toward several things. It intends to increase the
compulsory superannuation (retirement program) contribution by
working Australians from 9% to 12% over seven years, and to provide
low-income workers with as much as A$500 a year to supplement their
superannuation. The government also says it will reduce the
corporate tax rate from 30% to 28% over two years, and create an
A$700 million fund to boost resource-related infrastructure around
the country in the first year.
Which issues are the most contentious?
First, let me make a brief disclaimer. We are guests in Australia
and have been treated very well by everyone we have come in contact
with during the four months we've been investigating precious and
specialty metal projects. Our approach is predicated on the notion
that many of these companies have significant resources but are not
well-enough capitalized to put together road shows to North America
or Europe to bring their projects to the attention of investors
there. We are, thus, in a position to help each other; and we don't
want to jeopardize this relationship by being seen as outsiders
editorializing on the Australian political system.
That being said, in addition to a couple peripheral matters, the
three most contentious issues are 1) the 5.7% threshold at which
the 40% RSPT is levied, 2) the retrogressive nature of the tax, and
3) the manner in which the administration is trying to force mining
companies to make the government a 40% partner in resource
Okay, would you address those issues one by one?
The ascendance of Australian mining over the last three decades is
attributable to previous administrations, Labor and Conservative
alike, embracing policies that encouraged competition. Those
policies fostered an environment in which mining companies could
attract the capital investment needed to put remote, high-risk,
very difficult projects into production. A significant portion of
this capital originated overseas, and the investors put up only the
capital for the chance of reaping large profits.
The RSPT would vault Australia from its current 38% cumulative
tax rate to more than 55% and into the dubious position of having
the second-highest mining taxes in the world behind Finland.
According to Citigroup, Australia's tax rate would rank well ahead
of the USA's 40%, Brazil's 38%, South Africa's 33%, Peru's 32%,
China's 30%, Russia's 30%, Chile's 26% and Canada's 23%. All things
being equal, capital tends to go where it is treated best, which
makes it hard to imagine that the new tax regime would help raise
domestic or foreign capital investment in Australian resource
Policymakers don't seem to appreciate that the A$202 billion
mining industry-which contributed 18% of GDP and accounted for 42%
of total exports last year-has itself been relying on a 17% annual
growth rate in foreign direct investment to make its fabulous
growth possible. Incidentally, that foreign direct investment
amounted to A$92 billion in 2009.
Further, the notion that an extractive project earning profits
in excess of 5.7% constitutes a "super profit" appears not to
consider the fact that no company would take on the kind of risks
these projects entail for that kind of pre-tax return. It would be
significantly below the cost of capital needed to undertake the
The cost of capital today is roughly 8% for the majors, such as
BHP Billiton Limited (NYSE:BHP; PKSHEETS:BHPLF)
Rio Tinto Ltd. (LSE:RIO; NYSE:RTP; AUS:RIO)
. For a second-tier company, such as
Fortescue Metals Group Ltd. (
, capital may run as much as 13% to 14%; but a greenfield
development, which carries an even higher-risk premium, would pay
more along the lines of 16% to 18% for capital. Combined with other
aspects of the tax, this essentially would put many projects
underwater from the get-go.
Let me give you an example of this high cost of capital.
Macarthur Coal Ltd. (TSX.V:MCC)
, a roughly A$3 billion company, recently negotiated a take-or-pay
contract with Queensland Rail (QR Limited) for the construction of
a new railway spur. The state-owned utility demanded a 15% rate of
return to underwrite the project.
And if a company as big as Macarthur Coal pays 15% for its capital,
small companies will pay considerably more.
Some critics suggest that the academics, economic modelers and
politicians behind the RSPT seem to believe the expertise to
develop massive projects, such as Olympic Dam, is widely available.
They figure that if the BHP Billitons and Rio Tintos of the world
won't develop Australia's vast but remote resource wealth, an army
of Andrew Forrest-like entrepreneurs waiting in the wings will. And
they apparently assume that banks will develop loan products at
little more than the 10-year bond rate.
A number of commentators have pointed out that it's as if the
Rudd government formulated the RSPT in a vacuum, seemingly unaware
that the cost of capital is increasing at the same time its
availability is decreasing-in itself a foreboding prospect. Because
decisions about which projects to develop or fund are based on what
promises the greatest after-tax returns, the RSPT significantly
undermines the attractiveness of a whole range of projects.
As it stands, it appears that roughly A$275 billion worth of
mining projects are on hold simply because long-term investment
assumptions cannot presently be factored into their risk/reward
models. Very few financings will get done until RSPT details are
ironed out and the matter is resolved.
That's what Graham Frank at Ernst & Young meant when, last
month, he wrote that Australia is "at risk of killing the goose
that laid the golden egg" with the RSPT.
Some claim the RSPT wants to cook the goose's ancestors, too.
Which brings up your second contentious point-that the tax is
Yes. They claim the retrogressive aspect makes the tax both
punitive and likely to discourage future investment in Australian
resources. It introduces policy instability and
ex post facto
taxation to long-term investment decisions that were made under an
entirely different set of sovereign-risk and tax assumptions. That
amounts to reneging on an agreement.
The combination of this retrogressive aspect and mining
companies having to take on the government as a partner leads some
people to refer to the RSPT as a 'resource nationalization ploy.'
The retrogressive tax sets a precedent that, in and of itself, will
stifle foreign direct investment.
It introduces the possibility that the risk-reward parameters can
change materially during a project's lifetime at the apparent whim
of whichever administration happens to be in power-potentially
undermining a project's profitability and continued economic
viability. As a result of all of this, at least one financial
institution now ranks Australia on a par with Indonesia in terms of
You've mentioned having the government as a partner in mining
projects. Can you explain that for our readers?
The idea of a resource rent tax was developed by American Economist
Cary Brown in 1948 and stipulated the government would supply the
cash for its share of a resource project-
, as is the case with the RSPT, to essentially require mining
companies to lend the government its 40% share, which would be
repaid to miners over time via tax concessions at the 10-year bond
rate. The RSPT amounts to demanding that a mining company lend
money to the government at a rate significantly below what a
company pays to borrow capital itself.
Further, Larry Summers, President Obama's chief economic
advisor, wrote a paper in the 1980s concluding the hurdle rate for
assessing U.S. firms' resource project viability far exceeded their
cost of capital-in fact often requiring twice that much. Thus, this
loan to the government for its share of the project would
constitute a material expense. The notion that the government will
cover 40% of the losses incurred in a project with credits, rather
than contributing development costs, is such a hollow promise that
some financiers view it as an incentive to fail. They would attach
zero value to it in their loan decisions, simply because it is
unlikely any of the guarantee would find its way back to them.
What's the story with those credits?
The government has guaranteed to credit mining companies if they
have a loss on a project. But there's a catch. The credit-40% of
the firm's extraction costs paid over time at the 10-year bond
rate-will not be paid until the government determines the
expenditures could not be carried over to another project.
You mentioned a couple of peripheral issues, too. What are
State and territory royalty programs now account for roughly $1 of
every $9 of pre-tax mining profits, just as they have for about a
decade. By and large, royalties are
-or levied on the value of the resource extracted, so the dollar
value has increased in lock-step with commodity prices.
Many people consider this to be an RSPT in itself, and it's
understandable that states and the Northern Territory are loath to
relinquish control of such substantial sums of money. In fact, they
may have a Constitutional defense for not relinquishing that
control. The RSPT also wants to broaden the scope of what is taxed
to include both the resource extracted and the value added in
logistics, processing and smelting; but it is difficult to conceive
under what circumstances 'the people' Mr. Rudd constantly purports
to defend would have a right to a share of such capital investments
in a capitalist system.
Further, because they could not agree with the states and
Northern Territory on the issue, the Rudd administration proposes
to levy the new tax on top of the state royalties, and then to give
mining companies a rebate for state royalties. Ironically, this
would further complicate the system rather than streamline it; it
would create a whole new layer of bureaucracy to deal with
More than one pundit has quipped that soon mining companies will
employ more accountants and lawyers to deal with compliance issues
than miners to extract resources.
What else do you find troubling about the RSPT?
Admittedly, I'm a bit cynical these days; but the RSPT being
announced during the height of the European sovereign debt crisis I
find highly suspect, because history has borne out FDR's comment:
"In politics, nothing happens by accident. If it happens, you can
bet it was planned that way."
It turns out the Rudd administration had the Henry Tax Review in
its possession since December 2009, which moved to circumvent its
own campaign promises regarding the use of public money for
political advertising purposes by arranging for a A$38 million
television campaign in support of the RSPT well in advance of the
announcement. They also chose the very time that markets everywhere
were under significant pressure from the sovereign-debt crisis to
announce what many suggest are the most sweeping changes in
Australian economic history. Clearly the administration knew the
RSPT was going to adversely affect the Australian dollar, stock
market, foreign capital investment and superannuation accounts,
because they made a frantic attempt, initially, to attribute the
effects of the RSPT announcement to the sovereign-debt crisis-this
despite the Australian dollar and stock market falling far more
dramatically than any other developed country, including both its
resource-producing peer Canada and the European markets at the
epicenter of the crisis.
In your four months investigating precious and specialty metal
projects in Australia, you've obviously been talking to people in
the mining industry about the RSPT. What have they been saying?
I'm happy to share some of their opinions, but bear in mind
that, by comparison, you'd consider my comments pretty tame.
Crescent Gold Ltd. (TSX:CRA; ASX:CRE; FKFT:CRE5)
CFO Mark Tory said that his company was in the middle of a
marketing campaign in North America when Mr. Rudd announced the
tax, "and it immediately put a hold on any investment money going
into an Australian resource company, as well as prompting analysts
to downgrade resource stocks on a cash-flow basis by up to 27%." He
also said that companies such as Crescent, which have spent money
over a number of years to bring development projects into
production, "will not get the deductions of that expenditure under
the announced resource tax regime and will pay tax on first-time
profits at a higher rate." He called RSPT a myth, "as most resource
companies' weighted average cost of capital is closer to 15% than
the current level set by the government for when the tax kicks in
at around 6%."
John Merity, managing director of
Northwest Resources Ltd. (
said, "the abrupt announcement of the tax, its inherently
retrospective nature and the government's unwillingness to
negotiate on anything other than peripheral aspects, put at risk
future investment in the resources sector in Australia." He
admitted that the exploration expenditure rebate "looks promising,"
but went on to say that if that rebate is "the carrot to win the
support of juniors, the government has fundamentally misunderstood
the exploration sector." As he put it, "You don't take the huge
risks exploration companies do (less that 5% of exploration
companies will ever build a mine) unless the equally huge rewards
are there. A 'reasonable return' is not what exploration is about.
If investors want a business with a reasonable return, they will
invest in pizza shops."
Richard Wolanski, director of
NiPlats Australia Ltd. (
shares that view in terms of juniors because the RSTP compromises
"the long-term ability to generate the capital investment or
financing needed to develop mines," thus "reducing investment in
juniors." He criticizes the RSTP as "an ill-conceived tax that has
been proposed without consultations with the mining industry by a
government whose ability to manage Australia's finances now has to
be questioned. It contributes to sovereign risk in that it
introduces uncertainty regarding what tax will eventually be
levied." He further suggested that confidence in Australia as an
investment destination "is now only likely to be restored by a
change in government."
That day isn't far off, according to Nicholas Garling, managing
Morning Star Gold NL. (
. He says that the Prime Minister "has signed his political death
warrant. The tax is not only unfair and unpopular but completely
unnecessary and, in all likelihood, unconstitutional. But it will
all matter little. Rudd's Labor Party was teetering prior to this
Ian Chalmers, managing director of
Alkane Resources Ltd. (
makes yet another point. Because the individual states own the
minerals, he claims "it could be argued that the RSPT is an attempt
by the federal government to wrest control, and hence revenues,
from the states." He says that taxing state-owned property violates
Section 114 of Australia's Constitution. Mr. Chalmers pulls no
punches, describing RSTP as a "cynical political ploy to try and
win over the great masses of voters in Sydney and Melbourne, who
have always thought mining is a dirty industry that generates
environmental messes and makes a few people very wealthy." He goes
on to say the RSTP "is an attempt to take the heat off major policy
failures, such as the (carbon) emissions trading scheme, the deadly
home-insulation scandal, wasteful school building programs. .
.People and the media in eastern states have been very slow to
recognize that the Australian mining industry kept the country
afloat for the last two years and insulated us from the worst of
the global financial crisis."
Barry Dawes, managing director of Martin Place Securities, calls
the RSPT a "poorly conceived. . .policy concocted by bureaucrats,
academics and ex-union officials with but minimal external
consultation or internal debate," really zeros in on the math.
"This RSPT brings in a 40% tax at the operating surplus level
offset only by a capital charge equal to the depreciated plant book
value times the 10-year government bond rate and applies before
interest, royalties and income tax. The tax reduces NPVs on new
projects by 30% to 40%, reduces free cash flow for debt service,
raises cutoff grades and reduces resources, and then reduces
attractiveness to equity and debt providers." Importantly, he
points out that "whilst the 'Crown' through the state governments
is the ultimate owner of the mineralization, this mineralization
only becomes a resource after substantial efforts by the tenement
holder; so ownership is transferred to the tenement holder with
compensation and profit sharing made through payment of a royalty.
The broad public cannot expect more."
Any other peripheral issues you'd like to discuss?
Only that the RSPT seems apt to have unintended consequences.
Mining projects are not light switches that can be thrown on and
off; sometimes billions of dollars are spent just to get a project
ready to go into production. Right now, the majority of project
funding has been frozen until some kind of decision is reached.
Because the RSPT will not be debated until after the Federal
election, slated for September or October, it is creating a gap in
the continuity of Australian projects coming onstream to meet
global mineral demand. And when a decision is eventually reached
regarding changes to the tax regime, all of the projects currently
in limbo will have to go back to square one and restart feasibility
studies and the like based on the new parameters.
This means the RSPT has effectively slammed the door not behind
companies operating today, but in the face of companies trying to
go into production tomorrow. It can be argued that the uncertainty
surrounding the RSPT has, itself, raised significant barriers to
entry for both exploration and upcoming development projects,
because funding will not be forthcoming in the current environment.
Companies that are cashed up, free of debt and in production now
may, in fact, be provided with competitive advantage in that they
have to opportunity to act while others do not. The longer the
issue remains unresolved, the weaker the companies in the latter
group will become-rendering them increasingly vulnerable to
acquisition at a discount.
Is your hunch that RSPT will be the law of the land soon?
My opinion, which $5 will buy you a cup of coffee, is that the RSPT
will not stand in its current form. I think either a significant
compromise will be reached, or the RSPT will be voted down in the
Senate. But until the issue is resolved, we think the best way to
proceed is to tighten our screening criteria further; it is clear
that we cannot recommend precious and specialty metal companies
whose projects are unfunded or underfunded at present, regardless
of their potential.
So you have no plans to cancel your circumnavigation of
No. The damage to Australia's reputation, currency and stock
markets by the less-than-optimal way in which the RSPT was framed
and introduced-the impact of which we believe was compounded by its
poor timing-will be only a temporary affliction. Barring an
outright global economic collapse, demand for these metals will not
abate significantly. Most are price-inelastic and have no
substitutes in a range of primary applications. If anything, the
RSPT will contribute to a shortage of these metals and
correspondingly higher prices by slowing the development of
Eventually, though, the market will recognize that precious and
specialty metal companies that are in production today-and have the
cash flow to expand production tomorrow-should command a premium.
The pullback that has been exacerbated by the introduction of the
RSPT affords long-term investors the opportunity to pick up a
number of excellent companies at a significant discount.
This has been really informative, Richard. Thank you so much for
your time and insight.
Richard Karn, as managing editor of
Emerging Trends Report
has a broad, multi-disciplinary background and a working
knowledge of precious and specialty metals, as well as considerable
research, analytical and writing experience. The first nine
Emerging Trends Reports,
which pertained to coal, gold, nuclear energy, silver, the
North American electrical grid, transportation fuels, recycling and
specialty metals and natural gas were reevaluated and updated
within the context of the global financial crisis and then
published in the form of an e-book,
Credit & Credibility
This spring, Richard-who divides his time between Alaska and
Australia-embarked on a lengthy tour circumnavigating Australia by
four-wheel drive to evaluate dozens of remote projects and
recommend the stocks of companies that are well-positioned to
supply burgeoning market demand for these critical metals. In
addition to managing The Emerging Trends Report and conducting
contract research for companies, Richard has written for
publications ranging from
Kitco and Fullermoney to
Financial Sense Online.
Want to read more exclusive
interviews like this?
for our free e-newsletter, and you'll learn when new articles have
been published. To see a list of recent interviews with industry
analysts and commentators, visit our
1) Brian Sylvester and Karen Roche of
The Gold Report
conducted this interview. They personally and/or their families own
the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors
The Gold Report:
Morning Star Gold.
3) Richard Karn: I personally, my fund and/or my family own shares
of the following companies mentioned in this interview: Alkane
Resources Ltd., Northwest Resources Ltd. and Morning Star Gold
is Copyright © 2010 by Streetwise Reports LLC. All rights are
reserved. Streetwise Reports LLC hereby grants an unrestricted
license to use or disseminate this copyrighted material (i) only in
whole (and always including this disclaimer), but (ii) never in
The GOLD Report does not render general or specific investment
advice and does not endorse or recommend the business, products,
services or securities of any industry or company mentioned in this
From time to time, Streetwise Reports LLC and its
directors, officers, employees or members of their families, as
well as persons interviewed for articles on the site, may have a
long or short position in securities mentioned and may make
purchases and/or sales of those securities in the open market or
Streetwise Reports LLC does not guarantee the accuracy or
thoroughness of the information reported.
Streetwise Reports LLC receives a fee from companies that are
listed on the home page in the In This Issue section. Their sponsor
pages may be considered advertising for the purposes of 18 U.S.C.
Participating companies provide the logos used in The Gold
Report. These logos are trademarks and are the property of the
Streetwise Reports LLC
P.O. Box 1099
Kenwood, CA 95452
Tel.: (707) 282-5593
Fax: (707) 282-5592