Change with the times: Countries around the world are revisiting the rules they apply to the mining sector

Over the past few years, with commodity prices spiralling ever higher and minerals like gold reaching record levels, many host governments have felt that they were missing out on potential windfalls from their extractive industries – much needed in an era of global belt-tightening. Amongst conditions of economic uncertainty, the mining sector – on the back of unprecedented profits during the commodity-boom years leading up to 2008 – has emerged as a prime candidate for resource-endowed nations to try and capture additional revenue. Ghana is no exception, and over the past three years, there have been incremental increases in everything from royalties to permit fees for mining sector.

REVISED RATES: In 2010 the calculation of royalties changed from a sliding scale of 3-6% to a fixed rate of 5%. The following year corporate taxes were increased from 25% to 35% and a 10% windfall tax was introduced. New environmental assessment regulations also require mining companies to provide a multimillion-dollar bond.

These moves have been met with concern from producers, not unexpectedly given the significant fiscal burden that they represent. At the same time, the reforms are very much in line with the efforts of governments in other major mining countries, from Peru to Canada to Indonesia. In fact, in some cases, Ghana’s moves are relatively sanguine when compared to some regulatory regimes, such as that recently enacted in Australia.

A LARGER SHARE OF THE PIE: The fact that the mining sector is coming under greater scrutiny from global policymakers is no surprise, given the success that the industry has experienced over the past decade. According to figures published by the UN Industrial Development Organisation, over the sustained commodities boom that took place between 2002 and 2008 – driven largely by increased consumption from Asia – revenues for the world’s 40 largest private sector mining firms rose by a remarkable 357%.

Over this same period, while some countries were able to benefit from this windfall through strong tax regimes linked to financial performance, others that had entered into long-term concessions with fixed royalty terms began to view themselves as being in unfavourable and inequitable positions. These countries typically responded by amending their mining codes to introduce additional taxation, local ownership and beneficiation requirements. Ghana, for example, had rolled out a generous framework in the 1980s, based in part on World Bank recommendations, to incentivise investment into what was then a sector in decline. Lengthy stabilisation agreements helped to protect producers from any future changes.

A TALE OF TWO CYCLES: The growth of the sector, however, is not a permanent trend. Commodity cycles, by their very nature, go both up and down. And while the recent raft of reforms is being rolled out with the previous boom in mind, miners today will argue that conditions have changed significantly from what they were during the peak profit period. Indeed, in 2012, global mining stocks fell slightly on average and have continued to drop by 20% over the first four months of 2013. Even gold, often considered the one metal that consistently appreciates in value, has seen its price dip from around $1700 per oz to around $1360 between January and August of 2013.

During the commodities boom, the main focus for miners was on maximising production volumes and expanding operations, sometimes into marginal fields and high-risk exploration areas. However, the focus for many companies moving forward is on squeezing maximum returns from existing operations, while also cutting down on capital expenditures and disposing of non-core assets. According to the Fraser Institute, a Canadian think tank that publishes an Annual Survey of Mining Companies, only 46% of respondents indicated plans to increase their exploration budgets for 2013, down from 68% in 2012 and 82% in 2011. More than half of those surveyed indicated that they expected only moderate price increases (less than 10%) or reduced prices for silver, copper, diamonds, coal, zinc, nickel, potash and platinum over the next two years.

A QUESTION OF MARGINS: The general consensus is that the slowdown the industry faces will not last forever, and that growth rates will strengthen significantly by the end of the decade. However, it is also believed that this recovery will come amidst higher overall costs, as current deposits mature and input prices jump.

Most respondents to the Fraser Institute survey expect “stable or moderate increases (up to 15%) in inflation-adjusted commodity prices over the next 10 years”. China is the world’s biggest consumer of coal, steel, lead, copper, aluminium, cement and zinc, and it is expected to continue its reign as the largest market for commodities. Projections – based on domestic reserves versus demand – suggest that China will remain a net importer of 25 minerals until at least 2020, including iron, copper, aluminium and potassium. While growth rates are less than what they were a decade ago, the base from which the country is growing is now larger.

Along with steady demand from maturing economies such as India and Brazil, and an eventual recovery in Europe and the US, the longer-term macroeconomic fundamentals tend to support projections of steady, albeit restrained, growth for mineral production. BHP Billiton’s chief executive, Andrew Mackenzie, stated in early July 2013 that he expects overall demand for raw materials to grow by 75% over the next 15 years. A number of mining firms’ shares rose in August when China recorded an impressive 10.9% growth in imports for July, RISING COSTS: Mining companies, in addition to contending that revenues are not what they once were, also argue that margins are being affected by an appreciation of input prices, such as power and transportation, that is now outpacing rises in commodity prices. A survey of the world’s top 40 mining companies conducted by PwC, showed net profits fell by 49% in 2012, with the report stating that, “with the structural change in the cost base that has occurred, moderate price increases will not be enough to claw back lost margin".

Globally, the market for risk capital has tightened, making it difficult for companies to secure capital during early stages of mine development. With exploration taking place during a time when lenders are especially risk averse and commodity prices volatile, added uncertainty and concerns over nationalisation threats or amendments to tax regimes adds even more pressure on executives to prove the viability of new projects. Similarly, given that new finds in traditional destinations like South Africa, Australia and Canada are rare and maturing fields are becoming more costly, miners are increasingly moving into non-traditional countries in pursuit of untapped resources. This can introduce added cost layers in the forms of currency volatility, infrastructure challenges and lower labour productivity.

This trend can be seen in the growth in activity in Africa. Figures from the African Development Bank show that the continent accounts for 40% of the world’s gold reserves, 80-90% of its platinum group metals, 85% of all phosphate reserves, 50% of cobalt and one third of bauxite. From 2000 to 2011, resource extraction accounted for over half of all growth for more than 15 African states including Ghana, Equatorial Guinea and the Democratic Republic of Congo (DRC). According to KPMG, Africa received 15% of global exploration and mining investment in 2012 – a major increase from the 5% share the continent received in the early 1990s.

HISTORICAL CONTEXT: It would be overly simplistic to suggest that recent efforts by governments to secure a larger share of domestic mining activity were a purely opportunistic move that places the burden solely on corporations. In many jurisdictions the mining industry has thrived historically on exploitative practices, and tighter control is a positive step towards proper governance. New policies will help ensure that a nation’s mineral riches contribute to more inclusive economic development. Considering that resources are finite and will eventually deplete, measures seeking to reinvest mineral wealth into diversified and sustainable economic programmes is an unarguably responsible goal.

According to the Brookings Institute, two thirds of the world’s poor (and as much as 80% of Africa’s poor) live in countries that are considered resource-rich: a not uncommon paradox demonstrating that in many locales mineral endowment has not lead to poverty eradication. There is a clear need for countries to more effectively oversee the sector so that benefits are able to enrich the lives of local communities and the population as a whole, rather than a few local elites. Recent moves by Peru, for example, to introduce policies that formalise informal mining employees and redistribute royalties at the local level have been applauded by nongovernmental organisations, industry watchdogs and the private sector. In South Africa, producers must meet certain affirmative action requirements for ownership.

CAPITAL CONSTRAINTS: The approach is an understandable one but nonetheless is met with concern by the private sector. Between December 2012 and February 2013, accounting firm BDO conducted a survey with 130 senior financial executives representing mining companies from the UK, Australia, the US, Canada and South Africa. Focusing on the perceived challenges and opportunities their companies faced, 44% of respondents cited “global economic disruption” as the top risk. This was followed by “environmental and regulatory issues” and “geopolitical unrest” at 18% each.

Professional services firm Grant Thornton, in their annual 2013 international mining survey that included 389 mining executives in Australia, Canada, South Africa and the UK, found that 44% of participants reported “access to funding” as the top constraint limiting their business expansion. This was followed by “increased government involvement and/or regulation”, which was identified by 42% of respondents. Other major limiting factors included: “permitting/licensing procedures” with 36%; “volatility of commodity prices” at 34%; and “operating costs” reported by 26% of respondents.

While market conditions and financial constraints were the top rated risks and concerns, respectively, the prominence of regulatory and policy issues highlight the increasing impact that changes in legal and fiscal frameworks are having on miners worldwide.

A MATTER OF POLICY: The Fraser Institute’s survey also asked mining executives to rank the investment climates of different jurisdictions based on an index of 15 policy factors. Finland came out as the “best place to do business” for the sector in 2012/13, with Indonesia ranked as the worst out of the 96 destinations evaluated. As some countries have provincial rather than national mining legislation, certain countries, such as Australia, the US, Argentina and Canada had multiple jurisdictions rated. Joining Finland in the top 10 were: Sweden, Alberta (Canada), New Brunswick (Canada), Wyoming (US), Ireland, Nevada (US), the Yukon Territories (Canada) and Norway. Joining Indonesia in the bottom 10 were Vietnam, Zimbabwe, the DRC, Kyrgyzstan, Venezuela, Bolivia, Guatemala, the Philippines and Greece. In terms of regional top and bottom performers, Botswana was the top-ranked African jurisdiction, placed 17th globally, with the DRC and Zimbabwe coming out the worst. Chile placed top for Latin America, ranking 23rd globally, with Venezuela ranked the lowest for the region. In terms of pure production potential, when removing policy issues from the equation, Mongolia was ranked first followed by the Yukon ( Canada), Papua New Guinea, Indonesia and Alaska.

IT’S ALL MINE: Jurisdictions place varying limitations on the ownership of mining assets, with the most extreme scenario being nationalisation, whereby majority ownership must be in the hands of the state. Two prominent examples of this position are Venezuela, which nationalised its gold industry under former President Hugo Chavez, and Zimbabwe, which announced in 2012 that it intends to fully nationalise its diamond industry. Not surprisingly, both countries ranked in the bottom five of the Fraser Institute’s policy survey. Towards the other end of the ownership spectrum is Ghana, which is rated favourably overall by executives and requires 10% government interest in all mining companies’ domestic operations.

Ownership policy can also stipulate that equity stakes be in the hands of local business and investors, in addition to government. Indonesia, for example, requires all foreign-owned mines to have at least 51% ownership transferred to local Indonesian investors following the 10th year of production, while Mongolia has placed a 49% cap on foreign ownership.

In South Africa, recent years have seen a number of members of both the ruling and opposition parties calling for resource nationalisation. However, while any move towards nationalisation being enacted as policy was directly quashed by President Jacob Zuma, the public debate has nonetheless made an impact. “In the eyes of an investor, the very fact that nationalisation was vocally pushed for by quite a lot of people means it remains a threat irrespective of the official policy,” Sipho Nkosi, chief executive of Exxaro Resources, a South African-listed mining group with facilities in Africa, Asia, Europe and Australia, told OBG. “Investors want certainty. Even if a country demands majority state ownership in mineral assets, I will invest so long as I can show that, at 49% ownership, I am still able to generate positive returns and that my 49% will not be reduced. It is less about ownership than it is about clarity and the ability to plan for the long term.”

Equally important in terms of certainty is the acquisition of land, permits and mineral rights. A transparent award of mining rights, preferably through an open tender and bidding process, benefits all parties. Overly complex and cumbersome tendering processes can increase the time taken to receive approvals and introduce further layers of compliance and administrative costs. The US and Papua New Guinea ranked as the countries with the most numerous permitting delays, according to mining advisory firm Behre Dolbear Group’s 2013 “Ranking of Countries for Mining Investment”. The authors explain that in the US, due to the heavy involvement of the Environmental Protection Agency, there is on average a 7-10 year waiting period between application and approval for activity being granted. Countries ranked as having the fewest mining permitting delays were Australia, Tanzania, Mexico, Chile and Colombia. In addition to timely decisions, miners want to make sure that once a title is granted, it will not be disputed, and that the asset they have invested in will remain in their possession for the contracted period.

ACCESSING LAND: As part of the push to increase local ownership, governments are increasingly taking steps to ensure that those communities most affected by mining production have a share in its revenues. In an effort to redress past wrongdoings under the apartheid regime, South Africa’s Mining Charter calls for 26% ownership participation by “historically disadvantaged” groups by April 2014. This is an 11% increase from the 15% requirement mining firms had to meet in 2009.

The condition applies equally to local and foreign-owned mines and it has generated hotly contested debate as to whether or not it has been effective in transforming the industry. In the Grant Thornton survey, “57% of mining executives in South Africa reported that disputed exploration rights/title uncertainties regarding assets are a significant or moderate issue, well above the 44% global figure”.

In August 2011, Peru approved the Law of Prior Consent, a new piece of legislation that will require the government to consult with native communities prior to approving any mining or energy projects. Miners, while agreeing with the rationale and intent behind the law, argue that along with more stringent environmental impact assessment requirements that were also recently introduced, massive delays are making projects increasingly difficult to budget and plan for operationally. Subsequently, the number of petitions for concessions has decreased from 5959 over the period of January-May 2011, to 2188 for the same period in 2012 and 1451 for 2013.

Some jurisdictions, deeming that public pressure and good intentions are inadequate, opt to mandate that certain percentages of profits or revenues must be spent on community programmes and outreach. This is presently the case in Indonesia, the DRC and Zambia. While more recently, India has considered forcing coal mining companies to spend a portion of their profits on improving community welfare.

HIGHER TAXES: Perhaps the most noticeable trend in the wave of regulatory revisions is the push to increase the share of tax and fee revenues that government’s receive. Royalty and tax levels can be set, monitored and collected at a national, or in the case of places like Canada, the US and Australia, provincial level. In many jurisdictions, they tend to vary by mineral type.

Most major mineral-producing countries, both established and non-traditional, require royalty payments. Mexico stands out as one of only a few prominent mining destinations that does not currently charge royalties; however, it is expected to do so in the future. This follows an overall trend, according to PwC, of royalty and tax rate increases, as governments face revenue shortages while demand for state expenditures rises.

One of the more aggressive new tax schemes, and in turn most closely observed, is Australia’s Minerals Resource Rent Tax (MRRT) which was enacted in July 2012 and imposes a 30% tax levy on iron ore and coal projects for companies with annual profits exceeding $75m. As of August 2013, a full year since the passage of the act, only A$800m ($881.36m) in taxes has been collected, well below the A$2bn ($2.2bn) that the government projected. Predictions are that the MRRT will raise nearly A$4bn ($4.41bn) less than originally forecast over the next four years, according to PwC.

Because the tax generated from the MMRT is directly linked to profits, the underwhelming returns can be partially attributed to reduced profits for mining companies due to falling iron ore and coal prices – well below the 2008 peak levels – combined with a rising Australian dollar, which has negatively affected sales. The shortfall has led some analysts and politicians to call for the tax to be extended to other commodities extracted in the country, such as gold and base metals. Others, however, are calling for the scheme to be scrapped entirely, claiming it has had the adverse impact of causing the mining industry to delay or cancel new projects.

Dubbed a “super tax”, many other countries, including South Africa, are believed to be considering introducing a similar instrument, and these countries are therefore monitoring the impact of the MRRT closely. In May 2013, Canada’s provincial Quebec government released its own proposal towards a super profit tax, ranging from 16-28% to be applied proportionally to profits falling in the range of 35% to 50%. WHO’S COUNTING?: Taxable profits are not purely about absolute revenue relative to absolute costs, as the reported figures are dependent on the accounting principles behind how they are calculated. According to PwC, one noticeable current accounting measure being implemented by many jurisdictions is a “ring fencing rule” relating to how losses can be treated against group profits. Ghana’s 2012 budget statement stipulated, for example, that losses incurred at one mining site can no longer be offset against profits generated from another contract area belonging to the same company in determining corporate income tax.

SANCTITY OF CONTRACT: Stabilisation agreements are also playing a key role in determining investment attractiveness for mining producing countries. When preparing projections to influence a “go or no go” capital expenditure decision, miners must calculate the return on investment over the entire lifecycle of the mine, from exploration and development into production and ultimately through to the mine’s closure. Commodity price volatility already presents an element of huge uncertainty in financial modelling. And if investors cannot properly forecast tax outlays and royalty payments, they cannot accurately assess if the investment will be satisfactorily recouped. The degree to which the government and the local tax authorities are able to effectively administer and adjudicate their tax policies is thus critical, as a regulation is only solid if it is adhered to and consistently enforced.

It is common practice for mining firms to try and enter into stabilisation agreements with governments, which set out an agreed time period during which any subsequent legislative changes to mining rights, royalties and taxes will not apply. Chile, a highly rated jurisdiction, offers a fiscal stability regime under Decree Law 600, which, in addition to stating certain rights and benefits for investors, specifies binding tax rates over the duration of an awarded concession.

In the 2013 Behre Dolbear Group report, Chile placed behind only Australia and Canada as “jurisdictions that reflect conditions that promote investment growth in the mining sector”. In the case of Ghana, stability agreements are ad hoc and negotiated individually between the government and mining companies. They are subject to parliamentary approval and ratification, and when approved can sometimes run for longer than a decade. In fact, some of the country’s largest producers still have several years to go before they will be affected by any changes in fiscal burden.

Indonesia retracted its stability agreements in 2009, and is currently seeking to re-negotiate existing “Contracts of Work” reached with companies before 2009 to align with the current tax regime. Peru, meanwhile, has taken a less forceful tact in an attempt to raise revenues off historic mining contracts where low royalty rates were locked in. This is being done by requesting companies who had entered into stability agreements to voluntarily make increased royalty contributions.

DOWNSTREAM DEVELOPMENT: As discussed earlier, legal frameworks are being revised with an eye towards ensuring direct local participation through ownership and compensation in mining production. However, there is also a broader push – often using a mixed bag of both requirements and incentives – to ensure more processing occurs in-country. Many emerging mining economies, lacking an industrial base and technical know-how, face a scenario whereby the majority of their commodities are exported in raw form, with downstream, value-added activity being done elsewhere. This is a precedent that some jurisdictions are actively looking change by implementing interventionist measures, such as discouraging minerals from leaving their shores through levying export duties or tariffs. Other approaches include imposing domestic market obligations, whereby a certain percentage of output must be made available to domestic industry or, in the case of coal, as a feedstock to the power sector – oftentimes at fixed, below-global-market-value prices.

In Indonesia the government placed a 20% tax on the export of 65 minerals in 2012, and there are further talks of banning raw mineral exports entirely by 2014 in order to encourage miners to build local smelting and manufacturing facilities.

Other governments are taking a more direct approach of targeting the miners themselves, by making it compulsory, or offering incentives, for companies to invest or participate as partners in projects that refine or add value to the resources they are extracting in-country. Commonly referred to as “beneficiation”, South Africa, Brazil, Indonesia, Vietnam and Zimbabwe each have strategies in place to help raise the local economic contribution of their mining sectors.

Rob Davies, South Africa’s minister of trade and industry, cited an example of beneficiation to OBG, explaining that, “We are currently exporting mineral sands at $400 per tonne; however, we are now supporting a project to convert these sands into titanium alloy, which we will be able to sell at a market value of around $100,000 per tonne and create several thousand jobs. This is value which, at the moment, is being realised in economies outside of the continent.”

Bheki Sibiya, chief executive of the Chamber of Mines of South Africa, agrees that it is in the collective best interest of industry and the government to add value domestically where possible. He cautions, however, that developing local capacity cannot be regulated via a blanket approach, as beneficiation’s economical feasibility depends on the mineral in question and the country’s ability to competitively add value to it. “For some beneficiation, like jewellery assembly, the skill and market access required to do so is not available in South Africa. And assembly rather makes sense for highly populated countries, like India or China, or for highly specialised countries, like Italy. If you force the industry to rush into beneficiation, it will fail”.

POSITIVE ENFORCEMENT: While the regulatory trends discussed so far have generally focused on moves by government to place more burdens and monitoring on mining companies as a means of securing added local value, it should be noted that not all regulatory policies act as deterrents. Many government’s still offer incentives and tax holidays to actively encourage costly exploration. Canada is considered a leader in this capacity, and in the Grant Thornton survey around 80% of mining executives sampled perceive Canada’s public policy as one that encourages exploration. Only 47% of participants reported the same about Australia. In line with this sentiment, a study by the University of Western Australia's Centre for Exploration found that Canada, through pro-active legislation, has increased its share of global exploration spending from 14% to 18% between 2002 and 2011, while over that same period Australia saw its share fall by half.

Efforts by mineral-rich jurisdictions to capture more local economic benefit from their mining industries is understandable, considering the tremendous profits mining firms reaped during the commodities boom. Amidst softening global demand and a reduced appetite for capital lending, however, exploration activity is tailing off. This, in turn, is weakening the tax- and future production base from which governments’ are able to accrue earnings. These trends are leading governments to search for regulations that are better able to strike the optimal balance between encouraging mining activity while simultaneously ensuring local benefits.

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The Report: Ghana 2013

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