Friday, March 2, 2012

Resource rents will render South African mining uncompetitive – Solomon

JOHANNESBURG  – The imposition of resource rents in South Africa would render the South African mining industry uncompetitive, mining industry executive Michael Solomon said on Friday.

Solomon was commenting, at a mining law seminar hosted by law firm Bell Dewar, on the State intervention mining study (SIMS) of the ruling African National Congress (ANC), which in rejecting the nationalisation of mines, proposed that South Africa introduce a mineral rent, in which mining companies and the government would share post-profit upside on a 50:50 basis.

Defining resource rent as the surplus between the revenue and the directly productive costs, Solomon a real financial model to prove that South African was currently as competitive as any, but the moment a minerals rent was introduced, the model showed that South Africa was rendered completely uncompetitive.

He took an actual polymetallic deposit in South Africa and theoretically placed it in countries including the US, Canada, Australia, Chile and Brazil to determine the impact on the South African mining industry of a rents imposition.

“While each of the regimes have different components that go into their tax and royalty regimes, one way or another they balance out at the end of the day and the only one that is not is South Africa if you add the resource rent,” said Solomon, who has 30 years experience as a mining engineer and who is currently group executive mining for J&J Group.

“It sounds like a good idea to be able to share in mining’s upside, but it really messes up our competitiveness and we will see less and less investment coming to South Africa if it is introduced,” Solomon warned.

The former Wesizwe Platinum CEO said that the ANC’s 600-page SIMS document contained many positives in terms of constructive State participation, but the resource rents would be debilitating.

Much rent would arise from mines that had low costs and very little rent would arise from mines with high costs.

The rents would follow social licence costs, fiscal flows, which averaged 23%, and “reasonable” investor returns, which might range from 5% in Canada and 10% in Australia and to 25% in the Democratic Republic of Congo.

Lower commodity prices would squeeze rents, which would in turn result in decisions to mine higher grades and sterilise lower grade ore.

As South Africa already had a mature industry and was mining at greater depth, productive capacity would be reduced, which would lower labour absorption capacity.

While SIMS and the ANC Youth League saw State intervention as creating more jobs, it would thus actually work in reverse.

As inefficiencies in the system were increased and cut-off grades rose, mines would close sooner, curtailing jobs still further not only in mining, but also in the secondary and tertiary sectors of the economy, which in South Africa’s case were well developed.

In the exploitation of the polymetallic deposit chosen as an example, rent absorbed a third of the project’s 39% internal rate of return (IRR).

The SIMS document advocates that rent be shared 50:50 over-and-above a 22% IRR, with the difference between 22% IRR and 39% IRR split equally between government and the mining company.

In the example, the project’s net present value (NPV) of R1.1-billion net present was reduced to R675-million, knocking R435-million off the IRR, which was taken down seven points from 39% to 32%.

“The government may argue that the mining company is still doing well by getting an IRR of 32%, but we are not in isolation from the rest of the global minerals economy.

“There seems to be a perception that investors are falling over one another to get to the South African mineral sector, but they are not.

“What is happening is that investors are falling over themselves to get in to Latin America, the rest of Africa, Indonesia and Malaysia and we’ve got Australia and Canada to compete with,” Solomon said.

Moreover, the weighted average cost of capital (WACC) defined the NPV and the cost of capital defined the profitability.

The two most important factors within the WACC were the risk-free rate, which in South Africa was 7.78%, Australia 4.09%, US 1.97%, Spain 4.88%, Canada 2%, Brazil 8.5%, Chile 2.5% and Indonesia 5.75%.

The other component was the country risk premium and the long bond reflected the state of the political economy, which was high for unstable countries and low for stable ones.

Then there was also the discretionary risk premium that investors themselves put into the WACC.

South Africa’s risk premium was 6.3%, Australia’s 5.8%, US’s 5.5%, Spain’s 5.9%, Canada’s 5.9%, Brazil’s 7.7%, Chile’s 5.7% and Italy’s 4.5%.

Putting the South African project used as an example in Australia gave Australia a R550-million NPV advantage over South Africa – 40% versus 32% – making it a no-brainer to opt for Australia as a better investment destination.

He guessed that if the major mining companies opted to leave South Africa, other investors would take their place, but he questioned whether they would be of the same quality.

If they were of a lower quality, as was likely, it was likely that the frustration of near-mine communities would be exacerbated.

South African mining companies had gone through decades of mining companies getting its act together in terms of social licence and environment and it was unlikely that the new foreign companies would have the same level of empathy with the philanthropic aspects of mining.

“Unless you have a reasonable investor return, you will not have an industry,” Solomon believed.

“Mining creates money. Every time a miner mines something, it creates real money and real value,” said John Meyer of London mining analyst company Fairfax in a note on Friday.

Meyer added that the economic value of mining was substantial and created a multiplier impact on economies that went for downstream processing.

Smelting and refining captured value while manufacturing was the key to maximising value from national resources.