Feature Stories | Jul 07 2010
This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP
This story was originally published on July 5, 2010. It has now been re-published to make it available to non-paying members at FNArena and readers elsewhere.
By Greg Peel
It is not known whether the Australian people will ever be allowed to appreciate the full extent of the Henry Tax Review and the hundred plus proposals therein, and whether or not it contained all sorts of balances and offsets in one complete package. All we know is that the Rudd government chose only three proposals, one of which was the explosive 40% Resource Super Profits Tax (RSPT). This stood out like a sore thumb. Tax reform? For once Tony Abbott was justified in using his “great big new tax” spin.
Clearly Kevin Rudd expected a visceral revolt from the resource sector, but he also assumed selling a tax on “greedy” miners for benefit of all Australians would be an electoral pushover. He was wrong. Australians are simply not so stupid as to believe that any tax on someone other than themselves is necessarily a positive. Australians understand the importance of mining – and particularly bulk commodity mining – to the Australian economy. They understand the employment impact. And they also understand that any tax on miners is also a tax on their superannuation.
Rudd was also proved wrong to use the example of the 23-year old Petroleum Resource Rent Tax (PRRT) introduction as a comparative test case. Yes, there was a lot of opposition to that tax as well, both locally and internationally and yes, everyone eventually got over it. But Rudd clearly did not foresee the impact this tax would have on Australia's international reputation at a time of global economic uncertainty, did not foresee the shot in the arm the tax policy gave to an otherwise struggling Opposition, and did not foresee just how quickly the public could turn on a prime minister who only months before looked unbeatable.
The RSPT was the final nail in the coffin for Kevin Rudd. Rightly or wrongly, Julia Gillard is the new prime minister and she wasted no time in radically overhauling the resource tax proposal, this time with industry consultation. What we now have is a much watered down proposal.
Before moving on to discuss the changes, consider first that there remains a lot of detail to be worked through by the team of Martin Ferguson and the former chairman of of BHP Billiton ((BHP)), Don Argus. Some points remain unclear. There also remains a good deal of opposition from junior miners left out of the negotiations, with suggestions made that the new policy is a deal only for the big miners BHP, Rio Tinto ((RIO)) and Xstrata. And consider that the proposed tax must yet pass through parliament.
On that basis, the earlier Environmental Trading Scheme (ETS) episode will be fresh in Gillard's mind. The ETS proposal – a significant plank of Rudd's election policy – was shot down because the Opposition argued it was too tough and the Greens argued it was too lax. Thus an impossible stand-off occurred. Similarly, the Opposition is opposing any form of resource tax while the Greens are upset by Gillard's back-down. Another stalemate looms.
One can only thus assume Gillard will take her new tax policy to the people. If she wins the election, she has a mandate in theory, albeit the Greens are tipped to win the balance of power in the Senate, and the Opposition could also strengthen its Senate seats. So there would still be no certainty unless parliament agrees the election is realistically a resource tax referendum, as Abbott suggests. If the Opposition wins the election, then no resource tax.
So as far as resource sector analysts are concerned, the whole thing is still up in the air. But what they can do is compare the valuation impact on mining and energy companies under the new proposal to the impact of the initial RSPT proposal. At least as far as current detail allows. So what are the differences?
The original RSPT taxed all mine and onshore gas projects at 40% of “super” profits. Profits were deemed to be “super” when a mine's return exceeded the book value of the mine plus the long bond rate. That rate currently sits between 5-6%. Mines could offset their exploration and development costs, would have their state mining royalties rebated against the RSPT, and the RSPT deducted from their corporate tax. The corporate tax rate would fall from 30% to 29% and then to 28%. The government would refund 40% of costs of a failed project.
Put this altogether and analysts agreed the net impact was that miners would be paying something like 56-57% tax compared to around 38% previously. This compares to equivalent international mining tax rates of mostly around 40% or less. It clearly made Australia less competitive. Its structure also meant that iron ore and coal, and particularly BHP and RIO, would be up for 75%-plus of all revenue collected by the government from the RSPT. Legacy mines, such as BHP and Rio's Pilbara iron ore assets, would be severely disadvantaged by having to measure their profits off the book value and not the market value of a mine. The RSPT was retrospective, and the Pilbara mines date back decades. And the long bond rate measure could hardly be called a “super” threshold when the large miners' cost of funds is more like 12%. And more for juniors.
The RSPT, in its original form, is now out the window. In its place is a new Mining Resource Rent Tax (MRRT) along with the existing PRRT.
The MRRT taxes “super” profits at 30% instead of 40%, and given a 25% “extraction allowance” the rate is realistically 22.5%. Market value of a mine now replaces book value as the starting point for determination, and the threshold has been lifted from the long bond rate to the long bond rate plus 7% (ie 12-13% today). The corporate tax rate will still fall to 29%, but not 28%.
Miners can now choose either market value or book value for depreciation purposes. The RSPT depreciation rules favoured start-up mines over established mines. The choice now evens out the playing field. State royalties will no longer be rebated but will be carried forward against future MRRT. This avoids new mines being hit with state royalties before they have sufficient profits to pay a tax, and offers a future offset in times of low commodity prices.
Once again, it's all a big mess of proposals which analysts are still yet to fully remodel. Questions such as “who determines market value?” remain. But in simple terms, the MRRT implies a tax of 44-45% instead of 56-57% according to initial analyst calculations. That's still high in comparative international terms, but a lot closer. Citi, specifically suggests the MRRT is 50-80% “better” than the RSPT.
But the most profound change of all is that only iron ore and coal producers will be subject to the MRRT. Miners of other commodities – base and precious metals etc – are completely off the hook. And the MRRT works the same way as the RSPT in that it is the mine being taxed, not the miner. So while BHP, for example, is still being hit for iron ore and coal it is not being hit for copper, uranium etc.
Junior iron ore and coal miners will pay no MRRT until profits reach $50m per annum.
The other concession is that all oil and gas projects, including onshore (eg CSM LNG) and offshore (including the once exempt North West Shelf) will pay the PRRT and not any RSPT. While some producers will thus now have to pay the PRRT for the first time, it is a better option than paying a more imposing RSPT.
So what is the specific impact on stock valuations?
Here analysis varies at this early stage, but we'll take two examples. Citi calculates the valuation impact of an MRRT would be 1-3% for BHP and Rio compared to 12% under the RSPT, and 2% for Fortescue Metals ((FMG)) compared to 25%. For coal producers the impact would be 5-8% compared to 15-20%.
Macquarie suggests the impact on BHP would be 3-5% compared to 10-12% and for Rio 4-6% compared to 13-15%.
Clearly any miner not mining any iron ore or coal will have its valuation impact reduced to zero. RBS points out a handful in this camp, including copper producer OZ Minerals ((OZL)), uranium producer Energy Resources of Australia ((ERA)), gold producer Newcrest Mining ((NCM)), and manganese producer OM Holdings ((OMH)). Obviously any producer of anything other than the bulks can breathe a sigh of relief.
UBS notes companies such as ERA, Panoramic Resources ((PAN)), Western Areas ((WSA)) and Minara Resources ((MRE)) were looking at 9-17% valuation reductions under the RSPT and now are looking at none.
For junior iron ore and coal miners, negotiations continue. But Macquarie points out that we are homing in on more valuation certainty now for the likes of a Mt Gibson Iron ((MGX)), or Whitehaven Coal ((WHC)).
On the gas front, Deutsche Bank suggests a PRRT regime instead of an RSPT regime will “significantly de-risk” proposed CSM LNG projects who are seeking equity partners. Big Oil & Gas has long been used to the original PRRT scheme and knows how to value projects accordingly. UBS suggests a PRRT should allow projects such as Santos' ((STO)) GLNG to continue moving towards final investment decision (FID) status with more certainty.
Macquarie suggests Woodside Petroleum's ((WPL)) net asset value would fall by 2.4% under the new PRRT proposal, Santos' by 2.2% and Oil Search ((OSH)) would remain unaffected as it is operating offshore.
To sum up, consider GSJB Were's conclusion:
“On balance we see the MRRT as an important first step towards an acceptable compromise for the mining industry, and towards repairing sentiment regarding the increased sovereign risk for business investment in Australia. However, we should not lose sight of the fact the MRRT still represents an incremental tax burden for the producers of coal and iron ore, and for those producers of gas not already subject to PRRT, relative to the pre-RSPT status quo.”
And from Credit Suisse:
“While the MRRT is likely to result in an increase in taxes over the existing tax system, it is far less punitive than the original RSPT proposal, and should see Australia remain an internationally competitive mining nation from a taxation standpoint.”
What also has to be considered is the spill-over effect. Various industries, such as the mining services industry in particular, and right down to airlines and accommodation etc, would have been indirectly impacted by the RSPT. Assuming Australia will no longer lose all those projects it would supposedly have lost under an RSPT (Xstrata, for one, has now taken projects off hold), then there is a much wider sigh of relief being breathed across the country than just among the mineral and energy producers.
In terms of direct impact on share prices, two points must be taken into consideration. Firstly, the market has already been assuming a compromise for some time now, so the MRRT is only a level of confirmation. Secondly, The world is currently gripped with concern over a slowing in global economic growth, which is currently outweighing any tax impact.
Click to view our Glossary of Financial Terms
CHARTS
For more info SHARE ANALYSIS: BHP - BHP GROUP LIMITED
For more info SHARE ANALYSIS: ERA - ENERGY RESOURCES OF AUSTRALIA LIMITED
For more info SHARE ANALYSIS: FMG - FORTESCUE LIMITED
For more info SHARE ANALYSIS: MGX - MOUNT GIBSON IRON LIMITED
For more info SHARE ANALYSIS: NCM - NEWCREST MINING LIMITED
For more info SHARE ANALYSIS: OMH - OM HOLDINGS LIMITED
For more info SHARE ANALYSIS: OZL - OZ MINERALS LIMITED
For more info SHARE ANALYSIS: PAN - PANORAMIC RESOURCES LIMITED
For more info SHARE ANALYSIS: RIO - RIO TINTO LIMITED
For more info SHARE ANALYSIS: STO - SANTOS LIMITED
For more info SHARE ANALYSIS: WHC - WHITEHAVEN COAL LIMITED