Why the industry needs to remain vigilant despite retreating resource nationalism
Resource nationalism rocketed to mainstream prominence in Australia in 2010 with the (failed) proposed Resources Super Profits Tax (RSPT). With the commodity price boom well under way, and governments around the world struggling with diminishing revenue and reduced corporate activity due to the global financial crisis, attention focused on the mining sector as an easy target. The RSPT led the way for countries globally to look for increased share of mining spoils during the super cycle.
As a result, in 2011 resource nationalism went to the top of EY’s annual top 10 mining business risk list as governments globally looked to cash in on the super cycle. While resource nationalism has since dropped down the risk ratings – and from mainstream prominence (particularly after the repeal of the RSPT replacement, the Minerals Resource Rent Tax (MRRT)) – it firmly remains in the top business risk issues for miners.
With government finances in trouble in Australia and around the world, resource nationalism is not an issue that is going away and needs to stay on the executive agenda of mining company boards and management. The need for miners to tell the broader community what they do and how they contribute to the economy and community is as important now as it has even been.
For governments, the new world of resource nationalism is a balancing act between promoting investment and maximising in-country benefits. With shrinking investment, some governments have begun to promote initiatives to attract mining investment into their jurisdictions. At the same time, despite declining commodity prices, we are still seeing waves of resource nationalism by countries keen to gain a greater share of shrinking returns from the mining and metals sector to shore up declining budget revenues.
The most dramatic example of recent resource nationalism activity has been mandated beneficiation and state ownership. Mandated beneficiation is very popular politically as governments seek to extract greater value from their resources by mandating that minerals are processed in-country prior to export.
However, the long-term fallout of this policy is unclear, and it can swing either way: significant investment can occur in downstream investment if the country invests to create competitive advantage or mining moves elsewhere. Greater state ownership comes from the desire to take direct equity exposure to mining investment development and production. Though there are fewer success stories than there are failures.
Mining and metals companies need to continue to educate governments on the impact of resource nationalism on investment decisions, whether that is taxes, use-it-or-lose-it conditions or in-country processing requirements. Companies need to continue to demonstrate effectively the benefits of mining and metals to the broader community and enhance the understanding that raising the cost of doing business may scare away investment and jeopardise those benefits for the government and the community.
Retreating resource nationalism
Current low margins and high-supply environments mean many projects are being cut and/or operations have been put on care and maintenance. With fewer expansionary projects advancing, competition to attract those that will invest is intensifying.
In Australia, the abolition of the Mining Resource Rent Tax (MRRT) in October 2014 was welcomed, as was the royalty relief, albeit temporary, provided to smaller iron ore producers in Western Australia. Australia was not alone.In 2014, many countries changed their mining tax policies to attract mining investment. These changes to resource nationalism included privatising state-owned assets (Kazakhstan), amending mining codes
to be more investor friendly (Mongolia and Kyrgyzstan) and reducing export taxes (Vietnam).
Geology will always be foremost in the decision of where to invest, but the political environment in a country of investment is also important. Any government promoting tax policy
stability will be favoured as miners seek low-risk investments with minimal political uncertainty.
Dilemma: boosting the economy or scaring away investment?
Resource nationalism is a balancing act for governments between attracting highly mobile investment into the sector and ensuring their countries get the maximum benefit in return. Countries may have a comparative advantage in the extent of their resources, but what else they offer will also make them competitive in attracting investment. Mining and metals companies will continue to assess the cost of development and production through their whole supply chain. It may be that a country with similar resources can provide better infrastructure, access to energy or skilled labour, and therefore have a competitive advantage.
The most dramatic example of resource nationalism activity in 2013 and 2014 has been the introduction of mandated beneficiation and state ownership. With depleted treasuries, the use-it-or-lose-it policy has re-emerged, with governments threatening to revoke licenses of loss-making projects put into care and maintenance. Governments are seeking to extract greater value from their resources by mandating that minerals are processed in-country prior to export. In theory, this will capture more of the value chain as finished products and will achieve higher prices. In order to ensure in-country beneficiation, governments are imposing new steep export levies or complete export bans on unrefined ores.
Indonesia, for example, introduced a new export levy of 25 per cent on mining exports in the first half of 2014, increasing every year thereafter. The Indonesian Government believes that it will help to develop its mining industry, create jobs, and make it a producer of higher-value finished goods from an exporter of raw materials. Similar measures are also being considered in other countries, including South Africa, Gabon (which is seeking 100 per cent of minerals processed locally by 2025) and Zimbabwe (where an export ban on unprocessed platinum and chrome will take effect within two years).
Given global supply chains, even for miners that do not have operations in countries taking these measures, mandated beneficiation can have a significant impact on the sector. Indonesia’s export ban on unprocessed nickel ore in January 2014 altered the nickel market, with prices rising 40 per cent in the first six months of 2014, and increasing 12.4 per cent on average during 2014, driven by reduced supply availability.
Mining and metals companies have to weigh up the risk versus reward when investing in countries where downstream processing of minerals becomes compulsory. The capital required in a project will increase, and it also concentrates investment risk in a country which by virtue of this policy could well become a poorer competitive environment. The return on investment decreases as it necessitates greater downstream investment, where there are potentially lower rates of return and greater risks of losses. The reality is the restrictions and regulations are likely to come at a cost.
Both the retreat of resource nationalism and the creation of a positive investment environment are vital for countries that wish to remain attractive for continuing and future investment. We are likely to see continued retreating resource nationalism, likely in the form of retraction or reduction of export taxes, increased privatisation of state-owned assets and reduced red tape for licenses (exploration, environmental, etc).
As we have already seen, mandated beneficiation (and the associated export bans) can have a significant impact on the sector. Indonesia’s actions, for example, have altered the nickel market, with prices having already risen steeply when the export ban was introduced.
Clearly, if a similar policy is adopted in other countries, we will see an unnatural inflation of some commodity prices, to the long-term detriment of the sector. The impact of base erosion and profit shifting (BEPS) on the mining and metals companies is less clear. Many countries seem to be in favour of a BEPS action plan, as long as the actions do not harm global trade and investment through convergence of high tax rates or policies that distort competition.
Companies should evaluate the pros and cons of additional voluntary disclosure, and ensure that there is more proactive engagement with fiscal authorities on their tax position.
- Become involved with trade and industry groups to influence future taxation schemes.
- Seek value-recovering trade-offs, such as improvements in time for project approvals.
- Put forward recommendations to demonstrate the impact of changes to both taxes and policies affecting mining and metal companies.
- Think proactively and really engage the government on both a local and country wide basis to demonstrate the benefits of mining to the community.
With regard to BEPS, companies should use a framework that identifies and assesses areas in the organisation that have limited transparency, consistency and substance. Undertaking a holistic review, with full value chain transparency and with focus on the BEPS actions, will identify key risks in relation to BEPS, enabling a company to prioritise the impact of these risks and define risk mitigating actions.
The views expressed in this article are the views of the author, not Ernst & Young. This article provides general information, does not constitute advice and should not be relied on as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Liability limited by a scheme approved under Professional Standards Legislation.