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to the Industry Commission

Mining and minerals processing: industry assistance, taxation and the environment

A

ble S , puee 19 and Table 13, page 61.

Effective rate Net subsidy of assistance ecluivalent

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:tails of implied adjustments to subaggregates available: contact: )m Waring on (06)246 9487.

lese revisions affect the text on pp. 2 and 19.

Australian Bureau of Agricultural and Resource Economics

Mining and minerals processing: industry assistance, taxation and the environment

I m Project 5226.102

O Commonwealth of Australia 1990

This work is copyright. The Cupyright Act 1968 permits fair dealing for study, research, news reporting, criticism or review. Selected passages, tables or diagrams may be reproduced for such purposes provided acknowledgment of the source is included. Major extracts or the entire document may not be reproduced by any process without written permission of the Director Publishing and Marketing, AGPS. Inquiries and requests should be directed to the Manager, AGPS Press, Australian Government Publishing Service, GPO Box 84, Canberra ACT 2601.

ISSN 0814-9445 ISBN 0 644 13010 5

Australian Bureau of Agricultural and Resource Economics GPO Box 1563 Canberra 2601

Telephone (06) 246 9111 Facsimile (06) 246 9699 Telex AGEC AA61667

ABARE is a professionally independent research organisation attached to the Department of Primary Industries and Energy.

Published for ABARE by the Australian Government Publishing Service, Canberra PRINTED BY PIRIE PRINTERS SALES PTY LTD, FYSHWICK, A.C.T. 2609

Foreword

In October 1989, the Treasurer announced an Industry Commission inquiry into the mining and minerals processing industries. The Commission is required to report by 28 February 1991 on factors which lead to inefficient resource use in these industries and on courses of action to reduce or remove such inefficiencies.

The focus in this submission is on government intervention in the Australian mining and minerals processing sectors and the potential for resource misallocation. Particular attention is paid to mineral taxation arrangements and resource management issues. These are the two broad

areas in which government policy influence is the strongest and in which the scope for increasing the efficiency of resource use is potentially the greatest.

BRIAN FISHER Executive Director

Australian Bureau of Agricultural and Resource Economics

July 1990

iii

Acknowledgments

This submission was prepared in the Cox, Paula Bames and Peter Hancock. The Minerals Economics Branch under the model simulations of the coal taxation supervision of Tom Waring. The project arrangements were carried out in the Energy was developed and managed by Anthony Economics Branch by Sally Thorpe, Cox and the principal authors were Anthony Geraldine Anthony and Quentin Croft.

CONTENTS Summary 1

1. Introduction 1.1 Terms of reference 1.2 Objectives and scope of the submission

2. Outlook for the mining and minerals processing sectors 7 2.1 Situation and medium term outlook 7 2.2 Factors affecting the mining and minerals processing sectors 11

3. Government intervention in mining and minerals processing 16 3.1 The objectives of government intervention 16 3.2 Assistance measurement 18 3.3 Summary 22

4. Mineral taxation arrangements 23 4.1 General properties of optimal mineral taxation arrangements 23 4.2 Mineral taxation in Australia 26 4.3 Alternative taxation arrangements 29

l

l 4.4 Coal industry taxation: a case study 33 1 4.5 Summary 36

5. Environmental issues 5.1 Institutional arrangements 5.2 Policy constraints 5.3 Policy options

6. Other issues 6.1 Capital and operating costs 6.2 Export controls 6.3 The international trading environment

I 7. Conclusion 55

Appendixes A Terms of reference B Activities covered by the reference C Detailed assistance estimates D Effect of gold mining tax change on rate of assistance E Taxation arrangements applied to the mining sector F Assessment of alternative taxation arrangements G Details of the coal taxation case study

References

Figures A Sedor contributions to Australian gross domestic product B New fixed capital expenditure, by sector C Ratios of investment to consumption, OECD countries and Asia

Tables 1 Average annual growth rates of mineral resource consumption in the

market economies 2 Volume of Australian mineral resources exports 3 Real value of Australian mineral resources exports 4 Assistance to the mining sector, 1987-88 5 Assistance to the mining sector, by industry, 1987-88 6 Assistance to the minerals processing sector, by industry, 1988-89 7 Comparison of assistance to sectors of the economy 8 Short run effects of the removal of assistance on sectoral real net returns 9 Major taxation arrangements applied to the Australian mining industry

(excluding the petroleum industry) l 0 Mineral royalties, by industry class, 1987-88 11 Parameter values assumed in simulations 12 Non-tariff measures affecting international trade in minerals 13 Detailed estimates of assistance to mining industries 14 Assistance to gold mining industry: removal of tax exemption 15 Royalty schemes applied to the Australian mining industry

(excluding petroleum) 16 Aggregate simulation results: constant coal prices 17 Aggregate simulation results: rising coal prices 18 Aggregate simulation results: falling coal prices 19 Results by variable for opencut mines: constant coal prices 20 Results by variable for underground mines: constant coal prices

Summary

On 18 October 1989, the Treasurer asked the Industry Commission to inquire into the mining and minerals processing industries, excluding petroleum and petroleum products. The Commission was requested to report on any institutional, regulatory or other arrangements subject to influence by governments in Australia which lead to inefficient resource use, and to advise on courses of action to reduce or remove such inefficiencies. In this submission, the market prospects for mineral commodities are assessed in order to establish the economic conditions in which this policy review is to be undertaken. A broad economic perspective on the role of government and the impad of industry assistance on the mining and minerals processing sectors is provided. The two areas of policy seen as most relevant to the efficient use of resources in these sectors - taxation arrangements and resource management - are assessed in more detail.

Outlook for mineral commodities Australia's mining and minerals processing sectors make a major contribution to the economy in terms of their share of gross domestic product and exports. The relatively capital-intensive nature of these sectors accounts for their high share of investment and low share of employment relative to their contribution to gross domestic product. Australia is among the world's leading exporters of many mineral resource commodities, and its mining and minerals processing sectors are highly export oriented. Exports from these sectors account for nearly half of Australia's total merchandise exports and 38 per cent of total export earnings.

The outlook for mineral markets is generally positive. Policy initiatives or

refinements under consideration for the sectors are generally those aimed at improving the efficiency of resource use in the context of further sector growth, rather than, for example, those which would more efficiently manage sector decline or structural adjustment.

World demand for most minerals is expected to continue to grow, albeit at slower rates than in recent years. The sustained improvement in prices over recent years has encouraged companies to expand production, and expansion in supply is expected to be more rapid than growth in demand. Prices are therefore expecsed to ease in real terms, but to remain high above the lows of the mid-1980s by historical standards.

Australia is expected to consolidate its position as a substantial supplier of minerals to the world market. Low production costs for the major minerals reflect Australia's comparative advantage in mineral extraction and processing. In particular, Australia is well placed to take advantage of growth in demand in the South-East Asian countries. However, Australia's competitiveness depends not only on the natural advantages of large mineral deposits, low energy costs and proximity to expanding markets but also on its efficiency in the allocation and use of resources. Arrangements which lead to inefficient resource use have the potential to increase costs and decrease competitiveness.

Assistance to the mining and minerals processing sectors Policy instruments which are used to assist industries, such as tariffs and subsidies, draw resources toward the relatively highly assisted industries and away from the

Mining and minerals

relatively lightly assisted industries. This changes the relative sizes and structures of the industries from those which would prevail in the absence of the assistance. The 'effective rate of assistance' measure provides a useful means of comparing assistance between various activities, industries or sectors.

Effective rates of assistance for minerals industries are presented in this submission. Overall, the mining sector is penalised by government industry policy and assistance intervention, with an effective rate of assistance of -1 per cent of the unassisted value-added. Although a range of measures assist the sector, the effeds of interventions aimed at assisting activities which supply inputs to mining outweigh these positive influences. There is considerable variation in the effective rates of assistance between mining industries. They range from -22.7 per cent for tin mining to 13.4 per cent for gold mining. All mining industries except gold mining have negative effective rates of assistance. The rate for the gold mining industry is expected to fall but remain positive when the taxexemption on gold mining income is removed in 1991.

The minerals processing sector receives more net assistance than mining, with an average effective rate of assistance of 9 per cent. The rates range from -8 per cent for the copper and nickel smelting and refining industry to 49 per cent for the aluminium rolling, drawing and extruding industry. The minerals processing sector on average has a similar effective rate of assistance to the agricultural sector. The manufacturing sector is the most heavily assisted sector, with an average rate almost twice that of the agricultural sector.

While providing an indication of relative net assistance across industries, the effective rate measure does not fully capture the overall effects of assistance, or of changes in assistance. The effects of the removal of assistance from all sectors of the economy have been examined in other studies using the ORANI model. The mining sector would

- -

receive the largest net gains from such a reduction in assistance. The minerals processing sector would also experience improved profitability. The gains to these sectors would result largely from the removal of manufacturing tariffs, particularly tariffs on inputs to mining and minerals processing, and of domestic marketing arrangements for some agricultural products.

Mineral taxation arrangements There is a broad spectrum of mineral 'taxation' arrangements at present in operation in Australia. Ideally the allocation of access rights and the implementation of taxation mechanisms should be done in a manner which is consistent with the efficient allocation of resources in the economy. Under a wide range of circumstances, an optimal tax is one which is 'neutral' in its effects, in that its imposition does not distort the efficient allocation of resources by companies. An example is a tax which is levied on economic rent and is symmetric in its treatment of profits and losses. (Economic rent is the amount by which the profits obtainable from the use of a resource exceed the level at which that use would just be economically feasible. An example of tax symmetry is the full deductibility of losses from subsequent profits.) If there are a number of alternative taxation arrangements which are neutral, the arrangement with the lowest collection costs is preferable.

The design of optimal taxation policies is heavily influenced by the effects of business risk. Where future earnings are uncertain, taxation arrangements may involve a redistribution of risk between governments and private firms. (For example, if a government sells an exploration right for a lump sum, the risk that nothing saleable will be found is borne entirely by the purchaser. When the government taxes profits, in contrast, it accepts the risk that no profits will be earned.) To some extent, firms can cover their risks by means such as insurance and futures trading, but the

ABARE submission to Indust y Commission

view, in effect, that the amounts of economic rent associated with the operations of most industries in the mining sector tend to be misperceived, and that the efficiency gains of reform are likely to be small relative to the costs. It appears that governments would require large amounts of information, on mineral resources as well as accounting information, in order to maintain the optimal properties of rent-based taxation arrangements. The major practical difficulty is the measurement of economic rent. On the other hand, the acquisition and dissemination of the required geological information by governments would also partly compensate for the incompleteness of risk markets, by reducing the uncertainty faced by private firms, and could thus improve efficiency of resource allocation and use.

Careful consideration is required as to whether the costs of implementing the alternative arrangements in particular industries are higher or lower than those arising from the current arrangements. A case study of the black coal industry - an industry in which the potential benefits of resource rent taxation have been mooted, and where a type of rent taxation has been attempted in some areas of costs and charges - highlights inefficiencies in the main forms of taxation applied to this industry. The results indicate strongly that rent-based taxes are preferred alternatives to the current production-based and revenue-based taxation schemes.

market for risks is not complete, and it may thus be efficient for the government to carry a share of business risk. However, it is not clear what level of risk is optimal for the government to bear in the interests of efficiency.

In Australia, existing taxation arrangements involve allocation of mineral access rights by non-market mechanisms, and the imposition of taxes whose amount depends on the outcome of the mining enterprise. The mechanisms used to allocate access rights are based on 'first come, first served' and work program bidding (in which firms compete in the amount and type of work they offer to perform). These mechanisms are inefficient, because they include conditions that restrict the ability of companies to maximise returns from exploration and prevent the resale of property rights. Taxation mechanisms are mostly based on production or revenue, and include royalties, export duties and charges in excess of costs for the use of government infrastructure. Because these mechanisms are not directly based on the taxation of economic rent, they distort resource allocation by altering production decisions and making marginal mines uneconomic.

There is a range of alternative taxation arrangements which are based on economic rent (that is, actual or anticipated profits).

Environmental issues

I

Environmental issues have become increasingly prominent in relation to the mining and minerals processing sectors over the past few years. Competing claims for access to land have provided most cause for concern from both an industry and a public policy perspective.

Institutional arrangements have major consequences for the conduct of environmental policy and for the ability of governments to determine the socially optimal allocation and use of natural

These include the 'Brown tax', the resource rent tax and cash bidding for mineral rights. The Brown tax and resource rent tax are both taxes on profits, differing in the way losses are treated. There is also the possibility of combining a tax based on profits with cash bidding. Such a combination provides an efficient mechanism for allocating access rights to the resource. These alternative arrangements are - at least in principle - preferable to existing arrangements, because they are based on extracting rent and are less distorting than production-based taxes.

Several other issues would need to be addressed, however, in considering the possible implementation of these alternative arrangements. Industry has expressed the

Mining and minerals

resources. The main instrument used by the Commonwealth and state governments in determining the environmental standards to be met by development proposals is the environmental impact assessment process. Potential sources of constraint inherent in present arrangements include: differences in the objectives being pursued by the various levels of government; the extent to which economic techniques for measuring both tangible and intangible costs and benefits of proposals are incorporated into the environmental impact assessment process; and the heavy emphasis on the use of regulations to achieve conservation goals.

In addition, the absence of markets for some of the conservation services provided by the environment, particularly off-site benefits, may limit the ability of governments to implement market solutions to resolve competing claims. Uncertainty over the geological and environmental values of particular areas may also impose a policy constraint.

There are a number of policy options for governments in developing more efficient methods of resolving competing claims between minerals development and other resource uses. First, there is scope for improving the information base on geological and environmental resource values affected by development proposals. Because of the inability of firms to capture the full benefits of any information they generate, the amount of information provided by the private &or is likely to be less than socially optimal. Second, the increased use of economic analysis in the appraisal of social costs and benefits in the environmental impact assessment process will assist in balanced decision making. Third, there is scope for rationalising procedures between the various levels of government. Finally, greater emphasis should be placed on the use of alternatives to regulation as a means of achieving conservation goals. In particular, off-site costs generated by minerals processing activities may be more efficiently controlled

4

through the use of taxes on side effects.

Other issues Other important issues discussed in this submission relate to capital and operating costs, export controls and the international trading environment.

Government influences on capital costs include the provision and pricing of infrastructure, and foreign investment guidelines. Among variable costs, energy and shipping costs reflect inefficiencies in resource allocation which result from the fact that public authorities and companies providing such services are insulated from competition by legislation.

Export controls on minerals have been substantially relaxed in recent years, but are maintained for some commodities, including coal, iron ore, mineral sands, alurnina and uranium. These controls have been used to attempt to achieve objectives such as 'fair and reasonable' market prices and protection of the environment. However, the circumstances in which export controls can affect world markets in the long run are becoming increasingly difficult to identify; as markets evolve, the influence of any one nation diminishes. There are also significant costs involved in administering export controls.

In international mineral markets, policies to protect and assist domestic industries distort the efficient flow of world trade, imposing costs on the economies of the protecting countries as well as other nations. As a major exporter of minerals, Australia is vulnerable to these effects of barriers to trade. There has in recent years been an increase in non-tariff measures such as subsidies, government price support schemes and quantitative restrictions. A lack of data on the more subtle of these measures makes it difficult to estimate the costs of protection in world minerals markets. However, it is clear that continued efforts in international forums to reduce trade barriers have the potential to substantially benefit Australia.

ABARE submission to Industry Commission

1. Introduction

1.1 Terms of reference On 18 Octokr 1989, the Treasurer requested that the Industry Commission (then the Industries Assistance Commission) inquire into the mining and minerals processing industries, excluding petroleum and petroleum products. The Treasurer specifically requested that the Commission 'report on any institutional, regulatory or other arrangements subject to influence by governments in Australia which lead to inefficient resource use, and advise on courses of action to reduce or remove such inefficiencies'. The Commission was asked to report by 28 February 1991. The details of the terms of reference are provided in appendix A.

The terms of reference reflect the broad nature of the inquiry. The topics which the Industry Commission has indicated will provide the main focus in the inquiry include: - factors affecting minerals exploration

and development, including allocation of mineral property rights and construction costs in remote sites;

- operating costs such as energy, transport and labour costs, and the availability of these inputs;

- the structure and efficiency of Commonwealth and state government resource taxation and royalty payments;

- access to technology and factors affecting the level of research and development; and

- factors impinging on the trading environment of these industries. The range of activities covered by the

reference is also very broad. Appendix B provides a detailed list of the activities under reference. In summary, the terms of reference nominate Division B (Mining) of

Mining and minerals

the Australian Standard Industry Classification (ASIC), excluding petroleum and petroleum products, as activities falling within the scope of the inquiry. This covers ferrous and non-ferrous metal ores, coal, uranium, construction materials such as sand and gravel, and other non-metallic minerals such as limestone and salt. Mineral exploration 'on own account' and mining and exploration services are also included.

The minerals processing activities to be covered by the inquiry cannot be so readily identified. The terms of reference specify that the inquiry cover 'value added processing of minerals, including coal, to the unwrought refined metal and alloy stage or the equivalent stage of processing of coal and industrial minerals' (see appendix A). Such a definition includes the smelting and refining of the non-fenous metals and the production of basic iron and steel products. However, the Commission has indicated that the next stage of processing - rolling, drawing, extruding, casting and forging - can also be included under the definition. This may be the case where plant facilities enable continuous processing from the unwrought metal through to rolling, drawing, and so on.

Throughout this submission, the term 'mining sectof refers to the extractive and exploration industries which come under Division B of the ASIC, excluding the petroleum, petroleum products and petroleum exploration industries. The term 'minerals processing sector' refers to the industries which come under ASIC 294 (basic iron and steel), 295 (basic non-ferrous metals) and 296 (non-ferrous metal basic products). In the chapter dealing with the outlook, the term 'mineral resource sector' is used when referring to the combined mining and minerals processing sectors.

5

1.2 Objectives and scope of the submission ABARE's submission focuses on several issues of particular relevance to the growth of efficient mining and minerals processing sectors in the 1990s and beyond. The objectives in the submission are: - to briefly assess the prospects for

minerals markets both in Australia and internationally in order to review the trading and policy environment and indicate the potential for further growth in the sectors;

- to provide a broad economic perspective on the role of government and the extent of assistance to the mining and minerals processing sectors in order to gain insight into the overall relative efficiency of resource use in the sector; and

- to provide a detailed assessment of the two areas of policy seen as most relevant to the efficient use of resources in these sectors. These are the taxation arrangements for the mining sector (and associated issues of property rights) and the institutional arrangements concerning environmental policy affecting resource use management.

This submission consists of seven chapters. A brief overview of the medium term outlook for the mining and minerals processing sectors and the major factors influencing the outlook follows this introduction. The sector outlook provides a background against which the effects of policy alternatives can be considered. Chapter 3 reviews government intervention in the mining and minerals processing sectors and provides upto-date estimates of assistance accorded to the sectors. The following two chapters deal with the issues of taxation arrangements and environmental resource management. These are the areas where government policy has been assessed as having the greatest potential for improvement to the efficiency of resource allocation and use. Chapter 6 provides a

brief analysis of. government policies relating to other areas of importance: capital and operating costs, export controls, and the international trading environment. Concluding comments are provided in chapter 7. Supporting material is contained in the appendixes.


2. Outlook for the mining and minerals processing sectors

An assessment of the market outlook for the mining and minerals processing sectors will provide a background against which the policy alternatives that governments may contemplate in the pursuit of efficient resource use can be assessed. Selection from a set of policy alternatives is often conditional upon the objectives of government policy toward particular industries. These objectives may, in turn, be influenced by the economic health of the industry and the direction in which development in the industry is headed. Policy choices will differ according to perceptions as to whether an industry is facing decline or is expanding. Policy designed to remove development bottlenecks will differ markedly from policy aimed at efficiently managing industry rationalisation. This is evident, for example, in the different policy regimes affecting the textile, clothing and footwear industries, on the one hand, and the mineral sands industry on the other.

Thus, the outlook for industries and sectors influences the relevance of alternative policy packages. Further, an understanding of the factors underlying the outlook will allow policy choices to be better targeted and to reflect the dynamics of mineral supply and demand and the structures of particular Australian mineral industries. For export-oriented industries, such as those in the mining and minerals processing sectors, it is international demand and supply factors that have the greatest influence on the outlook and hence on the direction of the sectors. The Commonwealth government has only very limited scope to directly influence these international forces. They are generally exogenous to Australia, in that - despite the international standing of our mineral

Mining and minerals

export industries - we trade as a small country in the majority of these world markets.

This chapter provides a summary of the medium term outlook facing the mining and minerals processing sectors in Australia. The underlying factors which influence this outlook are also examined. Particular attention is paid to factors which affect trends in the world demand for minerals and which influence the competitiveness of various locations of supply.

2.1 Situation and medium term outlook The contribution of the mineral resource sector to the Australian economy has changed over time. Although discrete eras, such as that following discoveries of gold in the 18.50~~ boosted the sector's economic importance, it is only since the 1960s that it has consistently made a major contribution to the economy.

The mineral resource sector's share of gross domestic product grew rapidly in the 1960s before stabilising at around 6 per cent in the 1970s. In the 1980s, the sector's contribution rose again to around 8 per cent, following si@cant growth between 1978 and 1980. In contrast, the share of gross domestic product contributed by the manufacturing sector fell from 22 per cent in 1%9-70 to around 16 per cent in 1988-89, while over the same period that of the rural sector fell from 7 per cent to around 4 per cent (figure A).

Relative to its contribution to gross domestic product, the mineral resource sector's share of investment is high. This is a consequence of the relative capital intensity of the sector. Generally, between a

7

A Sector contributions to Australian gross domestic product

Resources sector

Rural sector O/,

fifth and a third of total private new fixed capital expenditure takes place in the mineral resource sector (figure B). Though large discrete projects and 'mining booms', such as that in 1982, result in peaks in investment in the mineral resource sector, the sector's share of investment is on average about the same as that of the manufacturing sector. The capital-intensive nature of the mineral resource sector also results in its share of employment being low. In 1988439, only 2.4 per cent of the workforce was engaged in mining and basic metal production.

As noted earlier, Australia's mining and minerals processing sectors are highly export oriented. The share of exports accounted for by the sector has expanded rapidly from around 30 per cent of total merchandise exports in the late 1960s to 48 per cent in 1988-89. The share of total export earnings accounted for by the sector has increased from 27 per cent to 38 per cent over the same period. The value of exports by the mineral resource sector is well above the value of manufacturing sector exports, and has been greater than rural sector exports since 1981-82.

On an international scale, Australia is among the world's leading exporters of many mineral resource commodities, including coal, alumina, mineral sands, aluminium, iron ore, diamonds, lead, zinc, and gold. However, four commodities

dominate exports by Australia's mineral resource sector: black coal, aluminium/ alumina, gold and iron ore accounted for over 65 per cent of these exports in 1988-89. The relative importance of particular mineral exports has changed substantially over the years. Base metals and iron ore, which were the major export commodities in the early 1970s, have declined in relative importance as aluminium and gold exports have risen to prominence.

The late 1970s and early 1980s was a period of depressed demand in the markets for most metals. Prices were low by historical standards and there was substantial rationalisation of supply capacity. Stronger world economic growth in the second half of the 1980s led to a resurgence in the demand for metals. Capacity utilisation rates for mine and processing facilities increased and stocks declined as growth in demand outpaced growth in production. Delays in commissioning new or recommissioning idle capacity, and short term supply disruptions, exacerbated supply problems. With demand growing ahead of supply, metals prices increased sharply and, despite significant easing in prices throughout 1989- 90, have remained high by historical standards. Strong demand has also resulted in substantial price increases for iron ore

New fixed capital expenditure, by B sector E AB ARE


and coal in recent years, though in this case following a prolonged period of surplus production capacity and low prices. The uranium market has remained depressed as a result of large inventory holdings.

The outlook for mineral markets over the next five years is generally positive. World demand for most minerals is expected to continue to grow, albeit at slower rates than in recent years (table 1). The slowdown in rates of growth in demand from the recent high levels mainly reflects an expectation of a slowdown in world economic activity. Economic growth in OECD countries is assumed by ABARE to decline from 3.4 per cent in 1989 to 2.7 per cent in 1990 before recovering to average 3.0 per cent a year through to 1995 (Hogan, O'Mara, Crofts and Wright 1990; ABARE 1990a). Rates of economic growth in the East Asian region and China are expected to be below the relatively high levels achieved in recent years, but to remain around double those for the OECD.

Following the industry rationalisation of the mid-1980s, the sustained improvements in prices over recent years have encouraged companies to expand production. In general, this has been achieved initially by companies operating at or above rated capacity, and then by expanding existing facilities and undertaking smaller new

1 Average annual growth rates of mineral resource consumption in the market economies

1970 1980 1985 1990 Commodity -79 -84 -89 -952

Aluminium 5.3 0.6 3.7 2.5 Copper 2.9 1.9 4.0 1.6 Lead 2.1 0.7 2.0 1.7 Zinc 2.2 0.7 3.3 0.7 Nickel 2.8 2.5 4.0 4 . 2 Steel 3.2 -1.1 2.6 0.2 Coal 0.9 2.5 3.2 a M

Uranium na 7.1 3.5 na

World real gross domestic product 3.3 2.2 3.6 3.2

a 1935-88. z ABARE pro@tion. M Not available. Sources: ABARE(1989a,b).

Mining and mimrak

projects. It is expected that, over the next five years, the very high capacity utilisation rates will ease and older, high cost facilities will be closed. Production from some major new projects is expected to come onstream and large expansions in capacity of both mines and processing facilities are projected for most minerals, with the major exception of steel. Over the same period, because of the age of much existing plant and equipment, both the aluminium and steel industries are facing decisions on a new investment cycle.

With projections of modest growth in demand for minerals and metals and somewhat more rapid expansion in supply, prices are generally expected to ease in real terms over the period to 1995. Although prices are projected to be lower than the recent high levels, over the period they are expected to remain above the lows of the mid-1980s for most mineral commodities. Generally low stocks, in historical terms, may lead to price volatility in response to demand or supply disturbances. However, against the background of the significant productivity gains achieved over the past decade, the underlying strength of minerals markets is expected to ensure prices remain at profitable levels for most world producers.

Australia is expected to consolidate its position as a substantial supplier of minerals to the world market. Low production costs for the major minerals reflect Australia's comparative advantage in mineral extraction and processing. Production is expected to expand for most minerals, especially aluminium, mineral sands, base metals and coal.

Summaries of ABARE's projections of the volume and value of Australia's exports of mineral resources to 1995 are given in tables 2 and 3. Overall, reasonably strong growth is projected for the export volumes of most mineral commodities, with the exception of alumina, iron ore and gold. However, real declines in some world prices are expeded, with the consequence that the

9

2 Volume of Australian mineral resources exports

Annual average growth rates

1995 z 1990-95 z Commodity Unit

Alumina kt Aluminium (primary) kt Copper Ores and concentrates kt Refined kt

Lead Ores and concentrates Rcfined Bullion

Zinc Ores and concentrates Refined

Iron ore Crude steel a

Gold Mineral sands

Rutile llmeni te Zircon

Coal b Uranium b

a Crude steel and pig iron (mcludes ferroalloys). b Fiscal year, for example 1989 = 198990. c 1980, tonnes of concentrate; after 1980, tonnes of U,O,. p Preliminary. f ABARE forecast. z ABARE projection. Sourcm ABARE(1989a,b).

3 Real value of Australian mineral resources exports (1990 dollars)

Annual average growth rates

Commodity 1970 1980 1989~ 1990 f 1995 z 1990-95 z

Alumina 561.9 2215.2 2835.0 2746.0 2380.0 -2.82 Aluminium 219.9 135.4 2577.0 2091.0 2420.0 2.97 Copper 408.2 414.0 631 .O 650.0 720.0 2.07 Lead 721.1 725.0 450.0 482.0 615.0 4.99 Zinc 412.3 544.0 947.0 1000.0 1060.0 1.17 Nickel 0.0 581.0 836.0 750.0 922.0 4.22 Iron ore 1901.8 2524.6 2229.0 2400.0 2534.0 1.09 Crude steel a 214.0 263.9 139.0 144.0 488.0 27.65 Gold 122.8 195.3 2841.9 3350.0 2265.8 -7.52 Mineral sands 323.0 267.0 593.0 609.0 721 .0 3.43 Other b na na 784.7 833.5 808.4 -0.61 Total non-energy minerals C 4 888.0 d 7 865.4 d 14 863.6 15 055.5 14 933.4 0.31

Coal e 1119.0 4102.0 5785.0 6128.0 7536.0 4.22 Uranium e 0.0 120.0 283.0 320.0 1268.0 31.70

a Crude steel and pig iron (includes ferroalloys). b Includes diamonds, silver, tin, manganese, salt and tungsten concentrate. c Excludes coal and uranium. d Excluding 'other'. e Fiscal year, e.g. 1989=198990. p Preliminary. f ABARE forecast. z ABARE projection. Sources: ABARE(1989a,b).

10 ABARE submission to Industry Commission

real values of exports of individual commodities will not rise at the same rate, and in some cases may fall. The real value of alumina exports is expected to decline marginally between 1989 and 1995 as the effects of falling world prices outweigh increased export volumes and an assumed easing of the exchange rate. The volume and value of gold exports are projected to decline after a peak in 1990-91, as structural adjustment takes place in the Australian industry.

2.2 Factors affecting the mining and minerals processing sectors Underlying this medium term outlook is a range of broad structural and cyclical influences. Australian mineral export prospects depend on international trade opportunities and trends in the demand for minerals around the world, particularly in Asia. These demand trends are linked generally to rates of economic growth, and more specifically to rates of industrial production and capital investment. The ability of Australian producers to take advantage of these opportunities depends on the behaviour of market competitors, costs of production in Australia relative to competing producers overseas, trends in hight costs and other supply factors. The international demand and supply factors are examined in turn.

Demand factors In general, there is a strong positive correlation between minerals demand and economic growth. Income elasticities for most metals range between 1.0 and 1.5, so that fluctuations in income can produce proportionately larger fluctuations in mineral demand. The view, prevalent in the early 19805, that metals demand has become 'uncoupled' from economic activity appears to have been ill-founded (Tilton 1988). A range of factors combined to produce a

Mining and minerals

prolonged trough in metals markets in the decade prior to that time: economic recession, excess production capacity as developing countries sought to exploit their mineral resources, and technological change resulting from the energy price increases of the 1970s. Industry rationalisation and stronger economic growth, particularly in the industrialised economies, reaffirmed the strong link between metals demand and economic activity. The consumption of energy commodities, such as coal and uranium, is influenced by world growth in eledriaty demand, which is also dependent on the rate of world economic growth.

However, from the perspective of a minerals exporter such as Australia, the aggregate rate of growth of world economic activity provides only part of the story. Variations in the composition of economic activity and its regional distribution have important implications for the pattern of minerals trade. Metals consumption tends to be concentrated in the capital goods producing industries, notably construction and machinery: for example, around 70 per cent of consumption of the major ferrous metals goes to the production of investment goods (Crowson 1989, p.16). In the industrialised countries, the shares of gross domestic product and employment generated by the metals-intensive manufacturing sectors have contracted in recent years, while those of the services and less metals-intensive manufacturing sectors have expanded (Hogan and Thorpe 1989). The decline in the relative importance of the metals-intensive industries is reflected in the ratio of investment to consumption in the OECD countries, which declined in the early 1980s before levelling off in the second half of the decade (figure C). In contrast, investment-consumption ratios in the developing economies of Asia have i m a s e d rapidly since the early 1970s and have been well above those of the industrialised countries for some years.

Regional differences in rates of economic growth also have major implications for

11

C Ratios of investment to consumption

g ~ s i a n countries 0.1 (excluding Japan)

Australia's mineral export prospects. The newly industrialising and developing countries are accounting for an increasing share of world consumption of commodities, including metals (Drysdale 1988, p.112; Garnaut 1989, p.9) and energy commodities (Ball and Naughten 1990). This trend is expected to continue, based on the strong economic performance of the Asian newly industrialising counties, natably the Republic of Korea and Taiwan, and strong growth in China. Growth in other countries in the region, such as Thailand and Malaysia, may prove to be equally impressive in the coming decade. There has also been a trend toward the relocation of a range of metals- intensive activities to the newly industrialising and other developing countries.

The size of these prospective markets has important implications for Australia's mineral exports. Metals consumption growth rates in the East Asian region have been among the highest of any region over the past two decades, but they have risen from a low base. Aluminium consumption by the developing countries of Asia has increased by an average of more than 9 per cent a year since 1970, yet still accounted for only 10 per cent of total consumption in market economies in 1988. The main growth in steaming and coking coal demand is also expected to be in the developing countries.

12

It should also be noted that, to a significant degree, the strong growth of the North-East Asian economies still depends on growth in the industrialised economies. Trading links between these regions remain strong. While regional growth is gradually broadening and deepening intra-regional trade, the demand for exports from the newly industrialising countries of Asia is expected to slow as import demand in the United States eases. In 1987 around 58 per cent of exports from North-East Asia went to North America and Western Europe, while 36 per cent of imports to North-East Asia came from these regions (Garnaut 1989, table 3.8).

Recent political developments in China have brought about a period of economic uncertainty and disruption in that country. The recent policy of partial economic liberalisation in the Soviet Union and many Eastern European countries has also had a short term disruptive effect on economic growth in those countries. It is likely to be several years before the benefits of these economic and social reforms are reflected in higher economic growth rates. However, it is expected that the future exports and imports by the Soviet Union and Eastern Europe will increasingly reflect their resource endowments. The Soviet Union has the potential to be a major net exporter of primary commodities, including minerals. Eastern European economies, like Western Europe, are expected to be net importers of resource products.

Technological change has both positive and negative effects on the demand for minerals. On the positive side, technology will continue to have a significant influence on demand in two main ways. First, applications for minerals in relatively 'high technology' fields will emerge as the result of scientific research and development. In Australia, this effect is reflected in the growing world demand for mineral sands and rare earths - for example, titanium for the aerospace industry. Second, new applications for traditional materials will


continue to be found. For example, while the quest for lighter, thinner and stronger steels reduces the amount of steel required for particular applications, the range of end uses for steel is at the same time inaeased. In turn, new uses have revived demand for minerals needed for steel alloys, such as manganese and nickel, and the zinc required for coated steel products. In addition, new technology in steelmaking allows the use of relatively cheaper coals, such as soft and semi-soft coking coals and coals suitable for pulverising. This expands the Australian export prospects for these resources.

Technological change can also have a negative effect on the demand for minerals. For example, more efficient use of inputs and improved production techniques in steel production in Japan affect Australia's export prospects for the minerals closely allied to steel production: iron ore, nickel, manganese and high quality coking coal. In addition, the pressure to introduce substitutes for metals will increase if metals prices relative to those of substitutes stay high for sustained periods. Copper, for example, has been replaced by optical fibres in telecommunication.

Concerns regarding the effects of industrial activity on the environment will increasingly influence the demand for mineral commodities in general and for energy commodities in particular. They will also affect the location and economics of metals production. Strict emission standards for sulphur dioxide may be favourable for Australian low sulphur coals in the short term. In the longer term, any proposals to reduce carbon dioxide emissions from burning fossil fuels will have implications for fuel choice, with uranium and natural gas being the favoured fuels over oil and coal. However, the International Energy Agency has indicated that the perceived safety risks of nuclear power continue to be of major concern to member countries and that this has further slowed the development of nuclear power (Ball and Naughten 1990, p.7). For other

minerals, environmental concerns focus on the management of waste products from the extraction, processing and consumption of metals. These concerns are expected to have relatively minor effects on market prospects over the short to medium term, being most clearly an issue in assessment of the location choices for incremental production capacity.

Supply factors Most of the new basic minerals processing capacity is expected to be located in countries with a comparative advantage in the extraction and processing of minerals, rather than in consuming countries. The factors determining the relative competitiveness of alternative locations will vary for different minerals, according to the nature of the processing and the characteristics of the final product. These factors include the location of mineral deposits, relative factor costs and input prices, the availability of mining and processing technology, the distance from major markets and the associated transport costs, and the security of supply. The effects of these factors on Australia's competitiveness as a supplier of raw and processed minerals will in part determine the extent to which Australia will be able to expand its capacity for further processing.

Countries which are relatively well endowed with mineral resources may have an advantage in developing mineral processing capacity, particularly where the raw materials are high volume and low value, and where processing is energy intensive. There have been few large discoveries in recent years that will have major consequences for the location of world supplies, and those few mainly provide additional supplies of base metals and gold. Following a period of sustained growth in demand, world copper production will be boosted by production from the Escondida mine in Chile, which is expected to come on stream around mid-1991, and other recently opened mines in Portugal and Papua New

Mining and minerals

Guinea. The opening in 1990 of the Red Dog mine in Alaska significantly increases world lead and zinc production. World gold production will be substantially increased as a result of production from the Lihir and Porgera deposits in Papua New Guinea and the Grasberg deposit in Indonesia.

There will be significant shifts in the regional pattern of processing capacity for other minerals. These largely reflect changes in development and operating costs which occurred as part of the large scale rationalisation of supply capacity in the early 1980s. In addition, older smelters and refineries in the industrialised countries will require extensive refurbishment or replacement in the next five to ten years. This expands the opportunities for relocation of capacity to other regions.

Relatively large scale additions to new aluminium smelting capacity - both expansions and new smelters - have been planned or are being considered in a number of countries, including countries in the Middle East, Brazil, Venezuela and Australia. This continues the trend away from the relatively high cost traditional locations of production toward countries with large low cost reserves of bauxite and energy. The major steel producing countries are expected to reduce capacity progressively - a fall which will be only slightly offset by expansions elsewhere. The regional concentration of steel production will shift from the United States and the European Community to the North Asian region, including China. Coal production is expected to fall in some OECD countries that currently have highly protected coal industries. Although exports from new suppliers will increase (principally Colombia, Indonesia and China), it is expected that most additional coal supply will be met by the traditional suppliers - Australia, the United States, and South Africa (if the lastmentioned country expands port capacities). Australia is expected to remain the world's largest exporter of coal.

Competitiveness in minerals production

depends not only on natural advantage conferred by large mineral deposits but on costs of capital, energy, labour and transport. The relative attractiveness of alternative locations will also depend on distance from major markets - that is, on the cost of transporting raw and processed materials. Freight charges are a large part of the landed cost of bulk commodities such as iron ore and coal. The relative importance of freight charges diminishes for the higher valued processed products. Although Australia is further from the traditional markets of Europe and North America than major competitors like Brazil and Canada, proximity to the relatively rapidly growing Asian market continues to be to Australia's advantage in marketing these commodities.

The location of processing capacity will be affected also by the spread of mining and processing technology. In particular, the newly industrialising and other developing countries have had increasing access to new technology, enabling them to raise their profile in world markets for some minerals. The increasing use in developing countries of technologies developed in the 1980s for extracting and processing gold is expected to significantly increase production in these countries. In addition, demands for the use of environmentally friendly technology for extraction and processing will be more pronounced in the industrialised countries, where the imposition of environmental standards could raise the costs of production. This may result in a shift of processing - particularly processing which produces large amounts of waste - to 1 countries with less stringent environmental standards. These countries tend to be the newly industrialising and other developing countries. Such shifts may serve to reinforce emerging changes in regional patterns of minerals production. However, companies would be less able to relocate processing facilities in this way to the extent that bilateral aid and development packages from organisations such as the World Bank


become increasingly tied to the implemen- existing markets. As a result, exporting tation of stricter environmental guidelines. countries may in turn be forced to diversify

Another consideration determining their markets. In assessing security of market structures, and one which has supply, the domestic political and industrial implications for the processes of price stability of supplying countries is also formation, is the strong desire of some perceived as a significant factor. This consuming countries to ensure security of concern has focused the attention of supply of raw and processed materials. This governments on the relatively high levels is particularly the case for energy of industrial disputation which have commodities such as coal and uranium and characterised Australia's mining industries, for bulk ores such as iron ore. Consuming particularly the coal industry, for many countries may engage in supply years. There has been significant progress diversification in order to limit their in decreasing industrial disputation in the dependence on particular sources of supply. Australian coal and iron ore industries in This imposes a limit on the ability of any one recent years. exporting country to expand its share of

Mining and minerals

Government intervention mining and minerals processing

The influence of government in the mining and minerals processing sedors is pervasive. The Commonwealth and state governments impose a wide range of charges, regulations and controls on these sectors. These range from direct controls such as the granting of exploration licences and mining permits and the imposition of associated royalties on output, through restrictions, controls and regulations covering most aspects of mine and processing operations, to indirect effects resulting from protection of industries supplying inputs to the sectors.

The total effects of these interventions on the costs and activities of the mining and minerals processing sectors, and on the efficiency of allocation of resources between activities, are difficult to estimate. However, it is possible to examine the effects of large parts of the array of interventions in isolation. The subject of this chapter is the effect of the provision of assistance to Australian industry on the mining and minerals processing sectors. In subsequent chapters the issues involved in mineral taxation and environmental management are examined. Before considering the issue of assistance, the objectives of govement intervention are briefly reviewed.

3.1 The objectives of government intervention An inquiry as wide ranging as this raises fundamental questions regarding the appropriate bases for government intervention in the mining and minerals processing sectors and the implications those interventions may have for the efficient use of Australian resources. The objectives of government interventions can be classified into three broad categories, although the categories are not mutually

16

exclusive. Interventions result from: - governments' role in granting access

rights to mineral and other natural resources;

- governments' function of regulating activity in the event of market failure; and

- government decisions to provide assistance to attract resources to particular activities or regions. A number of important government

policy actions which impinge on the mining sector arise from the first of these roles. Responsibility for the allocation of mineral property rights is divided between the various states, in the case of onshore state areas, and the Commonwealth in the case of the territories and offshore areas. The Commonwealth's responsibility for minerals in the Northern Tenitory (except uranium) has been transferred to the Territory government, and coastal waters within the three-mile territorial limit are now under state jurisdiction. Ownership is vested in the governments on behalf of the Australian community. Governments thus have a responsibility to ensure that the rate and pattern of mineral resource depletion and mining development accord with the community's best interests, and that an adequate return is received by the community for such resource depletion. These responsibilities are carried out through the allocation of access rights for exploration and mining and through the levying of financial charges on production and profit from mining operations. In- stitutional arrangements and policies in this regard are discussed further in chapter 4.

On a broader scale, governments also have responsibility as custodians of the wider environmental resources such as water, air and ecosystems. As in the case of


mineral property rights, here too there is a division between state and Commonwealth jurisdiction. Responsibility for environmental management rests largely with the states. However, in recent years the Commonwealth has played an increasingly important role in environmental policy development through the use of its constitutional power over exports and its obligations under international conventions and treaties. Issues raised by the use of common-property environmental resources are not confined to the minirig and processing sectors arise in relation to natural resources generally.

One of the most important objectives of government policy intervention in the mining and minerals processing sectors is to correct perceived market failures. Under certain conditions, a freely operating market can be shown to lead to economically efficient outcomes. That is, resources will tend to be allocated so as to ensure that goods are produced at minimum cost and that the combination of goods produced matches society's preferences and maximises social welfare. However, in some circumstances markets may not exist, or may not lead to efficient outcomes. Such circumstances of 'market failure' include situations in which property rights are not fully defined (which may occur in the use of common-property resources), those in which there are significantly increasing returns to scale in production, and those in which information available to market participants is incomplete or is not equally available to all. In such cases, markets can fail to allocate resources efficiently.

Where market failure occurs, there may be a case for direct government intervention to overcome, or at least reduce, the loss in economic efficiency. However, the existence of market failure is not in itself a sufficient condition for intervention to be socially beneficial. Government can usefully intervene only where it can improve on the market outcome - however imperfect - given the range of restrictions imposed on

its policy choices. The non-existence of markets for some of the major benefits provided by the environment presents special difficulties in achieving a balance between mining and conservation. Policy problems facing governments in this area are discussed in chapter 5.

The third objective of government intervention is the provision of assistance to industries in order to attract resources to particular activities or regions. Policy instruments used to assist industries in various countries include subsidies, grants, taxation concessions, tariff protection, marketing schemes, levies and prohibitions against imports. Such interventions change the distribution of income among activities, groups or individuals. Their effect is to draw resources toward the relatively highly assisted industries and away from the relatively lightly assisted industries. This will change the relative sizes of the industries from those which would prevail in the absence of the assistance structure. Such assistance measures have also been used to promote a range of other objectives such as regional growth, higher levels of national self-sufficiency, and development of basic industrial skills.

The extent of assistance resulting from these interventions can be measured, and compared between industries. In the next section, estimates of assistance to the Australian mining and minerals processing sedors are provided and are compared with the levels of assistance provided to other sectors of the economy. The analysis not only shows the relatively low level of assistance accorded to the activities of mining and minerals processing. It also focuses attention on the levels of assistance received by other industries: assistance which has consequences for the factor costs and input prices faced by the mining and minerals processing sectors. It is the net effects of the assistance structure as a whole which should be of concern to governments, rather than the assistance provided to individual industries.

Mining and minerals

3.2 Assistance measurement The 'effective rate of assistance' has been extensively used in industry policy development over recent years as an estimate of net assistance. This measure is defined as the percentage change, due to the assistance structure, in returns to an industry's value-adding factors per unit of output. It provides a useful means of comparing assistance between various activities, industries or sectors.

Comparisons of effective levels of assistance between activities are a means of measuring the extent to which the relative incentives to use resources in particular activities have been changed by government intervention (Industries Assistance Commission 1987, p.24). The effective rate estimates thus point to the potential for inefficiencies in production to arise through the consequent misallocation of resources. However, these estimates do not provide all the information required to predict the extent to which a particular activity would expand or contract under a different structure of assistance. This will be determined by a number of factors including the nature of demand for the activity's output and the ease with which resources can flow into or out of the activity (IAC 1983, p.12).

The procedures for measurement of assistance to the manufacturing and agricultural sectors of the economy are well established and the results of that analysis are widely known and understood. They have been the underlying basis for rationalisation of assistance to many industries in those sectors, and continue to be the f m s of monitoring of the processes of phased reduction of assistance for a number of these industries.

The analysis of the manufacturing sector by the IAC has included measurement of assistance to minerals processing industries, which it has treated as part of that sector. However, comparable estimates of assistance to industries in the mining sector

have been available only more recently (see Martin, Waters, McPhee and Jones 1988; and IAC 1988~). Extension of the analysis to include the mining sector has provided a clearer picture of the relative levels of assistance across all sectors of the economy. From that picture, a better understanding of the substantial constraints on the size of various mining industries imposed by assistance elsewhere in the economy is obtained.

Estimates of the effective rates of assistance Martin et al. (1988) provided detailed estimates of the effective rate of assistance to all industries in the mining sector. The IAC had previously published estimates for the black coal industry (SAC 1988~). The general approach adopted by Martin et al. (1988) to assess assistance to the mining industry was to extend to the sector the effective rate of protection theory developed by Corden (1971). It was broadly consistent with IAC approaches to measuring industry assistance.

The estimates of the effective rates of assistance for mining industries presented in Martin et al. (1988) were based on 1985-86 costs and on levels of assistance estimated to be applying in 1987-88, adjusted to apply to 1985-86 industry structures. Updated estimates are provided in this report. These are based on 1987-88 cost structures and incorporate the most recent available data on rates and levels of assistance (principally 1988-89 and 1989-90), adjusted to apply to 1987-88 industry structures. In particular, the updated estimates incorporate only the first phase of the tariff reduction program announced in the May 1988 Economic Statement. Under the tariff reduction program, particular tariffs are to be phased down to a target level in five equal steps by July 1992. Tariffs above 15 per cent - with some exceptions, such as passenger motor vehicles and textiles, clothing and footwear - are to be phased down to 15 per cent. Those tariffs between 15 per cent and 10 per cent are to be phased down to 10 per cent.


Tables 4 and 5 summarise the estimated Assistance to the mining sector, by 5 effective rate of assistance for the mining industry, 1987-88 sector and the assistance estimates for the industries within this sector, respectively. The details presented in table 4, for the sector as a whole, are provided for each of the mining industries in appendix table Cl. Details of method are also provided in appendix C.

The estimated effective overall rate of assistance to the mining sector indicates that it is penalised by govem,ent policy

4 Assistance to the mining sector, 1987-88 a

Item Unit Amount

Value of output WO) $m 16 349.00

Less Total inputs $m 6 615.70

Value added $m 9 733.30

Less Assistance to output (AO) - Export taxes (tariffs) $m -4.80 - Ewport controls $m nc

- Export incentives $m 0.00 - Joint Coal Board $m 1.96 Total A 0 $m -2.80

Less Assistance on inputs (AI) - Diesel fuel tax

(tax paid minus rebate) $m -31.65 - Tariffs on materials and capital

(net of CTCO) $m -312.37 - Capital controls $m M , Total AI $m -344.02

I Unassisted value added (WA) $m 10 080.15

Assistance to valueadding factors (

- Tax c o n d o n s . Exempt income - gold mining income - sale of mining rights

. Immediate deductions of expenditure on exploration

- Labour adjustment assistance - Research funding . Energy Research Trust . Supervising Scientist (uranium)

Total AVAF

Net subsidy equivalent (NSE) = AVAF + A 0 + AI $m -106.70

Effedive rate = (NSE/WA) X 100 % -1.06 Nominal rate = [AO/(VO - AO)] X 100 % -0.02

a Assistance measures based on the most upbdate rats and levels of assistance adjusted to 1967-88. na Not available. nc Not calculated. CTCO, Commercial Tariff Concession Orders.

Mining and minerals

Effective rate Industry of assistance

Ferrous metal ores Bauxite Copper ore Gold ore Mineral sands Nickel ore Silver, lead, zinc ores' Ti ore Uranium ore Non-ferrous metal ores Black coal Brown coal Other lminerals All mining

Net subsidy equivalent

$m

-77.44 -13.99 -8.58

185.21 -4.33 -5.08

-1 7.69 -3.68 -6.80 -5.00

-106.35 3.07

-39.99 -106.70

and assistance measures directed elsewhere in the economy, particularly to the manufacturing sector. While there are a range of measures that assist the mining sector, these are outweighed by the policies aimed at assisting activities which supply inputs to mining. The effective rate of assist- tance is small and slightly negative (-1.1 per cent). The major elements of positive assistance for the mining sector are the (soon to be removed) exemption of gold mining income from company tax, and the immediate deductibility of exploration expenditure. The largest components of negative assistance facing the sector are tariffs on material and capital inputs to mining operations (net of Commercial Tariff Concession Orders) and diesel fuel tax (net of rebates).

Effective rates of assistance to mining industries almost all lie in the negative range between -1 per cent (brown coal) and -6 per cent (ferrous ores). Only gold mining is positively assisted (13 per cent). At the opposite extreme, the rate for tin mining is -23 per cent.

The positive effective rate of assistance of the gold mining industry is largely due to its tax-exempt status. This tax exemption

will be removed in 1991; even then, the effective rate of assistance for this industry will remain positive, as the reduction in assistance from the removal of the taxexemption will be partly offset by the immediate tax deductibility of exploration expenditure, which is much higher in gold mining than in other mining industries. The implications of the removal of the tax- exempt status for the effective rate of assistance of the gold mining industry are examined in more detail in appendix D.

The minerals processing sector receives more net assistance than mining. Table 6 provides estimates of average effective rates of assistance for industries within the minerals processing sector. These estimates are for 1988-89, the most recent year available (IAC 1989~). As in the case of the mining sector, there is significant variation in the estimated effective rates of assistance between minerals processing industries. The average effective rate of assistance for the minerals processing sector is 9 per cent. However, the rates for individual industries range from -8 per cent for copper and nickel smelting and refining to 49 per cent for aluminium rolling, drawing and extruding. Assistance to material inputs to the basic non-ferrous metal industries result in negative effective rates of assistance to some of these industries. Positive effective rates of assistance to industries producing non- ferrous basic metal products, such as the aluminium rolling, drawing and extruding industries, result from assistance to output in the form of tariffs.

Table 7 summarises the average effective rates of assistance for the agriculture, manufacturing (including minerals processing) and mining sectors. The manufacturing sector is the most heavily assisted sector, with an average effective rate of assistance almost twice that of the agricultural sector. The average rate for the agricultural sector is around ten percentage points higher than the average assistance rate for mining, and is similar to that of mineral processing. The ranking of sedors

Assistance to the minerals processing sector, by industry, 198889

Industry

Basic iron and steel (ASIC 294) Iron and steel basic products Iron casting Steel casting Iron and steel forging Steel pipes and tubes

Effective rate of assistance

Basic non-ferrous metals (ASIC 295) 4 Copper and nickel smelting. refining -8 Silver, lead, zinc smelting, refining -1 Alumina -7 Aluminium smelting -2 Non-ferrous metals nec smelting. refining 2 Secondary recovery and alloying of non-ferrous metals nec 2

Non-ferrous metal basic products (ASIC 296) 39 Aluminium rolling, drawing, extruding 49 Non-ferrous metals nec rolling, 36 drawing, extruding

Non-ferrous metal casting 15

Basic metal products (ASIC 29) 9

Source: IAC (1989~).

changes only slowly, even though assistance to some industries, especially in the agricultural sector, is quite volatile.

These average sector rates for manufacturing and agriculture mask considerable variation in the rates for individual industries, in the same way as do the averages for the mining and minerals , processing sectors. While the rates for I

manufacturing and agricultural industries also range from negative to positive, it is in the mining sector that large, negatively assisted production activities are to be found.

The tariff component of negative assistance to mining will decline over the period to 1992 as further phases of the tariff reduction program are introduced. Provided these phased reductions proceed as scheduled this will raise the effective rate of assistance for the mining sector closer to


l

-- - 7 Comparison of assistance to sectors of the economy

Item Effective rate of assistance a

Agriculture 9

Manufacturing including minerals processing

Mining -1

a The mast recent estimates available have been used in each case. Manufacturing estimates relate to 198889, agriculture and mining estimates to 1%7-88. Mining estimates incorporate the most uptodate assistance measures. Sourccs: IAC (198914; ABARE estimates.

zero. The effects of the tariff reduction on the effective rates of assistance applying across the economy more generally are difficult to estimate, because the relative sizes and structures of industries may change markedly.

Intersectoral effects of changes in assistance

fourteen broadly defined sectors are presented. The real net returns variable shown is the change in the return to primary factors (land, labour and capital) less the change in the consumer price index; it represents the extent of the increase in returns to value adding factors. The first set of results is based on the assumption of fixed absorption; that is, real domestic expenditure and its components remaining fixed. The second set of results is based on the assumption of a constant balance of trade; that is, the balance of trade is held constant as a proportion of gross domestic product. The difference between these two assumptions is that in the first case any gains in national income are assumed to be used to improve the trade account, while in the second case they are assumed to be spent within the economy on consumption, investment and government outlays.

Under the assumption of fixed absorption, the removal of mining assistance (excluding the effects of tariffs on inputs) considerably reduces the real net returns to mining. m e effect on other sectors is very small with the exception of minerals processing, for which there is also a reduction in real net returns. The removal of assistance to the minerals processing sector has only a small effect on returns within the sector, and little effect on other sectors. When assistance to all sectors of the economy is removed, the mining sector receives the largest net gains, followed by agriculture. The minerals processing sector also experiences improved profitability. The gains to the mining and minerals processing sectors are largely the consequence of the removal of manufacturing tariffs, including tariffs on inputs to mining and minerals processing, and of domestic marketing arrangements for agricultural products. Under the assumption of a fixed balance of trade the results in most cases are as above in tenns of direction and order of magnitude.

Removal of assistance to all sectors of the economy would provide substantial incentives for expansion in the agricultural

The effective rate of assistance provides an indication of how net assistance compares among industries. However, the effective rate measure does not fully capture the effects of assistance, and of changes in

I assistance, on the economy overall. A general equilibrium model of the economy which takes account of complex linkages between industries and sectors is required to capture these effects. Martin et al. (1988) examined the intersectoral effects of possible changes in assistance using the ORANI model of the Australian economy. The effects of the removal of assistance to the mining and minerals processing industries and other sectors - that is, of bringing the net subsidy equivalents for individual industries to zero - were examined using the ORANI-Mh4P database, which provides more detail on the mining and minerals processing industries than the standard ORANI model.

The results of that study are summarised in table 8. The effects on 'real net returns' for

Mining and minerals

Short run effects of the removal of assistance on sedoral real net returns: Percentage change from base

Real absorption held constant Real balance of trade held constant

Remove Remove Remove mining Remove mining

Remove mineral & mineral Remove mineral & mineral mining processing pmcessing Remove all mining processing processing Remove all

Sector assistance assistance assistance assistance assistance assistance assistance assistance

Agriculture Agricultural senices Fishing and hunting Mining Mineral processing Food Textiles, clothing and footwear

Wood, paper and printing

Chemicals Glass and cement products 0.00 0.00 0.00 -0.06 -0.04 0.00 -0.04 -0.48

Fabricated metal products 0.01 0.00 0.01 -2.59 -0.03 0.00 -0.03 -2.74

Transport 0.02 0.05 0.07 -14.06 0.05 0.05 0.10 -13.73 Other manufacturing -0.01 0.03 0.02 -2.80 -0.01 0.03 0.02 -2.81 Services -0.01 0.01 0.00 0.01 -0.08 0.01 -0.07 4.33

Source: Martin et al. (1988).

and mining sedors and the export-oriented factor penalising the mining and processing mineral and agricultural processing Wors. sectors is the tariffs applied to material and Real net returns in the mining sector would capital inputs. Continued reform of the be expected to increase by 16 per cent if all domestic tariff structure will have a assistance were removed, compared with favourable impact on the costs and activities l

an increase of 7 per cent for the agricultural of these sectors. sector.

3.3 Summary It is clear that there are considerable differences between sectors and industries in the structure of assistance in Australia. Reductions in both the overall level of assistance and the disparities in assistance between activities would improve the efficiency of resource allocation in the economy. Industries engaged in mining and basic processing would particularly benefit from such changes, because they currently receive negative net assistance. The main


4. Mineral taxation arrangements

The role of governments in Australia in determining access to mineral resources results in a broad spectrum of mineral 'taxation' arrangements. These arrangements can be expected to have a si@cant effect on the efficiency of resource allocation within the economy.

There are important economic distinctions between taxes such as company tax, which are levied for fiscal purposes, and 'taxes' which constitute a payment for access to the resource. In Australia, property rights to mineral deposits are allocated, rather than sold, to private companies, and payment to the community for the use of those resources is usually made through output-related charges such as royalties and levies. These payments are often classified as taxes. If mineral property rights were privately owned, and the property rights were transferred to other private owners, the monetary consideration involved in transferring ownership would be described as a price rather than a tax. Nevertheless, to maintain consistency with the literature, the term mineral taxation is used in this submission.

In this chapter the major mineral taxation issues which face the mining sector are examined, and possible alternative arrangements for collection of payment for access to mineral resources are discussed. Section 4.1 contains a brief discussion of the general properties of optimal mineral taxation arrangements and the effects of uncertainty (geological, economic and 'sovereign') on the optimality of a tax regime. This is followed in section 4.2 by a discussion of the current arrangements in Australia for the allocation of mineral property rights and mineral taxation, and their deficiencies in the light of the desirable properties described. Section 4.3 outlines a number of

alternative taxation systems and some issues which might emerge if they were implemented. These alternatives are discussed further in sedion 4.4, which details a case study in which the effects of alternative tax arrangements on a range of representative black coal mines were simulated. Some potential inefficiencies of the main forms of taxation currently applied to the industry are highlighted. The final section summarises the mineral taxation policy options for governments.

The discussion of mineral taxation arrangements in this chapter draws heavily on two recent ABARE discussion papers. Hinchy, fisher and Wallace (1989) provided a theoretical analysis of these issues in a study into mineral taxation and risk in Australia. Hogan and Thorpe (1990) analysed the influence of taxation on crude oil exploitation in the presence of uncertainty.

4.1 General properties of optimal mineral taxation arrangements A mapr goal of policies aimed at obtaining a return to the community from the use of its resources should be to avoid reducing and, if possible, to improve the efficiency of resource allocation within the economy as a whole. The debate about the appropri- ateness of particular mineral taxation arrangements is often couched in terms of whether, on the one hand, governments achieve an 'adequate' return through specific policies or, on the other hand, taxation is 'excessive' and curtails exploration and development. However, an 'optimal' taxation policy could conceivably yield the government higher

Mining and minerals

taxation revenues than it obtains at present, while at the same time encouraging socially optimal development in the mineral industries.

A considerable body of economic literature on resource taxation concludes that if taxes on mineral production are levied only on economic rent (defined below), they will be 'neutral' - that is, they will have no effect on the incentive for companies to undertake a particular activity (see for example IAC 1988a). The imposition of neutral taxes will not distort the efficient allocation of resources by companies. That is, the taxes will have no influence on the combination of inputs used by companies, the timing of resource extraction, the allocation of exploration activity, or the decision to invest in the mineral industry rather than elsewhere.

Economic rent is defined as any profit obtained from undertaking an activity, in excess of that profit which would suffice to induce a firm to undertake that activity. The economic rent obtained by a company is the difference between its revenue and its total costs, where 'costs' include a rate of return on capital sufficient to retain capital in that activity, with due account taken of risk. Generally, unless there are barriers to entry into the activity, such economic rents cannot endure. In a competitive economy, other companies will be attracted into an activity by the above-average rates of profit. The new entrants will increase supply, thus either lowering prices or bidding up the cost of productive assets until the rent is eliminated.

Economic rents may persist in mining largely because there is not a perfectly elastic supply of non-renewable mineral resources (Hinchy et al. 1989, p.6). There are two components of economic rent which would originate from any particular mineral deposit. The first is quality differential rent: some mineral deposits have lower production costs per unit of output than other, more marginal deposits, giving a higher excess of revenue over costs.

The second element of rent is termed scarcity rent. It arises from the fact that a mining company has the option of extracting a mineral now or at a future date. Extraction of a resource today involves an opportunity cost in the form of potential future returns forgone. The opportunity cost is equal to the discounted difference between future revenue and future costs. To induce the company to extract the mineral now, it must earn a return at least equal to this opportunity cost. The element of return above the normal rate of return on capital is termed the scarcity rent. (Scarcity rent would be the only form of rent earned by marginal mineral deposits - those that offer no quality differential.)

Taxes on economic rents are described in appendix F. If taxes are levied on variables other than rent, such as on output, the neutrality condition is violated. Output- based charges, for example, are generally inefficient because they will encourage companies to cease some mining operations which still have positive economic benefits for society, and will constrain the development of marginally efficient mines.

The design of optimal taxation policies is heavily influenced by the effects of risk and uncertainty. That is, it may be necessary to modify taxation policies, which are optimal for pro* whose returns are known with certainty at the time when they are initiated, so as to take account of risk. It is therefore necessary to examine tax optimality under conditions of risk and uncertainty.

Companies investing in mineral exploration and extraction face three types of uncertainty: geological, economic and sovereign. Geological uncertainty is intrinsic in the exploration and development of mineral deposits, because there is an unknown - though finite - stock of minerals available for development. For many minerals, it is possible that, following further exploration, there will be upward revisions to the estimated size of the resources. Therefore, there is uncertainty about the size of total resources, and further


resources must be discovered before companies can proceed with development and extraction. Once new resources have been located, there remains uncertainty about the amounts of those resources that are recoverable economically, and about other factors such as ore grades.

In the case of mineral deposits which have already been discovered and are being developed, geological risk may not be a major issue. For example, there is a fair degree of certainty about the nature of Australia's known deposits of coal, bauxite and iron ore. In the case of new sites in previously unexplored areas, however, mineral exploration and development is clearly a risky endeavour.

Economic uncertainty is faced by companies because economic conditions such as output prices and input costs can change markedly. However, markets have been developed for trading in economic risk. For example, futures markets largely allow producers and traders to hedge against future changes in price. Economic uncertainty is faced by all companies in the economy to a greater or lesser extent; it is not confined to mining companies.

Sovereign risk is the possibility that government policies may unexpectedly change and influence the viability of a project. A situation where mineral taxation policies, for example, are continually reviewed and changed can be undesirable from this standpoint. The possibility of additional taxation in the future may lead a company to increase its extraction rates, resulting in excessively rapid depletion of the deposit. Sovereign risk may also result in less investment in exploration than is optimal. Nevertheless, there are circumstances where changes to taxation arrangements may be desirable from an efficiency perspective. There may be a case for altering existing output-based royalty arrangements for a particular mine, if the mine is marginally viable and the taxes on that mine's output are above the efficient level.

In the design of a tax on economic rent, in particular, the attitudes of companies toward risk are an important consideration. Companies which prefer to avoid risks - that is, are risk-averse - will require a risk premium in their expected returns from any investment of capital in exploration and development, and this premium will affect the measured rent. However, it can be argued that larger companies tend to be risk-neutral, or at least less risk-averse than smaller companies, because they have more opportunities to spread risk by engaging in a diverse range of activities. In addition, it could be argued that the debt and equity markets through which companies raise funds for exploration and development will also take account of risk.

The neutrality criterion provides a benchmark for considering the desirable properties of tax arrangements under conditions of uncertainty. It is useful to begin by distinguishing between two concepts of neutrality. A tax is defined as 'weakly neutral' if it does not alter a company's rankings of alternative projects. (It is assumed that a company has limited resources, and ranks possible projects in some order of preference prior to undertaking as many of the potentially profitable projects as it can.) A tax is 'strongly neutral' if it satisfies weak neutrality and also does not shift the cut-off point between those projects that would be undertaken and those that would not.

Weak neutrality is not necessarily a desirable property under conditions of risk, if a tax can result in some redistribution of that risk between the government and the company. Under conditions of risk, and in the absence of perfect markets for risk, the ranking of projeds by risk-averse companies may not be optimal, in which case weak neutrality will likewise not be optimal: the efficiency of resource allocation might be improved if the rankings of projects were changed so that, after tax, some projects would be undertaken that would not be conducted in the absence of the tax. It follows

Mining and miwals

that strong neutrality also is not necessarily desirable under conditions of risk.

It is clear that the actual market for risk is imperfect; that is, there is not a complete set of markets in terms of futures, insurance, capital and equities whereby companies can insure against all possible risks. Therefore, it is probably appropriate for governments to participate in risk bearing so as to encourage a more efficient allocation of resources than would prevail under the constraints of available markets and institutions.

The way in which taxation arrangements can influence the distribution of risk between govemments and companies, and as a consequence the efficiency of resource allocation, is as follows. If a company makes a lumpsum payment for the property rights to a mineral deposit - for example, a payment based on the expected value of its economic rent - then the company bears all of the geological and economic risk. The government receives a guaranteed return, but the company is faced with the possibilities of either no discovery, a discovery of less value than anticipated, or a more highly valued discovery than anticipated. If, on the other hand, the property rights are transferred on the understanding that the company will pay some type of tax that is dependent on the outcome of the project, then the government bears all of the risk associated with the transfer. This includes the risk of an uncertain income stream, and the possibility of no income (or negative income, if the government undertakes to pay the firm a rebate on unsuccessful exploration expenditure).

This raises the question of what amount of risk is optimal for governments to bear. An implication of the theory of risk is that, under a wide range of circumstances, it is optimal for governments and private companies to share risk (Hinchy et al. 1989, p.10). Thus, an optimal tax probably consists of both a lumpsum payment for the assignment of mineral rights, and a tax

which is dependent on the outcome of the project.

4.2 Mineral taxation in Australia

(a) Allocation of property rights The general practice of governments in Australia has been to transfer to private companies the right to exploit mineral resources. The states are generally responsible for allocating property rights to companies which intend to explore and develop mineral deposits. Governments do, however, have other options. They may elect not to exploit resources now but to retain the option for future development, or they may develop the resources themselves.

The methods used to transfer property rights over mineral resources from the government to private companies may be divided into non-market and market mechanisms. In Australia, the only market mechanism has been a system of cash bidding (described below) which has recently been used on a limited scale for offshore petroleum leases. The two major non-market mechanisms used in Australia have been the 'first come, first served' and 'work program bidding' systems (see Hinchy et al. 1989, pp.35-7). Though there may be a nominal licence fee under both of these systems, revenue from any eventual development of the deposit is obtained through output-based royalties and other charges.

Under the 'first come, first served' system, an exploration licence is given to the first applicant, often subject to a number of conditions including government approval of the applicant's proposed exploration program. However, where there are a number of applicants for a given area, exploration licences are often allocated according to the system of 'work program bidding'. Under this system, applicants bid


to commit speched factors of production in specified exploration activities, the successful applicant generdy being the one making the highest bid in terms of the expenditure committed.

These non-market mechanisms, which have been the main method of transferring property rights to mineral resources in Australia, have been shown to have major deficiencies (Hinchy et al. 1989, pp.6-7). The main disadvantage of the 'first come, first served' system is that it can result in excessive exploration of a given licence area, particularly if exploration licences are granted over small areas for a limited time. This is because a licence holder runs the risk of losing the licence to a competitor if minerals are not discovered within a specified time. Under these conditions, exploration is carried out to the point where the expected return from exploration and eventual development is only marginally positive, rather than where it is maximised. Excessive exploration can also result from government requirements with respect to minimum annual expenditures or the amount and type of exploration.

Another significant disadvantage of this system of assigning property rights is that the licence holder cannot sell the licence to another company which values its use more highly. This prevents rights to mineral resources from being transferred to firms who can use them most efficiently.

The work program bidding system also is an imperfect method of assigning exploration licences. It may result in a socially inefficient use of resources. The inefficiencies include excessive exploration, and distortions to the pattern of mineral development and to the timing of mineral exploration and development (Nellor 1984). First, if the proposed work program is subsequently observed to be inappropriate, firms are unlikely to be allowed to change either the sequence or magnitude of the program. As a result, the pattern of mineral development is likely to be inefficient. (If the government is known to prefer one

form of exploration over another, the company may indeed have biassed its work program toward this approach even where it is economically inefficient.) Second, timing decisions are best made on the basis of current and expected mineral prices and production costs. If expected prices suggest that society has more valuable uses for the factors of production which would be used in exploration, it may be efficient to hold the exploration licences for a time before exploration proceeds. However, the work program bidding system often imposes a commitment to commence exploration immediately.

Because of the deficiencies in existing methods of assigning mineral property rights, there is a case for the greater use of market mechanisms in transferring these property rights. Such a position is consistent with the conclusions of the Commonwealth govenunent in its examination of the results of cash bonus bidding for rights to petroleum sites (DPIE 1988, p.52).

(b) Mineral taxation arrangements After allocating exploration and mining rights, governments apply a number of mechanisms to collect a return to the community for the use of its mineral resources. Royalties are the most widely used mechanism These are cash payments to the government for the transfer of property rights in the resource from the community to the mining company. A royalty can be levied on production, as a fixed amount for each unit of physical output ( s e c royalty) or as a percentage of the value of output (ad valorem royalty). Other imposts are also applied. These include charges in excess of costs for the use of government services or infrastructure, such as rail freight charges on coal and port handling charges, and Commonwealth export duties for some coal production and uranium.

Appendix E outlines in some detail the various taxation arrangements applying to

Mining and minerals

mining within Australia. Table 9 the pace and extent of extraction: deposits summarises these provisions, while table may be left in the ground even though the 10 shows the amounts of revenue collected price of the product exceeds the total social from mineral royalties, by industry class, in unit cost of extraction. On the other hand, 1987-88. For the minerals under reference, the property rights system encourages none of the royalties and charges currently overexploration and premature extraction. used in Australia are such as to lead to the The effects on industry output of the same pattern of resource allocation as would combination of these two systems are result from charging a proportion of the ambiguous and are difficult to quantify economic rent associated with each unit of empirically. ore extracted. However, a major attraction of the royalty

These arrangements have distorting tax is its simplicity in administration. The effects on the structure of the industry. The tax base is the amount produced, and this is royalty tax is asymmetric, because there is easily identified. Indeed, the reliance by the no corresponding rebate on the costs of states on mineral taxes based on the volume failed exploration and development. Nor is or value of production may suggest a greater it neutral in its effect on company investment concern for administrative ease than with decisions. Because the tax raises the unit the effects of distortions to resource costs of extraction, it also tends to reduce allocation. Nevertheless, administrative

Major taxation arrangements specific to the Australian mining industry g (excluding the petroleum industry)

Revenue measure Revenue base Government

Exploration permits All states, NT

Mine lease payments All states, NT

Royalties - specific Volume of output NSW, Vic, Qld, WA, Tas.

- ad valorem Value of output NSW, Vic., Qld, SA, WA, Tas. Volume/value output Qld, WA (combined speaFic/& &em)

l - profits Accounting profit NSW (mine-specific)

NT (proportional profits) Value of output/ Tas (progressive profits/& oalorem) accounting profit Qld (ad dmem/profits combined)

Excess infrastructure charges - rail freight Volume of output NSW (coal), Qld.

- port handling charges Volume of output NSW (coal) I Export duties (coal and uranium) Volume of output Commonwealth

Company taxation - depreciation provisions Eligible capital Commonwealth

expenditure

- exploration expenditure Immediate Commonwealth deductibility

Note. Not all these measures apply to all minerals. Source: IAC (198% pp.3839, 58).


10 Mineral royalties, by industry class, 1987-88

ASIC code Description To governments To others a Total

Iron ore I Iron ore pelletising Bauxite Copper ores

J Gold ores Mineral ores Nickel ores Silver, lead, zinc ores Ti ores Uranium ores Non-ferrous metal ores nec

11 Total metallic minerals 227.0 93.9 321 .O

1201 Black coal 1202 Brown coal 1300 oil and gas

12-13 Total coal, oil and gas 561.2 53.6 614.9

1401 Sand and gravel 1404 Construction materials nec

14 Total construction materials 8.4 20.5 28.8

1501 Limestone 1502 Clays 1504 Salt 1505 Non-metallic minerals nec

1 15 Total other non-metallic minerals 23.9 2.8 23.4

Total mining 1987-88 820.5 172.3 992.9 (excl. services 1986-87 799.6 137.0 936.7 to mining) 1985-86 941.5 137.8 IU79.4

a Includes certain groups of land owners. np Not provided. Not elsewhere classified. Souru: A B (1989, p.9).

costs are a major factor to be considered appendix F. The alternative arrangements when designing optimal taxation policies. are directed at taxing economic rent, and

aim to maintain the desirable features 4.3 Alternative mineral highlighted in section 4.1. They can be

I taxation arrangements broadly classified as profits-based taxes and cash bidding systems.

1 This section briefly identifies alternative

I arrangements for inera1 taxation and some of the major issues which might emerge if (a) Profits-based taxes

I they were implemented. ~hese arrange- Profits-based taxes which have been ments are assessed in more detail in proposed in the literature include the Brown

Mining and miwals 29

tax, resource rent tax and various modifications of these taxes (see Hinchy et al. 1989; Hogan and Thorpe 1990). These taxes are levied on the economic rent generated by a particular project for each year. Economic rent is approximated by the net cash flow for the project. This is defined as the difference between revenue and total costs, where total costs include all capital expenditure during the year plus a 'normal' rate of return on capital. This 'normal' rate of return includes the premium demanded by a firm having a given level of risks. The government would receive a fixed proportion of the difference between revenue and costs thus defined, in years when it is positive - that is, when positive economic rents are earned.

The major difference between the proposed taxes is in the treatment of losses incurred by companies. Under the Brown tax, the government would pay companies a rebate in the event that losses are incurred. Under the resource rent tax, there is no provision to pay a rebate on losses. Losses, increased by a 'threshold' rate of interest, are carried forward until they can be deducted from future profits. (The rate of interest is so called because it acts as a threshold rate of return below which no tax is paid.) In the event that the project yields no profits, there is no provision for a rebate. In consequence, this tax is not neutral in its influence on firms1 project decisions.

It is possible to modify the resource rent tax to make it more nearly neutral. This could be achieved by making it symmetric in its treatment of profits and losses, by providing cash rebates on the costs of unsuccessful projects. Alternatively, losses could be offset against the returns from other, successful exploration, or could be sold to firms having projects subject to the same tax (Hinchy et al. 1989, pp.27-8).

Profits-based taxes, particularly resource rent tax, have been instituted in a number of countries, including Australia. However, they have been introduced only recently, and there is as yet little quantitative

knowledge of the extent of improvements in resource allocation which have resulted from this type of tax.

(b) Cash bidding systems Cash bidding systems for allocating mineral property rights have been widely used overseas, but only in the United States are they currently the usual method for assigning rights (Hinchy et al. 1989, p.22). In other countries, cash bidding is usually combined with other assignment and taxation methods. In Australia, a cash bidding system was introduced in 1985 for some offshore petroleum leases. Though it is not yet widely used, this system is regarded by the Commonwealth government as the most efficient and equitable means of assigning rights in highly prospective areas, such as the Timor Sea region, where competition for an exploration permit is likely to be strong (DPIE 1988, p.52).

Cash bidding systems include competitive cash bidding and a system of cash bidding combined with an outcome- dependent tax. Under the competitive cash bidding arrangement, property rights to a mineral resource are sold by auction to the highest cash bidder. The successful bid comprises full and final payment for the property rights, whether minerals are subsequently discovered or not, and rights are not conditional on exploration and development taking place. In addition, the successful bidder may resell the full property rights. The proceeds of the auction are therefore effectively a tax on economic rents.

The cash system may be combined with an outcome-dependent tax. In that case, companies bid for a site with the knowledge that a given tax schedule will apply if subsequent development of the site produces a positive cash flow. This system has the major advantage of moving toward an optimal sharing of risk between governments and private firms (see sedion 4.1).

ABARE submission to Industy Commission

(c) Issues in the implementation of alternative arrangements

Information requirements To implement these alternative arrangements in a way which would realise their potential, governments would require a large amount of information. The major difficulty in the use of profits-based taxes is the measurement of economic rent. (See appendix F: economic rent is not the same as the accounting profits, which are routinely measured.) A component of this problem is that of defining a 'normal' rate of return on capital for a given level of risks faced by a company.

Government acquisition and dissemination of information about the likely value of particular mineral deposits has been suggested as a means of compensating for incomplete risk markets. A case can be made for governments to intervene in the market in this way because the supply of information is likely to be subject to market failure. Knowledge about the value of a particular site has an economic value because it increases the degree of certainty about the most likely value of a deposit, thereby reducing risk. Companies are likely to underinvest in acquiring such information because it is difficult to capture and retain all of the benefits from it. In relation to an unmodified resource rent tax, governmental reduction of geological risk will increase the range of projects in which companies are willing to engage. In relation to cash bidding. it will in general increase the likely values of bids. From an efficiency point of view, the government could rationally invest in information up to the point where the cost of an additional unit of information was equal to the rise in average bids or in the benefit from a higher number of minerals projects undertaken.

As a result of information requirements, the administrative costs of the alternative arrangements would clearly be higher than

Mining and miwals

the administrative costs associated with the current arrangements based on output or accounting profits. This necessitates careful consideration of whether the net benefits to society from improving the efficiency of resource allocation and use by these means would be positive or negative. In particular, it needs to be assessed whether the costs of the inefficiencies in the current arrangements are greater than the information costs required to institute profits-based or cash bidding systems.

The overall economic and budgetary effects of the different taxes discussed above might not differ greatly if they were accompanied by the appropriate level of government investment in information (Hinchy et al. 1989, p.29). In the case of the Brown tax, and the resource rent tax modified to make it approximate the Brown tax, companies might be willing to undertake projects on a lower level of information than would be required to induce them to proceed if faced with an unmodified resource rent tax. In those cases, therefore, higher government expenditure (or reduced revenue) as a result of the government's loss-bearing role would be offset by lower expenditure on information. Under an unmodified resource rent tax, zero government expenditure on loss bearing would be offset by higher expenditure on information.

The additional information required may exceed the information that can be obtained through geological survey, requiring governments to undertake local exploration activities such as drilling. The roles of government in partly bearing the risk of losses in the case of the Brown tax, or acquiring information in the case of an unmodified resources rent tax, might effectively result in the same exploration activities being undertaken, whether by government or by companies.

Symmetry There are a number of issues involved in the use of taxes which treat profits and losses

31

symmetrically, as do the Brown and modified resource rent taxes. A popular argument against the Brown tax is that governments do not like arrangements that may commit them to unpredicted budgetary payouts. The symmetrical tax treatment of profits and losses is usually regarded as highly controversial or impractical, allegedly making such taxes politically infeasible. The arguments against a symmetrical tax system are not, in fact, entirely compelling (see Hinchy et al. 1989, p.20). Nevertheless, it seems that to date they have been sufficient to constrain governments from implementing symmetrical taxes.

Moral hazard and adverse selection From an economic efficiency perspective, other problems arise, including those of 'moral hazard' and 'adverse selection'. Moral hazard occurs - in this context - where loss offsets available under symmetrical taxes may reduce incentives for companies to avoid losses. In addition, such taxes may provide incentives to falsify accounting and taxation returns, although these incentives may not be greater than in taxation systems based on accounting profits. The adverse selection problem arises where the prospect of loss rebates attracts companies which have a higher than average chance of operating at a loss (due to poor management, for example).

One method of reducing the problem of moral hazard in symmetrical taxes would be to limit the liability of the government for rebates on losses to some given amount on each project, and to provide cover for certain kinds of loss only: for losses occurring when exploration expenditure does not lead to a mineral discovery (which would appear to be the major risk of loss in most mineral industries) but not for losses from sudden changes in prices and costs. The loss liability of the government could be set at a given amount depending on the stage of exploration or development. Further, there is a case for limiting the loss

at each stage of the project in an attempt to reduce incentives for companies to overspend on exploration without development, or to accumulate losses during the development stage for deduction from profits if exploration is successful.

Another option for modifying the resource rent tax, as noted above, would be to allow firms having successful pro)ects to purchase losses from unsuccessful projects. A theoretical discussion of a market for trade in losses is contained in Hinchy et al. (1989, pp.42-3). In summary, this approach does not involve direct government payouts, but revenue would be reduced because the tax collected on successful projects subject to the resource rent tax would be lower. Again, the government might limit moral hazard by setting maximum amounts of loss that it would allow to be traded. To eliminate speculative trading in losses (that is, the purchase of rights to a loss with the aim of re-selling them at a profit), it would be necessary that purchased losses be deducted from the profits of the buyer in the tax year of purchase.

Treatment of existing projects Finally, much of the preceding discussion has been cast in terms of unallocated mineral sites and undeveloped deposits. Changes to arrangements for existing projects may be somewhat more difficult to implement. A major difficulty is that a shift to a rent tax might involve some implementation costs where mines have been in production for some time. Such costs would be imposed for existing mines where, for example, new taxation arrangements would require the development of new accounting information systems. On the other hand, the flexibility of a royalty which takes into account mine revenues and current operating costs would extend the life of marginal mines which would be uneconomic under output-based royalties. In fad, a number of similar taxation arrangements are in use in New South Wales, Queensland and the Northern Territory,

MARE submission to Industry Commission

where royalties for some minerals are based on accounting profit (see appendix E).

Overall, it can be concluded that a move away from output-based royalties to an arrangement which is based on economic rent is clearly desirable, in that it could remove some of the inefficiencies associated with current taxation arrangements.

4.4 Coal industry taxation: a case study The coal industry is the one Australian mining industry, other than the petroleum industry, in which the concept of rent taxation has been discussed for several years. A major focus of discussion in recent times has been on the likely extent of excessive charges for the use of rail infrastructure imposed on the industry by state governments. There has been considerable debate in the literature regarding the extent to which excess rail freights are used to recover economic rent W C 1988~; Freebairn 1989). Freebairn argues that excess freight charges may be modelled as a constant per- tonne tax. He estimates that allocative efficiency, measured as the difference between the marginal value and the marginal cost of extra exports, would increase more than $150111 a year if excess charges were removed (and not replaced by an alternative tax). The export coal levy applied to the high quality coking coal exported from the large, low cost, opencut mines of the Bowen Basin may also be interpreted as an attempt at rent taxation. (Neither this nor excess freight charges, however, are rent taxes in the sense used in this study - taxes proportional to economic rent - being in the nature of royalties.)

More recently, a working party was established by the New South Wales government to examine the merits of rent taxation in the form of a resource rent royalty. The working party comprised the New South Wales Coal Association and the New South Wales State Treasury and Department of Minerals and Energy.

Mining and minerals

The case study presented here highlights some potential inefficiencies in the main forms of taxation applied to the black coal industry. It draws heavily upon the Hogan and Thorpe (1990) analysis of the effects of taxation on investment and production decisions in the crude oil industry. Appendix G outlines existing tax arrangements in the coal industry, explains the simulation method and key assumptions employed in the case study, and presents detailed results of the simulations.

(a) Summary of method It is assumed that the government, on behalf of the community, is entitled to some return for the transfer of property rights to firms engaged in exploiting non-renewable resources. Taxation arrangements are compared on the basis of an optimal tax criterion. An optimal tax is one which ensures an efficient resource allocation, while providing the government with some set proportion of the economic rent in exchange for the property right. If the first of these objectives is met, no sources of economic rent will be lost, and thus the aggregate of the government's and the investor's returns from economic rent will be maximised (relative to alternative systems of taxation).

Hogan and Thorpe (1990) studied the divergence of current crude oil taxation arrangements from the optimal tax objective, using numerical simulation analysis. Their work complemented the Hinchy et al. (1989) analysis of mineral taxation under risk. Hogan and Thorpe considered that, in the absence of perfect risk markets, the firm's decision making is influenced by the uncertainty as to the location and size of Australia's oil reserves. In their assessment of alternative taxation regimes, they therefore considered the firm's attitude to geological risk.

Hogan and Thorpe also assessed taxation arrangements under conditions of certainty regarding all inputs considered in the firm's decision making process. Given that

exploration risk is of little importance in the coal industry, geological certainty was assumed in this case study. Reserves of black coal are large and the major deposits are well known. The demonstrated economic reserves of black coal in Australia are 50 200 Mt (BMR 1990), while raw coal production in 1990 was 190 Mt. For simplicity, economic certainty was also assumed, although the economic parameters were given a variety of alternative values. (The literature of the debate surrounding coal taxation also tends to assume conditions of certainty, but compares the inefficiencies under the current taxation regimes with the no-tax situation; see, for example, Freebairn 1989.) Complications added by considering uncertainty were discussed in sections 4.1 and appendix F.

In this simulation study, the effects of taxation on returns to government and investors, and on coal companies' investment and production decisions, were simulated under a range of project conditions. Project parameters were largely based on representative mine-level data. Assumptions were made about mine sizes, production profiles, price and cost conditions and taxation settings (see table 11). The net present value of pre-tax net profits was taken to be the economic rent, and was used as the summary measure of mine profitability. The pretax rent of 162 simulated mines, with the variety of characteristics shown in table 11, was divided into a government return, an investor' S return and a loss. The latter is the loss of economic rent that occurs when a mine project becomes uneconomic as a result of taxation and is not undertaken. Simulation results for different taxes were compared with those under a neutral, non- distorting tax. Because the Brown tax can be shown to be neutral and not to distort resource allocation decisions (at least in the absence of risk), it was used as the basis for comparison of the effects of other taxes. The Brown tax was set so that the shares of the

11 Parameter values assumed in simulations

Fixed parameters

Project life: 20 years

Port charge: $5/t

Taxation parameters: Rate for Brown and resource rent taxes: 40 per cent Threshold rate: 10 per cent Ad adorem royalty rate: 11.45 per cent Spedfic royalty rate: $5.38/t

Opencut mine characteristics:

Capital Mine size tl t2 costs

Mt Y Y $m

Underground mine characteristics:

Capital Mine size tl t2 costs

Mt Y Y $m

where t l is the time to first production after initial capital expenditure and t2 is the time to plateau production after initial capital expenditure.

Parameters varied for sensitivity analysis

Coal price: constant at $60/t in 1989-90 values or rising or falling by l per cent a year.

Free-on-rail operating cost ($/t): opencut, 12, 22, 32; underground, 15, 25, 35.

Freight rate ($/t): 4, 8, 12.

Firm's risklgs real discount rate (%): 5, 10, 15.

pre-tax economic rent accruing to the investor and to the government were in the ratio 6040 for all of the projects considered.

Results are presented (see appendix G) for the whole population of 81 opencut and 81 underground mine projects, and also for sub-populations having specified characteristics. These latter results provide sensitivity analyses with respect to the specified variables - namely, mine size,


coal price rise or fall, operating cost, freight rate, and the finds discount rate for future costs and returns.

The taxes modelled were the specific and ad valorern royalties currently used in the industry, the (unmodified) Brown tax and the (unmodified) resource rent tax. In the simulations, the royalty taxes can be regarded as including any excess freight or port charges.

(b) Results and policy implications The study indicates that in the black coal industry, assuming certainty and the specified mine conditions, profits-based taxes are more efficient than the current royalty regimes. It follows that profits-based taxes are also more efficient mechanisms for collecting rent than excess freight rates, whether the latter are viewed as speclfic or ad mlorem royalties. The simulation results indicate that, by the optimal tax criterion discussed above, the Brown tax is preferable to the resource rent tax, specific and ad valorem royalties.

A practical problem with implementing the Brown tax (see section 4.3(c)) is that governments may be reluctant to provide cash rebates to companies when losses are incurred. The simulation results indicate that the (unmodified) resource rent tax, which avoids the need for cash rebates, generally has a less distorting effect on investor returns than royalties. However, any divergence between the threshold rate and the firm's discount rate distorts the investor's returns and can induce losses of otherwise viable projects. Ideally, to ensure a zero distortion across all projects it would be necessary to make the threshold rate and/or the tax rate project-specific. This could be done by means of a sealed-bid auction on either of these parameters, provided that the value of the other parameter was set by the government and announced before the auction (Hogan and Thorpe 1990). The considerations regarding

Mining and minerals

information in section 4.3(c) imply that the government is likely to receive more realistic bids, and higher returns, if it devotes some resources to generating and distributing relevant geological information.

The resource rent tax produces no distortions of investor returns or losses of projects if the output prices remain constant. When prices rise or fall steadily, it produces significant distortions and losses in aggregate. For those projects which remain viable, it overtaxes mines when output prices are rising and undertaxes when they are falling. On the other hand, because the resource rent tax does not have full offsetting of losses, there are some losses of projects when prices are falling.

It may be argued that the greatest risk in coal exploitation is the economic risk associated with large output price movements. The absence of the provision of full loss offset is likely to be a major weakness of this tax. Increasing the threshold rate would reduce losses of projects, but only at the cost of further distortion of investor returns, and hence of resource allocation, as a result of divergence between the threshold rate and the firm's internal discount rate.

When coal prices are constant, lower- cost mines are slightly overtaxed under the resource rent tax but (over the range of parameters simulated) no losses of projects result.

Under royalties, projects are far more vulnerable to variation of economic conditions. Of the variations simulated, the largest project losses and downward distortions of investor returns occur when operating costs are high. There is a tendency to overtax in this case. (Operating costs are the major component of variable costs, and the variations simulated were large in absolute terms.) Also, when coal prices are falling or freight rates are high, many rna@ mines become uneconomic. When these economic conditions coincide, reliance on royalties may result in a sizeable loss in income to the community from project abandonment.

Obviously, royalties are simpler to calculate than a resource rent tax, for both government and industry, because they depend on fewer parameters. However, it is just for this reason - because they do not take local conditions into account - that they are distortionary. Royalty rates do tend to be revised as economic conditions change or overall biases are detected, but on balance the inefficiencies of royalty taxation are likely to outweigh any benefits accruing from administrative simplicity.

4.5 Summary Governments aiming to obtain a payment in return for the allocation of property rights to mineral resources should ideally allocate such rights and implement taxation mechanisms in a manner which is consistent with the efficient allocation of resources in the economy. Thus, the taxation arrangements should be neutral in their effects on resource allocation. If there are a number of alternative taxation arrangements which are neutral, the arrangement which imposes the lowest collection costs on government and the lowest compliance costs on the company is preferable.

In Australia, the typical situation has been for governments to transfer property rights to mineral resources in return for only outcome-dependent taxes. A number of production-based and revenue-based taxation mechanisms, including royalties, excises and excess infrastructure charges, are presently used to extract this return to the community. It appears that governments have in this way borne the risks associated with the transfer of mineral property rights; though it is not clear what effect this has had on the attitudes of companies towards undertaking risky projects.

The key policy issue is whether consideration should be given to changing these taxation arrangements on the ground that they distort the allocation of resources within the economy. If the distorting effects of current arrangements can be

demonstrated to be significant, it becomes necessary to assess the costs and benefits of alternative approaches.

There are grounds for believing that existing taxation arrangements and non- market methods for allocating property rights in Australia have distorting effects on the allocation and use of resources. In general, profit-based - that is, rent-based - taxes are less distorting than produdion- based taxes. This conclusion is supported by the case study into the black coal industry reported in section 4.4. This result has been shown to hold under conditions of both certainty and uncertainty, in this study and in Hogan and Thorpe (1990). The case study also illustrates that a resource rent tax, while it distorts investor returns considerably less than royalties do, is sensitive to economic conditions if the firm's internal discount rate differs from the 'threshold' rate used in calculating the tax. To ensure either that the firm's discount rate and the threshold rate coincide, or that the effects of the difference are compensated, it would be necessary to make either the threshold rate or the tax rate project-specific. However, the information requirements of doing so are large. This problem could be addressed through the use of a sealed-bid auction.

As was mentioned in section 4.1, in the case of new mineral sites it may be optimal for governments and companies to share risk. In that case, the optimal taxation arrangement for new mineral sites may be a combination of a lumpsum payment and a tax which is dependent on the outcome of the project. (The latter transfers risk to the govenunent; the former does not.) There are the options of combining the cash bid system with either a Brown tax or a resource rent tax, and in the latter case, of the tax being set by f i m bidding on the tax scale.

The problem of lack of knowledge about the effects of mineral taxation on exploration, development and production could in principle be addressed by means of a taxation system that circumvents the need for explicit information about these effects.


This could be achieved by allowing distortions arising from sovereign risk, the companies to make an initial cash bid for a winning tax scale bid would need to be site as well as a bid on the tax scale. Under binding over the life of the mine and not this system, a modified resource rent tax is subject to renegotiation. Such a taxation likely to be the least distortionary of the policy could be accompanied by alternative taxes as well as the most feasible government investment in the generation politically. However, if the modification and dissemination of geological (provision of rebates on losses) were ruled information, to reduce uncertainty and out, the unmodified resource rent tax could redistribute risk for some projects. be combined with a cash bid. To limit

Mining and minerals

5. Environmental issues

Mining activities, from exploration to extraction and processing, have come under increasing public scrutiny over the past two decades as competition for environmental resources has intensified and community attitudes have shifted. It is widely recognised that community concerns about the pace, type and location of mineral development will have an even greater influence on the growth of the mining and minerals processing sectors in the future (see, for example, Loton 1989). In this chapter, the institutional arrangements whereby environmental policy is effected, as it relates to mining and minerals processing, are discussed. A number of factors constraining the development and implementation of policy alternatives are identified, and a range of policy options for improving the efficiency of resource use are presented.

5.1 Institutional arrangements Institutional arrangements have major consequences for the conduct of environmental policy as it affects mining and minerals processing. It is useful to briefly review the process of environmental management across the various levels of government, before considering its implications for efficient resource allocation.

Environmental management in Australia is conducted at all three levels of government - Commonwealth, state and local. As in the case of the allocation of mineral property rights, the Commonwealth government has no constitutional power over environmental matters except in those cases where the Commonwealth is itself a land manager. However, the Commonwealth government can influence policy through its powers

over customs, trade and commerce and corporations, and under its international treaty obligations. The key pieces of legislation used by the Comrnonwealth are the Environment Protection (Impact of Proposals) Act 1974, the Australian Heritage Commission Act 1975 and the World Hm'tage Properties Conservation Act 1983.

The broad obpdives of Commonwealth government policy applying to resource use were set out in 1989. Importantly, these principles, to be used by Comrnonwealth Ministers in all areas of policy formulation, were encapsulated in the legislation which established the Resource Assessment Commission. The principles have been summarised (Prime Minister 1989, p.5) as follows:

'there should be an integrated approach to conservation (including all environmental and ecological considerations) and development by taking both conservation and development aspects into account at an early stage; 'resource use decisions should seek to optimise the net benefits to the community from the nation's resources, having regard to efficiency of resource use, environmental considerations and an equitable distribution of the return on resources; Comrnonwealth decisions, policies and management regimes may provide for additional uses that are compatible with the primary purpose values of the area, recognising that in some cases both conservation and development interests can be accommodated concurrently or sequentially, and, in other cases, choices must be made between alternative uses or combinations of uses.' The Commonwealth system overlies a

complex system of state acts on matters

ABARE submission to Indust y Commission

ranging from the granting of mining leases to pollution control regulations. The state governments generally have priorities and objectives which differ from the overriding national interest objectives of the Commonwealth government. On behalf of the community, they control the subsurface property rights to the minerals, as well as having major responsibility for land-use management, including environmental management. In general, the objectives of state policy relating to resource develop ments have been to encourage development of mineral deposits and minerals processing facilities in the state and to maximise revenue from mineral resource extraction. In recent years, as a result of shifting community attitudes, the focus of these objectives has been broadened, giving greater weight to protection of the environment.

The role of local government in resource development and related environmental management issues is determined largely by the policies of the relevant state governments, and may vary between states. In general, local government has responsibility for examining and approving development applications, subject, however, to state legislative requirements including those for environmental protection.

The main instrument used by the Commonwealth and state governments in determining the environmental standards to be met by development proposals is the environmental impact assessment (EIA) process. Proponents of development proposals are required to prepare a report on the likely impact of their proposals on the environment. This report is then subject to public review in which the benefits of the development are compared with the impact on the environment. In general, the result of the process is the specification of environmental safeguards and environmental management procedures. In some cases, the project may be cancelled.

The extent to which economic techniques for measuring the benefits and costs of

development proposals, including the environmental effects, are incorporated into the EIA process varies widely Uames and Boer 1988). From an economic perspective, the overall merit of a proposal should be defined in terms of its potential effect on net social economic welfare. Though the EIA process is a comparison of costs and benefits, the evaluation of public-good aspects of the environment and of the unpriced goods and services provided by the environment is (in Australia) performed either qualitatively or not at all.

It is difficult to estimate the effects of the current institutional arrangements, including the EIA process, on economic efficiency in terms of net social economic welfare forgone or gained. From a qualitative perspective, however, it is clear that there are a number of important issues. First, some resources of the physical environment, such as air and water, have tended to be regarded as free goods in both production and consumption. As such, they have probably been overexploited relative to the socially desired level. The use of such resources should ideally be accounted for in the internal production costs of private firms and the costs faced by individual consumers.

Second, the values attached to off-site benefits that arise from conservation should be included in the evaluation of development proposals. This requires that the problems of measuring these values can be adequately addressed. Equally, the opportunity costs associated with not exploiting minerals in a disputed area are not sufficiently considered in the current evaluation process, particularly where comprehensive exploration data are not available and where regulations are used to meet conservation ends. Finally, the effects of uncertainty on the evaluation process should be taken into account more explicitly. The value of information as a public good in aiding decision making should be recognised.

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5.2 Policy constraints

Absence of markets The role of government in allocating access rights between mining and other uses of the resources of the physical environment arises largely because of the failure of the existing market mechanisms to allocate such resources efficiently. Market solutions to resource management issues, where they can be achieved, are likely to provide the simplest and most cost-effective means of attaining an efficient allocation and use of resources. If markets operate effectively, price signals between consumers and producers ensure that the combination of goods produced is socially optimal. However, this outcome requires that the full consequences of each individual's actions be borne by that individual. Systems of property rights, confening the ownership of assets and responsibility for their control, provide ways of ensuring that this occurs. Because of the difficulty of assigning property rights to some of the services provided by the environment, such as species existence and ecosystem integrity, there are only limited markets for these services. This absence of markets constrains the policy options available to governments for determining the combination of uses which maximises social welfare.

In the case of competition between development interests for access to resources, such as between mining and fanning, it seems likely that markets are, or could be readily made, effective. If property rights are well defined and trade in these property rights is not seriously restricted, the potential to arrive at economically efficient outcomes exists. Government intervention may be required in some cases to ensure that such property rights do exist and are clearly defined.

Where there are significant conservation uses of the land, market solutions may be less successful. Although a property right to the area of land in question could be

established, an efficient allocation of that resource between competing end uses would require that the true monetary values of those end uses be expressed in the marketplace. These would include both the monetary value of any mineral products and the monetary value placed on any conservation benefits. However, the social preferences and values with regard to conservation may not be adequately represented in any market-based solution because of the 'public good' characteristics of such conservation services and the associated 'free-rider' problem (see Freebairn 1987). In some circumstances, therefore, governments may reasonably be expected to represent these conservation interests in the resolution of competing claims for resource use.

The major characteristic of public goods is that they are 'non-exclusive' and 'non- rival'. A good is said to be exclusive if its benefits can be confined to specified individuals. For goods that are inherently non-exclusive, it is not possible to establish a market, because it is not possible to confine the benefits to purchasers: they are freely available to all.

A good is said to be rivalrous if the use or consumption of a particular item of it by one individual reduces or prevents other individuals from obtaining the same benefit from the same item. For example, food is rivalrous - that which is eaten by one person cannot be eaten by another - whereas information is not: the same piece of information can be provided to any number of people. Non-rivalry leads to difficulties in marketing, in that purchasers need not compete for access. The lack of competition in consumption of the good means that markets will tend to supply less than the socially optimal quantities of the good, if any is supplied at all.

Some of the benefits of conservation are both non-exclusive and non-rival. For example, it is difficult to establish a property rights system which excludes people from the off-site benefits which they may derive

ABAKE submission to Industry Commission

from the preservation of natural environments. And the benefits that one person obtains from the knowledge that a particular species or habitat has been conserved does not reduce the benefits available to others.

Because of this combination of non- exclusiveness and non-rivalry, competing claims for access to land by mineral development and conservation interests can be intractable. Largely as a result of the absence of markets for conservation benefits - off-site benefits in particular - and the difficulty of establishing such markets, it is unlikely that market solutions will fully reflect the underlying social preferences and thus achieve an efficient outcome. As a result, there has been a heavy emphasis on the use of regulation in the resolution of these claims in the current institutional arrangements.

Multiple land use Multiple land use may be an option in resolving competing land use claims. In that case, the policy problem is to determine the appropriate level or rate of each use. 'Multiple land use' can refer either to different uses occurring in a particular region at one time, or to different uses occurring in the same location over time. The concept of multiple land use is beginning to appear in state legislation. South Australia added the classification 'regional reserve' to its National Parks and Wildlife Act in 1987, to denote an area which is conserved for its wildlife or historical value while utilisation of its natural resources is permitted.

In the case of mineral development, there are constraints on the application of both types of multiple land use. Where development has significant offsite costs, the benefits derivable from concurrent uses may be reduced. For example, run-off from mine dumps and tailings dams into surrounding water systems may affect the amenity value in tourism and other recreation uses of the location. These effects

are generally not reflected in the marketplace as costs to mining.

With respect to multiple use across time, mining companies currently spend considerable amounts of money to regenerate areas affected by their activities. This enables future use of these areas for continued development, recreation, tourism and wildlife habitat. For example, rehabilitation and reafforestation in Weipa, the jarrah forest region of Western Australia and the Darling ranges have shown that rapid recolonisation by plant and animal species can occur (McIntosh 1989, p.35).

Where multiple land use is an option for resolving competing claims, the policy task is one of selecting the appropriate rate or level of each use. This should be based on a comparison of the additional benefits generated from an extra unit of one use with the loss of benefits from the associated reduction in another use. When all possible gains from further reallocation are exhausted, an efficient outcome will have been attained and social welfare maximised. However, the usefulness of the multiple use option for particular areas may be restricted where significant off-site benefits or costs exist.

Uncertainty From a public or governmental standpoint, uncertainty enters into what is perhaps the fundamental policy issue facing the community in dealing with the management of natural resources: choice of the trade-off between current and future use of non- renewable r e s o m . This involves deciding whether to use the resource now and put the proceeds towards generating other kinds of wealth (for example, investing in education or health); or whether to save the resource in its natural state. The consumption patterns of all current and future generations need not be identical. Indeed, the use of some resources now in order to build up capital stock and to contribute to new knowledge and technology might be a more effective way

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of passing on wealth to the next generation than leaving a resource in the ground.

In some instances the current generation may wish to make a commitment never to deplete a particular resource or change some part of the environment. By adopting the alternative of saving the resource in its natural state, the community trades-in a stream of financial returns over time for an uncertain future income or for some intangible benefits that might be associated with an unchanged environment. Of course, the current generation cannot make its commitment binding on those who follow.

With respect to mining and processing development, there are several sources of uncertainty which can have an effect on the efficient conduct of policy. These relate to the geological potential of areas, the environmental value of an area or the environmental impact of development on an area, and the effect of regulatory arrangements applying to exploration and mine development. The introduction of uncertainty into a decision-making framework for resource management requires a clear specification of the nature and sources of uncertainty and how these constrain policy options available to government.

The problem of geological uncertainty is inextricably linked to exploration and the granting of access to land for exploration. Successful exploration requires access to large areas of land: the probability of finding an economic deposit in a given exploration program depends on the scale of exploration. Even once significant mineralisation is discovered in an area, the existence of a commercial deposit can only be determined through further, intensive exploration.

From an economic perspective, the problem of geological uncertainty is also compounded by the divergence between the private and social costs of exploration. Where exploration is conducted in environmentally sensitive and valued areas, the impact of exploration on the

environment may have a social cost arising from the loss of non-market benefits. This can occur because there is little incentive for private firms to incorporate the social costs of environmental side-effects into their decisions, since they do not pay these costs. From a social pers-ve, the result may be over-intensive exploration and excessive environmental damage, leading to loss of social welfare. However, exploration techniques can be modified, at additional cost in terms of either expenditures or expected results, to reduce environmental impacts.

There are several aspects to the uncertainty which exists on the environmental side of resource use conflicts. There may be uncertainty over the environmental assets of an area which is subject to competing demands. There may be insufficient knowledge about the environmental qualities of an area, or the possibility of further types of use of the area, for a rational decision to be made. As a consequence, the long term effects of exploration and development on the future stream of conservation benefits derived from a particular area may be uncertain. In relation to some ecological impacts of resource development activities, there can be a high degree of uncertainty as to whether or not the effects are reversible. For example, in some cases the probability of the loss of species or the destruction of an ecosystem are very difficult to estimate. The possibility of irreversibility implies the need for decision makers to take into account 'bequest' and existence values in the analysis of current development decisions.

In addition, it is often argued that the future benefits of preservation may include the unknown future usefulness of particular , species as, for example, a source of genetic material for medical or other applications. The additional information about preservation benefits that may be derived by research while delaying irreversible development of an area has a social value. The expected value of information

ABARE submission to Industry Commission 1

conditional on the delay of development is termed a 'quasi-option' value (Fisher and Krutilla 1985). If decision-makers ignore the quasiaption value of information, they may give insufficient attention to development and management strategies that would allow greater opportunities for flexibility and adjustment to new information, and hence the possibility of increased social welfare at some future time.

As a consequence of information having some elements of a public good (that is, being non-rivalrous and non-exclusive to a certain extent), it is unlikely that a socially optimal amount of research will have been conducted on the geological and ecological value of an area subject to competing claims. Where it would be costly and time- consuming for individuals, groups or firms to provide the research data necessary for rational policy decisions to be made, there may be a role for an increase in the acquisition and dissemination of the required information by governments. This is discussed further in the next section.

In relation to irreversible effects on natural resources (including, for example, from land) it has been suggested that, for each resource, a 'safe minimum standard' can be set, so as to avoid a threshold or critical degree of disturbance beyond which further damage to the resource would be irreversible. It has been further suggested (see Chisholm 1988) that safe minimum standards should always be adhered to except where the social costs are judged (politically) to be 'too large'. This latter approach has been advocated where cost- benefit analysis is inconclusive (because of significant benefits or costs being unevaluated) and where there is some risk of very costly damage occurring irreversibly. However, this argument implies some moral hazard for those advocating conservation options, in that they may acquire a vested interest in promoting inconclusiveness and uncertainty.

There are also problems stemming from uncertainty over the regulations and

Mining and minerals

procedures governing the exploration and extraction process. For example, the mining industry has expressed concern that certain current institutional arrangements tend to increase the uncertainty surrounding the environmental aspects of proposals. Here, the major problem is that both Commonwealth and state legislations provide for EIA procedures with very little guidance on the minimum standards to be met with regard to environmental impact. Such uncertainty is known as sovereign risk: it includes the risk of approval for projects being withdrawn after considerable investment has been undertaken, or of rules governing mining operations being changed during the life of the mine. Sovereign risk will have an influence on company decisions relating to mineral development. Solution of the problem of inefficiencies arising from the influence of sovereign risk rests largely with improvement of the institutional arrangements for evaluating development proposals.

Qualitatively, the effect of regulatory uncertainty on mining activities is quite clear. Such risk and uncertainty increases the return that firms will require on their investment in exploration or development. This added premium may, in the absence of markets for trade in these risks, result in an economically inefficient allocation of resources. In the case of exploration, this would be reflected in less investment in exploration activity than is optimal from a social perspective, and clearly this would be most evident in areas subject to competing claims, where the risk of rejection of a development proposal is greatest. In the case of extraction, there would be more rapid extraction than is optimal, and less investment in mineral development. However, the quantitative impact of these effects is difficult to ascertain.

Legislative responsibility An overlap of responsibilities between various levels of government may also provide a constraint to the implementation

43

of economically efficient policies. Where there is such overlap, conflict may arise between the national interest and state development objectives. For example, it is possible for a project to attract attention under both Commonwealth and state EIA requirements, with conflicting results.

One of the major limitations of current EIA practice is its confinement to single development proposals, treated one by one. There have been few attempts at industry- wide, regional or issue-oriented impact assessments. As a result, differing standards may evolve between states, between pro* within states and over time. However, such differences between or within states do not necessarily imply inefficient resource use. They may merely result from differences in environmental sensitivity between regions. Thus, although uniformity of procedures and principles is desirable, uniformity of standards may not be socially optimal.

Dependence upon regulations to achieve many of society's environmental objectives, such as reducing pollution, has significant dangers. While regulation may lead to the achievement of conservation goals, it is not transparent in its effects on other benefits and costs. In general, the costs of regulation are hidden from the community. The alternative to regulation, namely the taxing of undesirable activities, also involves costs, but it makes the costs of any decisions more visible. In addition, dependence upon regulation may reduce the incentives or options for firms to incorporate into their production activities technological advances which may reduce environmental impact. This is particularly the case if regulatory arrangements are not often reviewed.

5.3 Policy options The aims of government intervention in resource management include efficient allocation of the resource between competing uses, and efficient use of the resource over time for each purpose. The achievement of these goals will require the

weighing up of the social costs and benefits of alternative courses of action.

In the case of mineral development, the benefits (assuming the scope of the mineral resources is known) are, in general, readily measured. They include the economic rent arising from the extraction and sale of the minerals, as well as any additional income accruing to labour and capital employed in the project over and above that which could be earned elsewhere. The costs include the environmental costs, such as any irreversible loss of species and habitats, loss of current and future recreational amenity, and adverse effects on surrounding ecosystems. In general, such costs are not so readily measured. However, there is a clear need to incorporate them into the cost-benefit analysis associated with any decision involving significant conservation goods and services. This may be done as a part of the existing EIA process, or as an adjunct to that process.

While it is difficult to measure environmental benefits and costs in dollar terms, there are several methods available which can be used to establish at least the broad order of magnitude in some cases. These include the travel-cost method, contingent valuation and the hedonic prices method. Comprehensive surveys of these methods are provided elsewhere (see, for example, Anderson and Bishop 1986; Freeman 1985), and they are not discussed further here.

In determining the balance between estimated net conservation benefits and the estimated net benefits of development, judgment is required on the part of decision- makers. Clearly, if the net measurable benefits of conservation exceed the net benefits of development, the resource should not be developed. If, on the other hand, the net measurable benefits of conservation are less than the benefits of development, judgment is required as to whether the non-measured benefits of conservation outweigh the difference. Between these two extremes, judgment may


socially optimal, or whether benefits could be derived from devoting additional resources to this activity.

An analogous argument may be made for the public provision of information concerning the environmental aspects of particular areas, again to reduce the uncertainty inherent in environmental policy development. Such information includes a taxonomic and ecosystem inventory of the area, investigation of the likely impact of proposed developments on the ecosystem, prospects and options for rehabilitation, and so on. Again, there is little economic incentive for individuals to collect and disseminate information about the environmental worth of an area. Though some major environmental organisations, such as the Australian Conservation Foundation, often conduct such research, and the proponents of development proposals may address some aspects in the EIA process, there may be a shortfall relative to the socially desirable level of research. Some environmental research is currently being provided by the public sector through organisations such as universities, CSIRO and the Bureau of Rural Resources. However, there may be a case for increased government provision of information to assist in reducing the uncertainty associated with the value of the environmental services provided by particular areas, both qualitatively and quantitatively.

Finally, allowance should be made in policy development for the possibility of irreversibilities in development proposals. The scarcity of the particular environmental resource is an important consideration in this case. In addition, the option value associated with irreversible changes to living resources should be taken into account.

be required as to the socially preferable extent of development and/or of conservation.

There is likely to be a role for government in the provision of information to reduce the uncertainty inherent in such judgments. To the extent that information relevant to both the mining and conservation aspects of development proposals is a public good, the generation and dissemination of such information is likely to be less than socially optimal in the absence of government intervention. However, it is difficult to offer precise and practically applicable guidelines about the optimal level of investment in information by the government. It is desirable for government to provide information up to the point where the marginal social benefits arising from an additional unit of information is just equal to the marginal social cost, but the practical difficulty lies in determining those social costs and benefits.

In the case of geological information on areas subject to conservation claims, the government currently provides some public information through the Bureau of Mineral Resources, Geology and Geophysics. In areas subject to development claims, private companies undertake their own information gathering activities. Uncertainty about the location, size and type of mineral resources

I is reduced by carrying out basic surveys of ' geological formations. A single firm could ' conceivably do the surveying and sell the information However, once the information was sold to one customer, the costs of transmission of the information would be relatively low so that the firm might get little revenue from subsequent users. There is therefore little incentive for private firms to carry out this type of research, even though use of the information in policy development might lead to a net improvement in social welfare and economic efficiency. More empirical research is required to assess whether the amount of such geological information currently supplied by governments is

Mining and minerals

6. Other issues

In the previous two chapters of this submission two of the major issues confronting the mining and minerals processing sectors have been discussed. There are, however, a number of other factors s u b j j to influence by govemments which have the potential to lead to inefficient resource use. In this chapter, the actual or potential effects of government policies on capital and operating costs, of export controls and levies, and of international trade barriers are discussed.

6.1 Capital and operating costs A variety of government policies influence capital and operating costs of the mining and minerals processing sectors. For example, policies associated with the government provision of infrastructure, macroeconomic management and controls on foreign investment influence the cost of capital, while electricity pricing policies affect operating costs.

(a) Infrastructure costs The location of both mining and minerals processing developments is largely dictated by the location of minerals and energy resources and proximity to markets. These locations may either be close to existing infrastructure or in remote areas where there is no preexisting infrastructure. In remote areas, both production infrastructure, such as railways and ports, and social infrastructure, such as townships, may be required to support a mine, and they are frequently tied to the life of the development project. Such infrastructure may be of limited or no value to other industries. Infrastructure which is generally available to all industries, such as water, power and

transport facilities, and schools and hospitals, is typically provided by govemments in urban areas.

Government policy objectives in the provision of infrastructure vary between states, regions, projects and types of infrastructure. Infrastructure may be publicly provided in cases where its provision has public-good aspects and private provision would not result in socially optimal levels.

It has been argued that, in the absence of other distortions in the economy, the basic principle for provision of infrastructure is 'user pays'. If developers do not pay the full opportunity costs of the resources used by their projects, including infrastructure, they may select projects other than those with the highest payoff to society. In the presence of other distortions, subsidised provision of infrastructure may compound inefficient resource use by benefiting only one industry, rather than all the industries adversely affected by distortions (Perkins 1985, pp.160- 1). On equity grounds, it has been argued that social infrastructure such as schools and health services, which is provided by government elsewhere in the community, should also be provided to mining communities in remote areas, or the mining projects would be penalised. However, it has also been suggested that this is not an argument for government meeting the full cost of provision. The cost of providing the , same services is likely to be greater in remote I

areas, and there is the risk of the facilities ~ not being used for their full life due to 1 closure of the project and an absence of other regional activities sufficient to sustain the community (Advisory Council for Inter- government Relations 1984, p.111).

The extent to which governments have assisted in the provision of infrastructure in


remote sites has varied. For example, in Western Australia in the 1960s Hamersley Iron was required by the state government to provide most of the social and industrial infrastructure to develop iron ore deposits in the Pilbara (Perkins 1985, p.161). In contrast, the Commonwealth government provided nearly all social infrastructure for Jabiru in the Northern Territory, the township associated with the Ranger uranium project (Perkins 1985, p.167).

The level of provision of infrastructure is also influenced by other government policy objectives. State governments sometimes provide free or subsidised infrastructure in order to encourage the location of projects in their state (which is seen as promoting economic growth, increasing employment and generating state revenues). For example, the electricity transmission line for Alcoa's Portland aluminium smelter was provided by the Victorian government (Perkins 1985, p.170). Many states also offer subsidised electricity tariffs in an attempt to attract large developments (see section 6.l(c) for further discussion). These attempts by state governments to attract projects may reduce returns from use of community resources and introduce distortions in resource allocation. Although such practices are not restricted to mining and minerals processing projects, infrastructure requirements for these projects are likely to be larger than for projects in other sectors. The potential resource misallocation may therefore also be larger.

In contrast, some states price infrastructure services in excess of cost as a means of extracting economic rent (though such excess charges are not, in reality, rent taxes). Pricing for services provided by public sector rail authorities often bears little relation to the costs of providing those services (IAC 1989b, p.18). Freebairn (1989) suggests that a reduction in excess infrastructure charges for the use of Queensland and New South Wales railway and port services by the coal export industry could provide substantial national economic

efficiency gains. This effect of excess charges for railway services was briefly discussed in relation to coal in section 4.4.

The efficiency with which public infrastructure is provided and operated also has implications for the competitiveness of the mining and minerals processing sectors. Inefficiencies in the provision of infrastructure services, such as overmanning, will tend to increase the price of these services and hence the costs of industry users and their international competitiveness.

(b) Capital costs The mining and minerals processing sectors are more capital-intensive than most other industries. They account for 9.0 per cent of GDP and 2.4 per cent of employment in 1988-89, yet have accounted for an average of 20 per cent of new fixed capital expenditure in Australia over the past five years (ABARE 1990b, tables 8, 9 and 12). In these industries there are usually considerable lead times before returns on investment are generated. Government policies such as those dealing with foreign investment and general macroeconomic management can therefore have a significant influence on the cost of capital to the sector.

Current foreign investment guidelines require new investment in non-petroleum minerals developments of over $10m to have 50 per cent Australian equity and 50 per cent Australian voting strength on the controlling body of the project (Treasury 1989, p.6). However, there is provision for flexibility in the application of these guidelines. 'A proposal which does not meet these guidelines may still be allowed to proceed if it is considered not otherwise contrary to the national interest and if the Government judges that the unavailability of sufficient Australian equity capital on reasonable terms and conditions would unduly delay the development of Australia's natural resources. In that event, however, the Government will, as appropriate, seek satisfactory arrangements for the guidelines

Mining and miwals

to be met within an agreed period' (Treasury 1989, p.6). There are no specific Australian equity requirements for new minerals processing investments. Proposals of over $10m are examined by the Government and are approved unless judged contrary to the national interest.

The foreign investment guidelines for Australian participation in new mining projects are based on the Government's view that there should be adequate opportunities for Australian interests to participate in the development of Australia's natural resources (Treasury 1989, p.4). However, it is widely recognised that there may be efficiency losses associated with restrictions on foreign investment. Gains can be expected from the free international exchange of assets, in the same way as from the free trade of goods (Hartley 1984). Controls over international capital movements interfere with global resource allocation and therefore may reduce global economic welfare. In particular, companies may be prevented from obtaining capital from the cheapest source on a world-wide basis. In addition, such capital controls may prevent companies from selecting the commercially optimal mix of debt and equity in developing investment proposals (Martin et al. 1988, p.100).

It has been suggested that some of the support for the restriction of foreign ownership of mineral resources stems from concerns that foreign companies avoid Australian taxation of the high profits earned in mining (Smith 1982; Hartley 1984). High economic rents associated with mineral deposits can result in large profits. There are concerns that, where these deposits are controlled by foreign interests, the use of 'transfer pricing' mechanisms may result in these profits going untaxed. However, the design of more efficient mechanisms for extracting such rents (see chapter 4) may be a more efficient way of ensuring an appropriate return to Australian ownership of mineral resources than restricting foreign ownership.

48

Macroeconomic policies also influence the capital costs of the mining and minerals processing sectors. For example, real interest rates affect the terms on which these sectors can borrow funds locally, both absolutely and relative to overseas. Clearly, the effects of foreign investment and macroeconomic policies on capital costs are not restricted to the mining and minerals processing sectors, but the effeds on these sectors will be greater to the extent that they are relatively capital- intensive.

(C) Energy costs Energy costs - especially electricity charges - are an important component of total production costs for the minerals processing sector. The aluminium industry in particular is an electricity-intensive industry, electricity typically accounting for around 17 per cent of production costs in modem aluminium facilities (World Bank 1988).

Virtually all electricity in Australia is produced by public enterprises. Most aspects of electricity supply, including sales of privately generated electricity, are controlled by state-owned authorities. The implications of this government involvement in the electricity supply industry were examined by the Industries Assistance Commission in its inquiry into government non-tax charges (IAC 1989b). The Commission suggested that electricity authorities have been effectively insulated against possible competition from alternative sources of supply. Various ineffiaencies arising from excess generating capacity, overmanning, sub-optimal tariff structures and non-recovery of economic costs are attributable to this lack of competition (IAC 1989b, p.1). Competition could be introduced by allowing private ownership of generating capacity and greater access to the transmission grid. Such issues will be the subject of a further review by the Industry Commission.

The requirement for electricity authorities to adapt their pricing policies to other government objectives, such as regional


development and cross-subsidisation to low income groups, is also identified as contributing to inefficient tariff structures (IAC 1989b, p.24). It is likely to be more efficient to address these other objectives through direct budgetary outlays.

Some large industrial users of electricity, such as aluminium smelters, have negotiated specific contracts with bulk pricing discounts. The confidentiality of most information on bulk pricing arrangements makes it difficult to assess whether such contracts provide a subsidy to such industrial consumers in general (IAC 1989c, p.H.10). An exception is the long- term agreement for supply of electricity to the Portland aluminium smelter. It has been argued that there is a sizeable subsidy element in the electricity tariff for this smelter, although the measurement of the subsidy is sensitive to the real discount rate chosen as being appropriate to the public provision of electricity (Swan 1983). On the other hand, the Economic Planning Advisory Council suggests that the low tariff paid by this smelter may be commercially sound, because the smelter takes a large and almost constant wattage of high voltage electricity, thus decreasing transformation and distribution costs (EPAC 1988, p.34).

(d) Shipping costs Domestic coastal shipping costs are important to Australian mining and minerals processing sectors because of the need to transport raw materials and intermediate products long distances around the coast for processing. The sea distance involved is often comparable to the distances to overseas processing plants. For example, the distance from Port Hedland to Newcastle is about 5800 km, while that from Port Hedland to Japan is about 6200 km.

The viability of raw materials promsing in Australia is therefore highly dependent on the availability of an efficient and cost- competitive transport system. Despite recent improvements in its efficiency, coastal

shipping has been widely criticised for failing to match international freight rates (EPAC 1988; IAC 1988b). Trace (1987) suggests that high freight costs for bulk shipping deter investment in minerals processing, especially where bulk shipping is the only feasible means of transport. In some cases, the level of transport costs may be a primary determinant of site location (p.35). Australian-flag coastal shipping enjoys market protection under the Navigation Act, which effectively reserves intrastate and interstate coastal trade for Australian controlled and crewed vessels - a measure known as cabotage. It has long been asserted that in many cases it is cheaper to ship bulk cargoes from Australia to processing locations overseas, using international-flag shipping, than to transfer the same raw materials to Australian processing locations. For example, it has been stated that it is possible to ship primary aluminium from Tasmania to a number of Asian ports for less cost than to Sydney (Knapp 1988, p.17).

The Industries Assistance Commission, in its inquiry into coastal shipping, examined both ship and shore-based costs. Although acknowledging recent reforms, the Commission concluded that the industry as a whole remained inefficient and uncompetitive relative to those nations with similar standards of living (IAC 1988b, p.xxv). It was estimated that in most years, if international freight rates applied along the coast, coastal shipping freight rates would on average be 2&50 per cent lower. The factors the Commission identified as contributing to the lack of competitiveness of coastal shipping included high capital costs, high crew levels, generous employment conditions and high port charges.

The Commission stated that its analysis of the coastal shipping industry revealed an industry which lacked the performance incentives and cost discipline which would come from increased exposure to competition W C 1988b, p.xvi). It has been

Mining and minerals

argued that the practice of cabotage affords the coastal shipping industry highly preferential treatment relative to other Australian industries exposed to international competition, having the effect of a prohibitive tariff (IAC 1988b, p.xviii). Other regulatory and institutional factors, such as the ownership of ports, labour pooling and restrictive work practices, poorly structured pay scales and the excessive categorisation of the workforce, limit the opportunities for reducing costs and raising productivity, contributing to the lack of competition and the level of inefficiency.

It is clear, therefore, that the efficiency of coastal shipping as it relates to minerals processing can be improved. Some reforms to the industry are under way, and others have been announced. Reforms adopted include fiscal incentives such as capital grants and tax incentives linked to reductions in crewing, and waterfront reform. A rebate of diesel excise that is currently applicable to land transport programs is to be introduced from July 1992. The Prices Surveillance Authority (1990) has recently reported on how it could monitor the effect of government reform on coastal shipping freight rates (PSA 1990).

6.2 Export controls Under the Constitution, the Commonwealth government has power over trade and commerce with other counties. This power has been used to attempt to achieve a number of objectives: 'fair and reasonable' export market prices and other conditions of sale, national self-sufficiency, environmental goals, and international and strategic obligations. Instruments used by the Commonwealth include export controls on minerals such as coal, iron ore and uranium, and export levies on coal and uranium. Recent examples of the use of export controls include the three-mine uranium policy, intervention in the negotiation of iron ore, bauxite and alumina export contracts, and

50

the banning of export of the products of sand mining on Fraser Island.

In recent years there has been a trend towards a reduction in the number of minerals subject to export controls, as part of government efforts to improve trade competitiveness. Controls on bauxite, alumina and coal were relaxed in 1986 (Kerin 1986). In 1987 the federal Minister for Resources announced a further reduction in coverage with the relaxation of controls on primary forms of base metals, manganese and nickel (Morris 1987). More recently, the export restrictions on copper scrap and bulk salt have been removed (Cook and Button 1990; Griffiths 1990). Nevertheless, the government retains the power to reimpose export controls on minerals if and when a perceived need arises.

From an economic perspective, there are circumstances under which export controls could benefit a country. These include instances where the country as a whole has monopoly power in an overseas market, but where there is more than one firm producing the good domestically. The government, by encouraging or facilitating cooperation and communication between domestic f i m in their dealings with foreign customers, might be able in such circumstances to affect the world price of the commodity so as to maximise the amount of monopoly rent obtained. Similar results in terms of gains to the Australian community could theoretically be obtained in such circumstance by controls on the volume of exports or by export taxes.

Another case in which there might be some advantage from intervening in price formation occurs when two countries find it beneficial (over a limited range of prices) to trade with each other rather than with other countries. This might be because of geographical proximity (particularly for bulk commodities such as coal and iron ore where transport costs tend to be large relative to the market price of the commodity). Under such circumstances, if suppliers in the exporting country compete


against each other while the importing country operates as a monopsonist, the importing country may be able to exploit market power. The use of export controls to set a minimum price for a commodity, or to require producers to narrow the range of prices, may allow the exporting country to extract some monopoly rent from the importing country, or at least balance its monopsony market power. A monopsonist buyer would accept the new minimum price provided it remained lower than the cost of importing from an alternative source.

The central issues in this regard are the extent to which market distortion actually does occur in Australia's commodity markets and the relative efficiency and costs of alternative policy interventions.

Export controls may be effective in the short term in achieving some objectives. However, the circumstances in which they could be effective in the long run are becoming increasingly difficult to identify. The emergence of alternative export suppliers for most mineral resources, as developing countries seek to exploit their mineral wealth, and the opening up of new import markets, particularly those associated with the strong economic growth in the newly industrialising countries, have seen resource markets becoming , increasingly competitive.

In addition, there is the possibility of retaliatory action by other governments. The use of export controls to exploit any monopoly power may lead to other governments seeking to diversify their sources of supply. This may impose costs both on the importing country, in terms of higher costs of raw materials, and on the exporting country in terms of sales forgone. Increases in price may also provide incentives for producers to operate outside the controls, thus placing pressure on the control institutions. The need to gather and analyse market information and the administration of the controls themselves, also impose significant direct costs which must be taken into account.

Mining and minerals

6.3 The international trading environment In international minerals markets, individual nations acting either individually or in concert with other nations have established a large and diverse range of policies to protect and assist domestic industries. Protection policies distort the efficient flow of world trade. They also impose costs on the economies of the protecting countries, including expenditure on direct support measures and the substantial economic costs arising from distortions in domestic resource allocation.

As has already been noted in relation to Australia's industry assistance structures (section 3.1), protection policies are complex, and vary depending on the objectives they are intended to achiwe and on whether the country is primarily a producer or consumer of the commodity concerned. The major protection measures relevant to the mining and minerals processing sectors include tariffs, and non-tariff measures such as subsidies, government involvement in trading, taxes, quantitative restrictions on trade, government price support schemes and licensing.

Though average tariffs on traded goods in industrial countries have declined over the past decade, the effect on protection has been offset by a rapid increase in non-tariff measures (Department of Foreign Affairs and Trade 1989, p.4). Table 12 summarises the main non-tariff measures affecting world trade in minerals. Non-tariff measures not included in the table but which affect world trade in minerals include 'voluntary restraint agreements' (discussed separately below), technical standards which have a restrictive intent, production sharing the effects on world trade and prices of such reform (Jolly, Beck and Savage 1990). The paper notes that pressure for more rapid policy reform is growing as the European Community moves toward a single internal market by 1992. Australia has also been pressing to have coal subsidies effectively

51

12 Non-tariff measures affecting international trade in minerals

l

Measure Mineral Importers I Measure Mineral Imports

Government Iron and steel India, Indonesia, subsidies a Korea, France,

Sweden

Ferro alloys Canada I Copper ores and India, Sweden concentrates

Nickel ores and Greece concentrates

Zinc ores and France concentrates and unwrought zinc

Aluminium European Co&unity

Coal Canada, Belgium, France, Portugal, Spain, United Kingdom, India, Japan, FR Germany

Iron and steel Indonesia, Yugoslavia

Refined and Yugoslavia unrefined copper

Unwrought tin Thailand, Yugoslavia

Ferro alloys European Community, France, Italy, m Germany, Yugoslavia

Unwrought zinc European Community, India, Yugoslavia

Coal European Community, India, Japan

Zinc and lead ores India and concentrates

State trading b Iron and steel Indonesia, India

Copper ores and Portugal, India concentrates

Nickel ores and Greece, India concentrates

Aluminium France, Italy, Spain, India,Greece Indonesia, Norway

Government Unrefined copper Japan, Korea price suPF'J* and mattes schemes

Coal Canada, France, FE Germany, Japan, United Kingdom

Mineral sands France, h l a n d

Unwrought nickel Switzerland embar~oes

Copper mattes Indonesia

Licensing, Unwrought tin India including for and nickel

Coal

Taxes c Copper ores and Austria, Italy concentrates

European Community, India

Nickel, zinc and Austria tin ores and concentrates

monitoring purposes Unwrought zinc Korea

unrefined copper, nickel and tin ores

Iron and steel India I Quantitative Copper and lead Yugoslavia restrictions ores and

concentrates I Nickel ores and India, Japan, concentrates Switzerland,

Yugoslavia

Aluminium European Community, Yugoslavia

Zinc and tin ores India, Japan, and concentrates Switzerland,

Yugoslavia

and concentrates

Zinc and lead Korea, Japan, ores and Thailand, India, concentrates Switzerland

Copper ores Switzerland,Korea, and concentrates Japan, India

Coal Korea, Philippines, Switzerland

a Includes: government funded infrastructure; concessional loans, labour costs, taxation; and reduced or repaid environmental costs. b Includes the direct involvement of government in production and/or marketing. through national marketing organisations and centralised buying. c Including duty surcharges or other fees, discriminatory taxes against imports and duties additional to the tiuiff. Sourcc Department of Foreign Affairs and Trade (1%).

agreements, buyback agreements, long term purchase agreements and antidumping and 'countervail' laws (DFAT 1989~; Clark 1989, pp.4-5).

Because of the wide range of protection policies, and a paucity of reliable data, it is very difficult to analyse the economic consequences and distortionary effects of these policies across the spectrum of minerals industries relevant to Australia. This is particularly the case for the non- ferrous minerals and steel markets. However, studies have highlighted the substantial direct and indirect costs of protection for particular commodities (see, for example, ABARE 1989c, pp.lll-15.).

World trade in aluminium, for example, is affected by protectionist policies. Despite high energy costs, Western European aluminium production has remained relatively constant since the 1970s due to preferential energy pricing policies for aluminium smelters and other forms of government assistance. Government funded subsidies have been used in some countries to cover financial losses. These practices have reduced dependence on imported aluminium and have maintained employment in the aluminium industry (Kirchner 1988, p.61).

The 'voluntary restraint agreement' has 1 emerged as a major policy instrument which

distorts competitive minerals markets. Under such an agreement, an exporting country imposes a quota on its exports to a particular nation, by agreement with that nation, in order to restrict the impact of imports on the domestic industry of the importing country. One of the best known examples is the agreement on Japanese and Korean steel exports to the United States, introduced in the mid-1980s to assist the US steel industry (Clark 1989, pp.4-5, 6-9).

Protective measures designed to support high-cost domestic producers of hard coal remain in force in Europe and Japan, but are in the process of reform. A recent ABARE discussion paper provides an assessment of the effects on world trade andprices of such

Mining and minerals

reform Uolly, Beck and Savage 1990). The paper notes that pressure for more rapid policy reform is growing as the European Community moves toward a single internal market by 1992. Australia has also been pressing to have coal subsidies effectively addressed in the Uruguay Round of multilateral trade negotiations. The issue for Australia is the extent and pace of reform and its effect on world coal markets during the 1990s.

Results from the study by Jolly et al. (1990) provide evidence that a more rapid and extensive reform of protectionist coal policies would generate substantial trade benefits for Australia and other major coal exporting countries, including the United States, over the coming decade. If protection were entirely removed by the year 2000, world seaborne trade could be boosted by up to 20 per cent for steaming coal and around 7 per cent for coking coal during the 1990s. World prices could be increased by 65 per cent for steaming coal and around 4 per cent for coking coal. Taking account of both the increased volumes and the higher world prices, Australia would stand to increase its coal export revenue by up to 23 per cent by the year 2000. These figures are over and above substantial gains projected to result from policy reforms which have already been announced. Those countries supporting their coal industries would also gain by this reform, as the direct budgetary costs of support would be lowered and distortions to resource allocation in the wider economy would be removed.

The effects of overseas protection on world mineral markets are clearly of importance to major exporting countries such as Australia. However, the existence of such protection does not justify the provision of similar protection or subsidisation in Australia. As was demonstrated in chapter 3, assistance to domestic industries not only imposes a burden on taxpayers and consumers in funding the support measures but leads to

an inefficient allocation of resources and in operation elsewhere in world markets. reduces growth and employment A more rational approach is to continue the opportunities in other sectors of the pressure for trade reform being applied in economy. Positive assistance to AustraIian international forums and to highlight the minerals industries would also increase the potential gains which would accrue to all distorting effects of the protectionist policies countries from trade liberalisation.

- -

7. Conclusion

In summary, it is clear that the mining and minerals processing sectors make a significant contribution to the Australian economy. They account for a large part of Australia's exports and a substantial portion of capital investment. As efficient producers in competitive world markets, Australian mining and processing industries are likely to continue to grow over the medium term. That this is likely to occur in a world climate of expanding supply and increasing competition reflects Australia's comparative advantage in mining and processing.

The ability of the Australian mining and minerals processing sectors to fulfil these expectations depends both on world economic conditions and on how domestic institutional arrangements affect the sectors' competitiveness. This submission has focussed on three of the major areas of government policy affecting the sectors: assistance, taxation and the environment.

Domestic tariff reform is likely to have major effects on the costs and activities of the sectors. The mining sector, because it is relatively lightly assisted in comparison with the manufacturing sector, is significantly penalised by tariffs on material and capital inputs. The tariff reduction program currently in progress will go some way toward reducing these disparities, but there remains considerable scope for reducing them further.

Taxation arrangements for the mining sector also provide scope for changes in government policy to significantly improve the efficiency of resource allocation and use. There is considerable support for a change in the methods of collecting payments in exchange for access to Australia's mineral resources. A shift away from taxation mechanisms based on output to those based on economic rent (that is, on

Mining and minerals

profit) would be likely to be beneficial from an efficiency perspective. While the relative administrative simplicity of output-based royalties is an important factor in their continued use, the difficulties in implementing profits-based taxes seem surmountable. In particular, a scheme which allows companies to bid for both the mineral property right and the tax rate to be applied to the project would overcome the problems of high information costs and possibly inappropriate risk sharing inherent in the other profits-based systems. A tax system which takes into account mine revenues and current operating costs on a mine-by-mine basis would at least remove some of the inefficiencies associated with current taxation arrangements.

The extent of the gains to society, in terms of net social welfare, which may result from changes in the management of environmental resources are not so readily quantified. However, the gains from integrating the environmental and economic aspects of development proposals in the policy formulation process are likely to be substantial. Further research is required to determine these potential gains. There is scope for government involvement in the acquisition and dissemination of information regarding the geological and environmental attributes of areas subject to competing demands. This is a necessary input to the process of p r o w evaluation, which should take into account a wider range of social costs and benefits than is currently the case.

&pendLx A Terms of reference

The terms of r4erme fir the inquiry, as issued by fhe Treasurer on 18 October 1989, were as foIIows: I, PAUL JOHN KEATNG, in pursuance of Section 23 of the Industries Assistance Commission Act 1973 hereby: (1) refer the mining industry (as defined by

Division B of the Australian Standard Industry Classification), excluding petroleum and petroleum products, and minerals processing for inquiry and report by 28 February 1991.

(2) spec^@ that in respect of (1) above, the Commission's inquiry and report cover value added processing of minerals, including coal, to the unwrought refined metal and alloy stage or the equivalent stage of processing of coal and industrial minerals.

(3) specify that the Commission report on any institutional, regulatory or other arrangements subject to influence by governments in Australia which lead to inefficient resource use, and advise on courses of action to reduce or remove such inefficiencies.

(4) without limiting the generality of this reference, request that the Commission examine: (a) factors affecting minerals

exploration and development, including allocation of mineral property rights and construction costs in remote sites;

(b) operating costs such as energy, transport and labour costs (including on-costs) and the availability of these inputs;

(c) other factors such as access to technology and the level of research and development which may be impeding the efficiency, international competitiveness and

further development of Australia's mining and minerals processing industry.

(5) Specify that the Commission: (a) have regard to established social and environmental objectives of governments and ongoing processes, including before the Resource Assessment Commission, (b) consider the structure and efficiency of Commonwealth and State Government resource taxation and royalty arrangements, (c) and provide advice on the economic costs of different approaches to those objectives consistent with an appropriate return to the community for the exploitation of public resources.

(6) Specify that the Commission is free to hold public hearings in advance of releasing a draft report and to take evidence and make recommendations on any matters relevant to its inquiry under this reference.

P.J. KEARNG 18 October 1989

Apfsendh B Activities covered by the reference Subdivision a Group Class Industry

11 METALLIC MINERALS

111 Ferrous metal ores 1111 Iron ores 1112 Iron ore pelletising

Non-ferrous metal ores Bauxite Copper ores Gold ores Mineral sands Nickel ores Silver-lead-zinc ores Tin ores Uranium ores Non-ferrous metal ores nec

12 120 COAL

1201 Black coal 1202 Brown coal

13 130 OIL AND GAS (not under reference)

14 140 CONSTRUCTION MATERIALS

1401 Sand and gravel 1404 Construction materials nec

15 150 OTHER NON-METALLIC MINERALS

1501 Limes tone 1502 Clays 1504 Salt 1505 Non-metallic minerals nec

16 SERVICES TO MINING NEC

161 Mineral exploration (own account) b 1611 Petxoleum exploration (own account)

(not under reference) 1612 Mineral exploration nec (own account)

1 62 Mining and exploration services nec 1620 Mining and exploration services nec

(con timed)

Mining and minerals 57

DIVISION C: MANUFACTURING

Subdivision Group Class

29

294

Industry

BASIC METAL PRODUCTS

Basic iron and steel 2941 Iron and steel basic products 2942 Iron casting 2943 Steel casting 2944 Iron and steel forging 2945 Steel p i p and tubes

Basic non-ferrous metals 2951 Copper smelting, refining 2952 Silver, lead, zinc smelting, refining 2953 Alumina 2954 Aluminium smelting 2955 Nickel smelting, refining 2956 Non-ferrous metals nec smelting, refining 2957 Secondary rmvery and alloying of non-

ferrous metals nec

Non-ferrous metal basic products 2961 Aluminium rolling, drawing, extruding 2962 Non-ferrous metals nec rolling, drawing, extruding

2963 Non-ferrous metal casting

r Australian Standard Industrial Classification. b This group consists of establishments mainly engaged in exploration on their own account (that is, not mainly on a fee or contract basis for other establishments). nec, Not elsewhere dassified.


A~~ependix C Detailed assistance estimates

The basic approach of Martin et al. (1988) has been used in the estimation of the effective rates of assistance for the industries in the mining sector in 1987-88. Full details of this approach are contained in appendix B of Martin et al. (1988). Some variations in approach have, however, been necessary in updating the assistance estimates to 1987- 88. The purpose in this appendix is to briefly outline these variations and present the assistance rate calculations by mining industry. These calculations appear in table 13.

Diesel excise rebate The ABS (Australian Bureau of Statistics) Census of Mining Establishments provided data on diesel usage by mining industry prior to 1987-88. For 1987-88, however, these data were unavailable. An alternative approach was used to calculate net excise paid by each mining industry. The total value of diesel excise rebated to the mining industry in 1987-88 is provided in the Treasury Department's Tax Expenditures Statement 1989. This figure was used in conjunction with the rebate rate and the excise rate to calculate the net excise paid. Individual mining industry shares were calculated using ABS Mining Census data on diesel usage for previous years.

Commercial Tariff Concession Orders (CTCOs) Current data for CTCOs were unavailable. The value to mining of CTCOs in 1986-87 was adjusted to 1987-88 values using the Consumer Price Index.

Depreciation provisions Changes in the depreciation provisions have resulted in the mining industry being eligible for special depreciation provisions which

are not available to other industries. Division 10 of the Tax Act permits allowable capital expenditure by mining companies to be depreciated over the economic life of the mine or ten years, whichever be the less. This is a shorter period than is allowed for other industries and therefore confers a benefit to the mining industry, particularly to mines with long life spans. Accelerated depreciation defers tax payments and is therefore equivalent to an interest-free loan of a size related to the difference between actual mine life and the statutory mine life.

To estimate the benefit provided by accelerated depreciation, the asset value, economic life and taxation life of the asset are required, together with the market interest rate. This benefit has not been included in the estimates of effective rate of assistance presented, and to that extent the effective rates will be underestimated.

Immediate deductibility of eligible exploration expenditure Immediate deductibility of exploration expenditure confers the equivalent of an interest-free loan equal to the difference between the value of normal depreciation over 10 years and the value of the expenditure. The value of this loan has been estimated using a nominal discount rate of 15 per cent. This estimate is based on the assumption that exploration expenditure is an investment in generating future returns and should therefore be amortised over the expected life of the income stream arising from the exploration. One of the problems in applying this approach is that of distinguishing between successful and unsuccessful exploration. Unsuccessful exploration expenditure does not generate future returns and immediate deductibility confers no benefit in this case. In estimating

Mining and minerals

13 Detailed estimates of assistance to mining industries a

Item Mining Ferrous Copper Gdd Mineral

Unit Industry b metal ores Bauxite ores ores sands

Value of output (VO) $m 16349.00 2145.50 601.10 539.20 2466.20 451.10

Less Inputs - Eledcity, fuels - Stores. materials - ~ i n e & and other goods

f a resale $m 97.10 32.00 - - - 1.70 - Commision, submntract

work expenses $m 1089.60 230.00 10.20 16.30 535.40 23.40 - Repair and maintenance expenses $m 878.70 92.80 17.20 21.20 119.30 28.60 - Outward freight and caltage $m 2086.70 375.90 10.70 8.50 7.20 13.30 - Motor vehide running expenses $m 104.00 8.10 1.70 1.80 13.90 4.10 Total $m 6615.70 990.80 110.30 193.30 1099.70 144.20

Value added $m 9733.30 1154.70 490.80 345.90 1366.50 306.90

Less Assistance to outpt (AO) - Export taxes (tariffs) $m -4.80 - Export mntrols $m M: nc 0.00 0.00 0.00 M:

- Export incentives $m 0.00 - Joint Coal Board $m 1.96 Total A 0 $m -2.84 0.00 0.00 0.00 0.00 0.00

Less Assistance on inputs (Al) - Diesel fuel tax (tax paid

minus rebate) $m -31.65 -3.19 -1.49 -0.47 -7.11 -0.10 - Tariffs m material and capital $m -312.37 -75.94 -12.50 -11.48 -8.67 -6.02

(net of CTCO) - Capital contmls $m 0.00 Total A1 $m -344.02 -79.13 -13.99 -11.95 -15.78 -6.12

Unassisted value added (UVA) $m 10080.15 1233.83 504.79 357.85 1382.28 313.02

Assistance to value-adding factors (AVAF) - Tax a n ~ s s i m s

. Exempt incane - gold mining income $m 200.99 200.99 - sale of mining rights $m na na M M M M

. Immediate deductions of expenditure on exploraticn $m 31.25 1.69 0.00 3.37 0.00 1.79

- Labour adjustment assistance $m 0.34 - Research . Energy Research Tmst $m 1.19 . Supe~sing Scientist (uranium) $m 6.38

Total AVAF $m 240.15 1.69 0.00 3.37 200.99 1.79

Net subsidy equivalent (ME) $m -106.70 -77.44 -13.99 -8.57 185.21 -4.33 =AVAF+ AO+ A1

Effective rate = (NSE/WA) X 100 % -1.06 -6.28 -2.77 -2.40 13.40 -1.38

Nominal rate % -0.02 0.00 0.00 0.00 0.00 0.00 = [AO/(VO - AO)] X 100

a Assistan- measure$ based m the most upbdate rat= and levels of amstanoe adjusted to 1987-88. Lktah of outprn and lnplts for nickel om, tin m and uratuum ores have been ecamated by ABARE. b Excludes crude oil, nahnal gas. M Not available. nc Not calculated. nec Not elsewhere clasdied. CTCO C a n m d Tanff Concession Orders.


Non- Nickel Silver, lead, Tin Uranium ferrous metal Black Brown Other

ores zinc ores ores ores ores nec coal coal minerals

Mining and minerals 6 1

the assistance provided by immediate some categories of expenditure not deductibility, it has not been possible to allowable as tax deductions. The estimate identify unsuccessful exploration of the assistance provided by this deduction expenditure and remove it from the total will therefore be biased in the positive exploration expenditure figure. The total direction. exploration expenditure figure also includes

6 2 ABARE submission to Industy Commission

Appa1di.x D Effect of gold mining tax changes on rate of assistance At present the tax-exempt status of gold mining income results in the gold industry having the only positive effective rate of assistance among the mining industries.

The positive assistance of the tax exemption is not simply equal to the income tax revenue forgone. Where the benefit from tax-free status is reinvested in order to generate capital growth, it is eventually taxed via capital gains tax when shares in gold producing companies are sold. In the estimates of current assistance to the industry, adjustments have been made to account for the future capital gains tax.

Following the removal of the company tax exemption in 1991, several effects on the gold mining industry are anticipated. The reintroduction of taxation of gold mining income will be accompanied by the restoration of eligibility for certain company tax deductions available to mining in general. In particular, exploration expenditure will be immediately deductible against income. This will offset part of the loss of assistance currently provided by tax-

14 Assistance to L e gold mining industry: removal of tax exemption a

exempt status. However, exploration expenditure by the gold mining industry fell by around 20 per cent in 1988-89 from its 1987-88 level and is expected to fall further by 1991.

The effective rate of assistance in the absence of the company tax exemption has therefore been calculated for two scenarios: unchanged exploration levels, and a 50 per cent reduction in exploration levels. Table 14 incorporates these estimates. Such estimates are not an attempt to quantify the effect of the actual fall in exploration expenditure, but provide an indication of the sensitivity of the rates of assistance to the industry of such a fall. The results indicate that although removal of tax- exempt status reduces the effective rate of assistance, it remains positive.

These estimates take no account of reductions in gold production after 1991 which are projected largely on the basis of structural and cyclical trends in Australian gold mining. These trends include closure of some smaller mines and the effects of depletion of long-identified reserves (Huggan, Cairns and Hancock 1990). The removal of the taxsxempt status may affect future production.

Scenario Effective rate Net subsidy of assistance equivalent

Exemption from company tax 13.40 185.21

Tax paid, no change in exploration 4.89 67.53 expenditure

Tax paid, 50% reduction in exploration 1 .S7 25.87 expenditure

a Based on 1987-88 industry data.

Mining and minerals 6 3

Appendi74 FE Taxation arrangements applied to the mining sector

The mining and minerals processing sectors in Australia are subject to two general forms of taxation. Revenue taxation is levied as part of the Commonwealth government's corporate taxation arrangements. Royalties and other charges are levied by governments in their role as resource owners. Both Commonwealth and state governments are involved in both types of taxation. This appendix contains a condensed description of the main royalty provisions of the various mining acts and ordinances of the states and the Northern Territory, together with relevant Commonwealth provisions.

Royalty provisions Royalties are explicit charges imposed by owners of mineral deposits on mining companies for the right to extract and sell mineral ore from the deposit. There are three basic types of royalty arrangements applied by state governments on non- petroleum mineral production: specific (a fixed payment per physical unit of output), ad valorem (a percentage of the value of mineral production) and profits-based (using accounting rather than economic definitions of profit). Ad valorem and specific royalties are the most commonly used and apply to most minerals in all states but not in the Northern Territory, where a royalty proportional to profit is applied to most mining operations (table 15). In some cases, elements of all three types of royalty are used in combination.

A less explicit form of royalty has been excess charges for the use of infrastructure services (for rail freight and port handling facilities) levied where governments have some degree of monopoly power over this infrastructure. Such charges have been identified in the case of coal in Queensland and New South Wales.

6 4

Commonwealth corporate taxation measures

The mining sector may take advantage of a number of income tax provisions which are specific to the sector, as well as the general depreciation provisions of the Income Tax Assessment Act. Division 10 of the Act provides for deductions of capital expenditure on mining and some treatment operations; Division 10AAA deals with deductions relating to capital expenditure on the transport of minerals; and Section 122J deals with the deductibility of expenditure on exploration and prospecting.

The specific deductions under Division 10 relate to capital expenditure on 'prescribed mining operations', which are defined as mining operations on a mining property in Australia for the purpose of gaining or producing assessable income. Allowable capital expenditure on treatment is that for the initial concentration or processing, such as cleaning, crushing and other similar processes. Categories of expenditure specifically included are:

site preparation; building, plant and other improvements necessary for such operations including storage of minerals at the mine site; infrastructure such as water, light or power, or contributions to state governments for such infrastructure; housing and welfare, such as residential, health, educational and recreational facilities, for employees and dependants if they are at or near the mine site; plant and buildings for use in the treatment of minerals (although certain treatment processes are specifically excluded from this category); and purchase of prospecting information and prospecting rights.

ABARE submission to lndustry Commission

Royalty schemes applied to the Australian mining industry (excluding 15 pe,,eum,

Royalty scheme Royalty base Major applications a

New South Wales Specific royalties Volume of output Coal, bauxite, ion ore, limestone, granite,

phosphate

Ad oalorem royalties Value of output Rutile, zirron, ilmerite, monazite, garnet, other

Excess infrastructure charges - rail freight Volume of output Coal - port fadities Volume of output Coal

Profits royalties (mine-specific)

Victoria Specific royalties

Ad &em royalties

Accounting Lead, silver and zinc (from Broken Hill Mines), profit copper and zinc (from &bar Mines)

Volume of output Brown and bla& coaI, iron ore, manganese, gypsum

Value of output Uranium, tin, zinc, cobalt, copper, gems, lead, silver, sulphur, nickel

Northern Territory Proportional Accounting All minerals (except uranium) profit royalties profit

Queensland Specific royalties Volume of output Coal (used in Qld), gypsum, limestone,

rnagnesite, nickel, salt, marble, iron ore, rutile, zircon, ilmenite

Ad oalorem royalties Value of output Phosphate, coal (for export)

Spedfic and ud &em Volume and Bauxite, copper, silver, lead, zinc royalties combined value of output

Ad talorem and profits Value of output and Other royalties combined accounting profit

1 ~wcess rail charges Volume of output Coal

South Australia Ad oalorem royalties Value of output All minerals

Western Australia Spedfic royalties Volume of output Gypsum, limestone, phosphate, asbestos,

manganese, tin, zinc, bauxite

I W mlmm royalties Value of output Nickel, molybdenum, gems

I ? z a ? $ i n p Volume and value Alumina, iron ore, rutile, zircon, ilmenite, of output leucoxene,monazite

Tasmania Specific royalties Volume of output Coal, day, dolomite, limestone, kaolin, silica,

sand, gravel, stone

Value of output and/ All other mining products progressive profits royalties accounting profit

I Commonwealth Export duty Volume of output Coal, uranium

I a This listing is not exhaustive of mineral coverage. Sources: IAC (198&1), BMR (1%9).

Division 10AAA allows for deductions of capital expenditure incurred in transporting minerals mined in Australia. Excluded from eligibility is expenditure on railway stock, vehicles and ships (though these are eligible for the general depreciation provisions). Contributions to the cost of railway stock which is owned by a government or a tax-exempt government

authority is eligible for deduction under this Division.

Expenditure on exploration and prospecting for minerals is immediately deductible against income from any source. The owner of mining rights or information can transfer to a purchaser the tax benefit arising from capital expenditure which the owner has been unable to recoup.


Appendix F Assessment of alternative taxation arrangements

This appendix assesses a number of alternative arrangements for mineral taxation. The relative merits of these arrangements are identified, with particular emphasis on the optimality of taxation arrangements as discussed in section 4.1. The alternative arrangements can be classified according to their revenue base: profits based taxes; and schemes based on cash bidding.

Profits-based taxes

Brown tax The Brown tax (Brown 1948) is levied as a fixed proportion of the net cash flow for a particular project for each year. Net cash flow is defined as the difference between revenue and total costs, where total costs include all capital expenditure during the year plus a 'normal' rate of return on capital. This 'normal' rate of return includes the premium demanded by a firm having a given level of risks. Interest payments and receipts are excluded from revenue and costs. In years when revenue exceeds costs thus defined (that is, when positive economic rents are earned) the government receives a fixed proportion of the excess. In years when losses are incurred, the government pays companies a rebate, in the same proportion. If the tax rate is set at 100 per cent, it collects all of the economic rent and fully refunds losses.

Under conditions of certainty, the Brown tax has the characteristics of an optimal tax (see section 4.1 of main text), as it is levied on economic rent and is neutral in its effects. The tax is 'symmetrical' in its treatment of profits and losses.

-

Modified Brown tax

Where there is substantial geological and/ or economic uncertainty surrounding the expected net present value of a p r o m at the time of the investment decision, the Brown tax is not neutral if the company is risk- averse (I-Iinchy et al. 1989, pp.16-18). The rebate on losses may encourage companies to undertake some projects that would not be undertaken in the absence of the tax. This is not necessarily a shortcoming - and may well be an advantage - since neutrality is not necessarily desirable when there is risk. Nevertheless, it is of interest to xe what types of modifications would be required to achieve neutrality. It is possible to modify the Brown tax to make it approximately neutral by recognising a risk premium as a legitimate cost for risk-averse companies. However, the information required to set such a tax schedule would be large.

Resource rent tax A resource rent tax is similar to an unmodified Brown tax in that it is levied on economic rent on an individual-pro* basis; but there is no provision to pay a rebate on losses. Losses, increased by a 'threshold' rate of interest, are carried forward until they can be deducted from future profits from the project. There is no provision for a cash rebate to be provided by the government if no profits are obtained from the project.

The resource rent tax is equal to a Brown tax if the threshold rate equals the (risk- adjusted) rate used by the company to discount future costs and returns, and if the rates of tax are the same. For the tax to be neutral in conditions of certainty, these parameters would need to be set separately for each project. However, the information


requirements for implementing a project- specific tax are large. Moreover, even if the parameters are set correctly, the tax is asymmetric because companies bear all the costs of failed exploration. In conditions of uncertainty, therefore, the resource rent tax is not neutral. Because it provides no rebates in the event of a project proving to be unsuccessful, some projects that would be undertaken in the absence of the tax might not be undertaken when the tax is imposed.

Modified resource rent tax It is possible to modify the resource rent tax to make it more nearly neutral. This could be achieved by providing for full loss offset, making it symmetric in its treatment of profits and losses. In the case of successful exploration and successful development, a modified resource rent tax would operate in the same way as the unmodified resource rent tax. If exploration or development were unsuccessful, and the project made an overall loss during its economic life, the losses would be carried forward at a threshold rate of interest, as above, and the government would provide a cash rebate. The threshold rate would be the risk-free rate of interest, rather than a risk-adjusted rate, because this modification relieves the company of risk.

If the government preferred to avoid making cash payouts, the costs of failed exploration could instead be offset against the returns from successful exploration elsewhere. This would have the effect of widening the base of the tax from the individual project to the company. The government could also allow the sale of losses on unsuccessful projects to other firms having projects subject to the resource rent tax (Hinchy et al. 1989, pp.27-8). This would not commit the government to direct budgetary payouts, but it would reduce revenue by the same amount as if a Brown tax applied, because of the reduced tax liability of those companies which purchase the losses.

Cash bidding systems

Competitive cash bid Under this arrangement, property rights to a mineral resource are sold by auction to the highest cash bidder. The successful bid constitutes full and final payment for the property rights, whether minerals are subsequently discovered or not, and transfer is not conditional on exploration and development taking place. In addition, the successful bidder is able to resell the full property rights if so desired. Under competitive conditions, companies are likely to bid up to their perceived present value of the economic rent of the site. The bidding system is therefore effectively a tax on expected economic rents. The cash bidding system is neutral under conditions of either certainty or risk. However, it is not symmetric, in that firms do not receive a rebate in the event of unsuccessful exploration.

Competitive cash bidding for rights to mineral sites provides a means for the government to obtain a market value of a mineral deposit, and a means of assigning the mineral property rights to the company which values it most highly. This arrangement thus has the potential to solve both the taxation and property rights allocation questions at the same time.

There are, however, several factors which could inhibit the successful application of the system The main practical difficulty is that, under competitive conditions, aggregate revenue obtained by the government may be low compared with alternative arrangements, because at the time of auction there is likely to be only limited information about the potential value of the site and hence companies are likely to seek a high risk premium in their returns. In view of this, and the likelihood of some degree of market failure in the private provision of information in this area, it may well be efficient for the government to allocate additional resources to collecting


and assessing such information and making it publicly available. This would also make the government better able to assess bids which were offered.

Problems may also arise if there are only a small number of companies in the market and if these companies collude. If there is lack of competition because the cash lump sums required are high enough to constitute a barrier to entry for smaller firms, competition could be increased by allowing companies to make joint bids. Collusion could be countered by setting a minimum reserve bid, with the right to reject any or all bids and perhaps with the right to enter into private negotiations with any bidder to attempt to obtain a higher price.

Cash bidding is also subject to the problem of sovereign risk. There is the possibility that, if a site which is believed to be of low value and is sold for a low price actually turns out to be a major discovery, the government may change the agreed taxation arrangements. Such sovereign risk would reduce the amounts bid. To ensure the credibility of the system, the terms of the winning bid would need to be binding over the life of the project. This issue of sovereign risk is a major area of concern to the industry.

Combined cash bid and outcome- dependent tax Under this approach, companies bid for a site with the knowledge that a given tax schedule will apply i f subsequent development of the site produces a positive cash flow. The given tax may be a Brown tax, a resource rent tax or a modification of either, as discussed above. In a competitive situation, companies would be willing to bid up to their after-tax risk-adjusted valuation of the potential economic rent from a site. A system combining a cash bid with an outcome-dependent tax has the major advantage of moving toward an optimal sharing of risk between governments and private firms (see section 4.1 of main text). However, this system would still have the problem of the lack of

Mining and minerals

neutrality of the Brown tax or resource rent tax if they were used in their unmodified form, and the informational requirements for suitably modifying these taxes would remain.

Hinchy et al. (1989, pp.28-9) have suggested that one way to overcome this information problem would be to allow companies to bid on the tax scale as well as on the initial cash payment. Companies would be asked to submit a range of bids on both the cash payment and tax rate they would pay for given levels of profit which covered the likely outcomes for a particular project. The bids submitted could conceivably range from a pure cash bid to pure tax with no cash bid, although the winning bid would probably consist of a combination of cash bid and tax schedule.

This approach would also have the advantage of increasing the degree of competition for sites. Firms without access to the financial resources necessary to make a large cash bid would be able to offer to pay higher tax rates. The arrangement would therefore tend to increase the degree of competition for leases and reduce the risk of collusion.

One problem with this arrangement is that, because bids would comprise two variables, there would be no clear ranking of proposals (though conceivably one bid might dominate all others). As a consequence, there would generally be scope for administrative discretion in deciding which bid to accept. Hence, to encourage administrators to allow only financial considerations to enter into the ranking process, it would be desirable that the system required the government to offer a public explanation of the reasons why a particular bid was accepted as the winning bid. Such a system would reveal government preferences as between future possible tax payments (and participation in the risks associated with any project) and immediate cash payments.

Ars~endix G Details of the coal I P

taxation case study

This appendix contains details of the simulation study discussed in section 4.4. Existing taxation arrangements in the coal industry are reviewed in section G.1. Sections G.2, G.3 and G.4, respectively, provide details of the simulation method, data and key assumptions. The results are presented in section G.5.

G.l Current coal taxation arrangements The main resource tax in the black coal industry is the royalty. Around 96 per cent of Australian proceeds from black coal royalties are collected in New South Wales and Queensland, reflecting the concentration of the industry in these states (IAC 1988a). There are differences between states in the way royalties are applied (see appendix E). The Commonwealth also imposes an excise on black coal, as well as an export levy.

In New South Wales a specific flat rate royalty of $1.70/t is levied by the state government on all coal production. This charge is paid at the point of sale rather than the pithead. (An increase in coal stocks held by the mines therefore does not result in royalty payments to the state.)

In addition to the specific royalty, the New South Wales government has in the past imposed a 'super royalty' of 50c/t on most new mining leases and extensions to existing collieries granted since 1974. After a state government review of royalties in 1987 the super royalty was abolished for underground mines and reduced to 40c/t for opencut mines. These changes were made in response to the difficulties being experienced by the industry at that time. The 50c/t level was reimposed for some opencut mines in 1989, and currently seven mines continue to pay it.

The Queensland govenunent imposes an ad valorem (per unit value) royalty on coal exported. Coal extracted by opencut methods is subject to a royalty of 5 per cent of its free-on-rail (f.0.r.) value, while underground coal is subject to a 4 per cent f.0.r. royalty. In addition, any coal mine producing and selling coal within Queens- land is charged a specific royalty of 5c/t.

The Commonwealth government imposes a specific excise of 25c/t on all black coal extracted in Australia. It also imposes an export levy of $3.50/t on high quality export coking coal with a carbon content of 85 per cent or greater produced above a depth of 60 metres from opencut mines opened prior to 1 July 1980. This affects only large Bowen Basin mines which were originally developed by Utah Development Co. The cost of this levy to the producer is falling over time as greater amounts of coal are being extracted from below a depth of 60 metres.

It is generally recognised that both the New South Wales and Queensland governments have attempted to extract rent from the coal industry by charging freight rates in excess of the cost of providing the transport facility, though this is not officially acknowledged as a tax (and indeed is not technically a rent tax). Freebairn and Trace (1988) estimated that, on average, this 'excessive' freight cost was around $5/t in New South Wales and greater than $5/t in Queensland. Because these excess charges - to the extent that they still apply - can be regarded as a de facto tax, they are recognised as a form of taxation in this study. In effect they are specific royalties levied on the volume of production, at a rate which is largely dependent on the location of mining.


G.2 Simulation method This simulation study quantifies the influences of various taxation regimes on investorsf decisions to develop and extract black coal reserves. A population of 162 possible coal projects (81 opencut and 81 underground) was simulated, having all possible combinations of the characteristics shown in table 11 of the main text. The parameter values used do not necessarily reflect any particular investment propos- Oitions, but they do cover the range of likely investments. This population was subjected in turn to the specified taxation settings. The taxes modelled were the specific and ad valorern royalties currently used, which are production-based, and the Brown and resource rent taxes, which are profits-based.

The net present value of net profits is used as the measure of project profitability and of economic rent. A project's pre-tax economic rent, if positive, is divided into a government return and an investofs after- tax return. If a project's net present value is negative, it is uneconomic and is assumed not to proceed. When a taxation measure causes an otherwise economic project to become uneconomic after tax, a 'loss' is said to occur: the project's pre-tax rent is lost to the economy. The number of projects

1 classified as economic before and after tax is given in the simulation results.

In conditions of certainty (such as are simulated here), the Brown tax satisfies the optimal tax criterion (see section 4.1 of main text) because it captures a pre-specified share of the before-tax economic rent and does not induce any losses of economic rent. All other taxation regimes are therefore compared with the Brown tax. For a project that is economic both before and after tax, any deviation of the investofs return from the return provided by a Brown tax is termed a 'distortion'. Positive deviations in investor returns indicate undertaxing, while negative deviations indicate overtaxing.

Aggregate results are presented for the rent components and distortions under all

Mining and minerals

mine conditions. In addition, the simulations provide a form of sensitivity analysis. To isolate the effect of varying one parameter, such as operating costs the aggregate results are disaggregated by that parameter. The variable and fixed parameters are discussed below. Further details of the modelling methodology are contained in appendix D of Hogan and Tho'pe (1990).

G.3 Data and specification The parameters which define a coal mine's production and cost profiles were largely based on the representative data contained in the MINEC Pty Ltd database (described in Barnett 1987). Data on mine size, life span, technology, capital expenditure and operating costs were collected from the 1989 version of this database. Only data for prospective mines were examined, as it was assumed that taxation changes would not apply to existing mining operations.

Production profiles were assumed to have a short rising linear segment followed by constant production over the remainder of the pro jed's life. Coal mine life was assumed to be twenty years. The years of first production and of first reaching plateau production were specified as time lags following the first year of capital investment. A production profile was thus specified by these time lags and the mine's plateau rate of production. The lead times assumed, and the relationship between mine size and lead time to plateau production, accord with the MINEC data.

The levels of capital expenditure by mine size are $110m, $320m and $460m for opencuts and $80m, $135m and $340111 for underground mines. Thus, the marginal capital cost of output capacity is lower for small underground mines than for small opencuts. However, with larger mines the marginal capital cost for underground mines exceeds that for opencuts.

The capital expenditure profile of each mine was modelled as a step function with

three levels. In the first two years, 40 per cent of the capital budget is expended; an additional 35 per cent is spent in set-up costs in years 3 and 4; the residual budget is outlayed on capital replacement over the remainder of the project's life. Per-unit costs comprise free-on-rail (that is, operating) costs, freight rates and port charges. These rates are assumed to be independent of mine type or size. All costs and prices are in 1989-90 real values.

Cost and production relationships in opencut mining vary considerably from those used in underground mines (Beck and Jolly 1989). Consequently, simulation experiments were run for the two mine types separately as well as together. The data are such that opencut mines are generally more profitable (before tax) than underground mines.

The sensitivity of the rent components to changes in coal price conditions was exanuned. The simulations included nine experiments: three for all mines, three for opencut mines and three for undergrounds, each corresponding to either constant, rising or falling black coal prices. The base case price assumed, $60/t, was approximately the ABARE estimate for the 1989-90 unit export value of coking coal.

A port charge of $5/t was used for all projects in the simulation experiments. The freight rates shown are intended to represent the actual cost for providing the freight service - either $4/t, $8/t or $12/t Thus, any excess port and freight charges imposed by states are represented as part of the royalty taxes. A range was chosen because some uncertainty surrounds the measurement of the competitive supply price of rail transport (IAC 1988a; State Rail 1988).

Under the resource rent tax all net revenues from a project were cumulated at the 'threshold' rate, which was assumed to be 10 per cent, and resource rent payments were triggered when the cumulated stream became positive. A basecase value of 10 per cent was assumed also for the firm's real

riskless discount rate used in determining the net present value of net profits from a mining project. Discount rates of 5 per cent and 15 per cent were used to examine the effect of a divergence between the firm's discount rate and the threshold rate.

G.4 Taxation parameter values The taxation parameter values currently applying to the black coal industry were not used in the simulation study. Instead, as in Hogan and Thorpe (1990), parameters were calibrated to permit consistent comparisons across taxes. That is, all taxation parameters were set to achieve a government tax take of 40 per cent of the combined net present values of the mid-range opencut and underground mining projects in the base cases. The 40 per cent tax rate is arbitrary, but is the tax rate currently applying to the only industry subject to a resource rent tax, crude oil. In the case of the Brown tax, the government tax take was set at 40 per cent for all (economically viable) cases.

The mid-range opencut mine produces 3 Mt of saleable coal a year, and in the base case has operating costs of $22/t and capital costs of $320m. The corresponding underground mine produces 2 Mt of saleable coal a year, has operating costs of $25/t and capital costs of $135m. Using a real discount rate of l0 per cent, a real coal price of $60/ t and freight and port charges of $8/t and $5/t respectively, the net present values and tax takes were calculated. To give the same tax take from these mines, an 11.45 per cent ad valorem royalty or a specific royalty of $5.38/t would be required. These rates were assumed to be common to all underground and opencut mines. Particular difficulties arise in calibrating a specific royalty rate. The above procedure has the effect that, over the whole population of mines, there is a tendency for the effects of a specific royalty to be underestimated.


G.5 Results

Aggregate results The aggregate results for a constant real coal price are given in table 16, both for all the simulated mines taken together and also for opencut and underground mines. The resource rent tax, like the Brown tax, achieves the desired 40 per cent revenue take without generating losses in economic rent or distortions to investor returns. In contrast, because losses arise under both forms of royalty, government and investor returns for royalty taxes are below the

neutral (Brown) tax outcome. In total around 20 projects are made uneconomic by the royalties, causing loss of economic rent of some 15 per cent under the parameter assumptions employed here. Losses do not differ dramatically between underground and opencut mines.

It is noteworthy that, for p rows which remain viable, the distortion of investor returns generated by the specific royalty is positive for the opencut mines as a group and negative for the underground mines. Thus, when a common rate of specific royalty is used for all mines, the mines which are more profitable before tax,

16 Aggregate simulation results: constant coal prices

Brown Resource Ad valorem Specific I tem Unit tax rent lax royalty royalty

All mines Shares of pre-tax rent a

Investor 90 60 60 51 52 Government 7'0 40 40 34 33 Loss % 0 0 15 15 Distortion 70 0 0 0 l

Changes in status b Economic to economic l 44 1 44 1 23 122 uneconomic 0 0 21 22

Uneconomic to uneconomic 18 18 18 18

Opencut mines Shares of prctax rent

1 Investor 70 60 60 53 53 Government % 40 40 35 33 LOSS 7'0 0 0 12 15 Distortion % 0 0 0 3

Changes in status Economic to economic 74 74 65 63 uneconomic 0 0 9 l1


Underground mines Shares of pre-tax rent

Investor % 60 60 50 .W Government 70 40 40 33 34 LOSS 70 0 0 17 16 Distortion 70 0 0 1 -1

Changes in status Economic to economic 70 70 58 59 uneconomic 0 0 12 11

Uneconomic to uneconomic l I 11 11 11

a Investor returns, government returns and losses are expressed as average shares of pre-tax economic rent. Distortion is the percentage deviation of the after-tax return to the investor relative to the neutral tax. b Projects may be profitable before and after tax, profitable before tax but not after tax or uneconomic both before and after tax.

Mining and minerals

opencut mines, receive a subsidy on average compared with the neutral tax, while the underground mines are overtaxed. The ad valorern royalty, in contrast, generates no distortion on average for those opencut p r o w which remain economic, while it is marginally positive for those underground mines which remain economic. This occurs because, while underground mines are less profitable on average, the effect of the ad valorern tax is to remove the least profitable underground mines from the sample.

The simulation results for a 1 per cent annual rise and a 1 per cent annual fall in the real price of coal are given in tables 17 and

18 respectively. When coal prices are rising, more projects become viable. The results across all mines indicate that the specific royalty then undertaxes by some 12 per cent, as compared with 6 per cent for the ad valorem royalty and an overtaxing of 2 per cent under the resource rent tax. When prices are falling the pattern of distortions of the specific royalty and resource rent tax is reversed. On account of propds becoming uneconomic, the distortion under the ad valorem royalty is negligible in aggregate when prices are falling. However, relative to the constant price scenario, royalty taxes cause far more projects to become

17 Aggregate simulation results: rising coal prices

Unit Brown

tax Resource

rent tax Ad valorem

royalty Specific royalty Item

All mines Shares of pre-tax rent a

Investor Government Loss Distortion

Shares in status b Economic to economic uneconomic

Uneconomic to uneconomic

Opencut mines Shares of pretax rent


Changes in status Economic to economic uneconomic

Uneconomic to un~xonomic

Underground mines Shares of pre-tax rent


Changes in status Economic to economic uneconomic

Uneconomic to uneconomic

a Investor returns, government returns and losses are expmsed as average shares of pretax economic r a t . Distortion IS the percentage deviation of the after-tax return to the investor relative to the neutral taw. b Projects may be profitable before and after tax, profitable before tax but not after tax or uneconomic both More and after tax.


pp-P P

uneconomic when prices are falling than they enable to survive when prices are rising. Hence, both types of royalty taxes appear to be regressive with respect to project profitability, and this effect is more marked for the specific royalty.

The pattern of distortions under the resource rent tax needs some explanation. Since the same tax rate was used here for the Brown and resource rent taxes, it follows that the resource rent tax undertaxes when the threshold rate exceeds the firm's discount rate, and the converse (Hogan and Thorpe 1990). The results show that the degree of under- or overtaxing depends on

the real coal price. When prices rise, more economic projects will incur resource rent tax earlier, other things being equal. Early payments reduce the benefit of the undertaxing by more than they reduce the cost of the extra tax. Consequently, mines tend to be slightly overtaxed when prices are rising and slightly undertaxed when prices are falling, averaged over the three simulated values of the firm's discount rate. However, losses rise as prices fall. Because the resource rent tax does not provide full loss offset, it provides an inadequate buffer to adverse price changes.

18 Aggregate simulation results: falling coal prices

Brown Resource Ad valorem Specific Item Unit tax rent tax royalty royalty

All mines Shares of pre-tax rent

Investor 90 60 60 46 42 Government 7'0 40 38 30 31 Loss % 0 2 24 26 Distortion '70 0 2 0 -4

Changes in status b Economic to economic 125 1 22 95 92 uneconomic 0 3 30 33


Opencut mines Shares of pretax rent

Investor 60 59 47 44 Government 40 38 28 30 Loss 0 3 25 26 Distortion 0 2 4 -2

Changes in status Economic to economic 65 63 49 48 uneconomic 0 2 16 17

Uneconomic to uneconomic 16 16 16 16 Underground mines Shares of pretax rent

Investor 60 60 45 41 Government 40 38 32 33 Loss 0 2 23 27 Distortion 0 2 3 -7

Changes in status ECO~ONC to economic 60 59 46 44 uneconomic 0 1 14 16

Uneconomic to uneconomic 21 21 21 2 1

a Investor returns, government returns and losses are expressed as average shares of pretax economic rent. Distortion is the percentage deviation of the after-tax return to the investor relative to the neutral tax b Rejects may be pmfitable before and after tax, profitable before tax but not after tax or uneconomic both before and after tax.


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