ABN 59 050 486 952 Level 13 133 Mary St Brisbane Queensland 4000 T 07 3295 9560 F 07 3295 9570 E info@qrc.org.au

www.qrc.org.au

QRC

submission

Working together for a shared future

Strong Choices for Queensland May 2014

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CONTENTS EXECUTIVE SUMMARY ................................................................................................................................ 3

INTRODUCTION ........................................................................................................................................... 4 1. THE NEED FOR FISCAL REPAIR ........................................................................................................ 4

1.1 The state government debt is unsustainable and carries a high opportunity cost ................... 4 2.2 QRC’s preferred policy options for retiring debt ........................................................................ 4

2. DIVESTMENTS MUST COME WITH PROTECTIONS FOR USERS ....................................................... 5

2.1 Users of the Gladstone Port, Port of Townsville and the Mount Isa-Townsville railway line are highly vulnerable to a new owner misusing monopoly power ........................................................ 5

3. INCREASING TAXES WILL IMPACT UPON EMPLOYMENT AND INVESTMENT ................................. 6

3.1 Increasing royalties the most inefficient of all tax options ........................................................ 6 3.2 Resources companies have cut costs substantially but cost problems persist ........................ 6 3.3 A quarter of Queensland coal is being produced at a loss ......................................................... 7 3.4 The impact of high costs on new investment ............................................................................... 3.5 Government’s commitment to the coal sector in September 2012 ......................................... 11 3.6 The difficulties confronting the metals sector ......................................................................... 11 3.7 The Queensland CSG/LNG sector is losing its global competitive position ............................ 13 3.8 Alumina and aluminium smelting and refining making negligible returns ............................ 14

4. REFORMS THAT ENCOURAGE INVESTMENT THE RIGHT COMPLEMENT TO ASSET SALES ......... 14

4.1 The importance of regulatory certainty in encouraging investment ........................................... 4.2 High taxes, labour, rail, energy, and regulatory (approval) costs can be addressed through policy reform .............................................................................................................................................

5. CAPITAL RECYCLING AND PRODUCTIVITY ENHANCING INFRASTRUCTURE ............................... 17

5.1 The infrastructure requirements of the Queensland resources sector ......................................

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EXECUTIVE SUMMARY The Queensland resources sector acknowledges the fiscal position of the Queensland Government and the steps taken by it to identify and communicate the risks and challenges of an unsustainable debt burden with industry and the community. The state government has identified options to return the budget to surplus and to retire debt. From a public interest perspective, increasing the array of inefficient state-based taxes such as royalties is the least desirable option. Up to date analysis for this submission by leading economic consulting firm Wood Mackenzie and economic modellers Lawrence Consulting highlights the magnitude of the risks associated with any increase in royalties. Despite vigorous cost cutting by all coal mines, 25 percent of all coal currently produced in Queensland is being done so at a loss (measured on an FOB cash cost basis) including half of all thermal coal production. If these mines were to shut, the direct loss of coal company spending on wages and goods and services purchases in Queensland would total $4.2 billion with a total loss to Gross State Product exceeding $9.7 billion, or 3.2 percent of the entire Queensland economy. Over 60,000 jobs throughout Queensland would be lost. The loss of state government royalties would amount to around $330 million a year. One of every 10 tonnes of coal currently produced in Queensland is incurring a loss of more than $14 per tonne. These mines are at extreme risk of shutdown. This would see the loss of $1.8 billion of spending power in the Queensland economy and the total loss to Gross State Product would exceed $3.6 billion, or 1.2 per cent of the entire Queensland economy. Over 22,000 jobs across Queensland would be lost. The loss of royalties would amount to $120 million a year. Queensland copper and zinc producers are precariously positioned on their respective global cost curves and in no shape to absorb a further royalty hit.

The CSG/LNG sector is already burdened by onerous and uncompetitive regulatory costs (mainly complex and heavily conditioned approvals) and substantial increases in operating costs such as drilling equipment, pipelines, roads, processing facilities and labour. Some $60 billion is being invested by the sector in the reasonable expectation of royalty stability. A further increase in the bauxite royalty rate, especially the rate on bauxite consumed domestically, would add to the competitiveness concerns of the Queensland alumina refining industry. Given the government’s need for significant and prompt revenue flows to stabilise debt levels and lower state borrowing costs, the QRC supports the government’s proposal for selected sale or leasing of assets, subject to appropriate regulatory and commercial safeguards being discussed with industry and implemented prior to divestment. To achieve structural improvements in the state’s finances, there is a need for higher revenue flows now and into the future. Government reforms targeted at lowering costs, improving productivity and encouraging new investment in the resources sector will lead to stronger flows of sector royalties to the state. Assuming improvements in cost structures and commodity prices, the resources sector can be expected to continue to invest in new projects based on the strength of global demand fundamentals.

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With minerals and energy resources in Queensland tending to be more remote and deeper, developers require more supporting infrastructure to reach market, and are forecasting lower returns from new projects. Smaller and mid-tier resources companies struggle to finance the infrastructure they require and capital is becoming increasingly mobile as alternative provinces open up globally. INTRODUCTION The Queensland Resources Council (QRC) is the peak representative body for the commercial developers of Queensland’s minerals and energy resources. With a voluntary membership of more than 300 businesses with interests in the sustainable development of minerals and energy resources in Queensland, the QRC enjoys 100 percent support from the state’s coal producers, over 90 percent of metals production, the four major developers of Queensland’s export CSG/LNG industry and a large cohort of minerals and energy explorers. The QRC marked its 10th anniversary in 2013 with a membership base now responsible for more than 430,000 direct and indirect jobs through $38 billion in wages and salaries and local purchases of goods and services. The resources sector is now calculated as responsible directly and indirectly for one in every four dollars of the Queensland economy and one in every five jobs.1 Minerals and energy are the primary source of export income for Queensland. Today, the sector plays a fundamental role in shaping Queensland’s regional future by contributing to economic growth, creating high-paying jobs, and supporting research and development, regional infrastructure, new services and investment. The future growth trajectory of the Queensland resources sector will play a crucial role in achievement of the Queensland Plan’s regionalisation objectives. 1 THE NEED FOR FISCAL REPAIR

1.1 The state government debt is unsustainable and carries a high opportunity cost The Queensland resources sector acknowledges the fiscal position of the Queensland Government and the steps taken by it to identify and communicate the risks and challenges to industry and the community. A $4 billion per annum interest bill carries high opportunity costs, including investment in essential social and economic infrastructure throughout Queensland. 1.2 QRC’s preferred policy options for retiring debt

From the material presented by government in its recent Economic and Fiscal Challenges and related documents, Queensland’s unique influencing factors include:

A need for significant additional revenues given projections that a BAU approach will see the state’s debt increase to $121 billion by 2022-23.

A need for prompt revenues ($25-30 billion) to stabilise debt given the substantial opportunity costs in servicing it and the imminent risk of further credit downgrade/s that will increase this debt per dollar borrowed.

To this end, a program of asset sales with careful consideration to what is in the long term interests of the state, and appropriate regulatory and commercial safeguards, is the most realistic policy option given the need for significant and prompt revenue flows to stabilise debt levels. To maintain current

1 QRC/Lawrence Consulting analysis at www.queenslandeconomy.com.au

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standards of living, there is also an obvious need to inject higher revenues now and into the future. Reforms that lower costs and encourage additional investment in the resources sector are strongly encouraged in this context. 2 DIVESTMENTS MUST COME WITH PROTECTIONS FOR USERS

In response to the Queensland Commission of Audit finding that the commercial operations of Gladstone Ports Corporation (GPC) and Port of Townsville (bundled with the Mount Isa-Townsville railway line) should be offered for long term lease to private operators, we note that government is yet to accept this recommendation, stating instead:

‘....the proposal is worthy of an open and transparent community debate to establish its viability and to inform stakeholders of the costs and benefits involved.’

The QRC supports the government’s cautious approach and welcomes the opportunity for engagement. The QRC is strongly of a view that public interest must be defined by reference to the long term impacts of government decisions. Consideration should be given to whether reforms strengthen the partnership and alignment of interests between the state as the owner and custodian of the state’s resources, and the producers whose role is to generate economic value from these resources. Reforms should also promote responsive capacity development, competitive supply chains and global competitiveness. Ideally, the sale proceeds should exceed the net present value of any future fiscal revenues (including earnings, royalties, and taxation revenues) that are likely to be foregone as the result of the sale.

2.1 Users of the Gladstone Port, Port of Townsville and Mount Isa-Townsville railway line are highly vulnerable to a new owner misusing their monopoly power

Current and prospective resources company users of the Gladstone Port, Port of Townsville and the Mount Isa-Townsville railway line have the following concerns:

Given limited port and rail alternatives, material pricing risk is introduced for current and future users if a non-industry aligned owner attempts to extract unearned economic rents by pricing on the basis of what the market may tolerate, as opposed to an appropriate rate of return that also supports long-term growth of the resources sector.

Monopoly pricing is likely to negatively impact investment in current and future resources projects and reinvestment in existing projects because higher infrastructure charges will translate into higher operating costs and reduced global competitiveness. Further, the transfer of profits from resources companies to the port and rail owners will reduce margins and the value of companies’ equity. The risk profile is substantially increased because of infrastructure pricing and access uncertainty.

It is material who becomes the owner and the operator. For example, pricing and development risk is introduced if a monopoly owner in the supply chain were to own and operate the port as certain rail expansions and resource projects could be favoured over others. Generally speaking, resources sector companies have a preference to operate export facilities, as this promotes operational efficiency and cost control.

Private investors may be more financially constrained than the state to undertake the projects necessary to improve the capacity and efficiency of port operations. A private investor may not take a long term view due to the strong incentives to earn high returns on already committed capital. In this respect, the terms by which privatised export infrastructure is to be expanded is of high importance when structuring and finalising a sale or lease arrangements.

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There are a variety of ways to address these risks, including reviewing and strengthening current contracts between users and the Gladstone Ports Corporation (GPC), Port of Townsville and Queensland Rail, and/or imposing a regulatory regime. The correct response depends on a number of factors, outlined in Appendix One. 3 INCREASING TAXES WILL IMPACT UPON EMPLOYMENT AND INVESTMENT

3.1 Increasing royalties is the most inefficient of all tax options

Consistent with other like studies2, the 2009 Henry Tax Review calculated the burdens of Australian taxes. On both measures (marginal and average excess burdens), royalties were the most economically inefficient of Australian taxes with an average excess burden of 50 cents of consumer welfare per dollar of revenue. Put another way, for every dollar raised in royalties, 50 cents in welfare is lost elsewhere in the economy due to the adverse impact on investment and consumption.

3.2 Resources companies have cut costs substantially, structural cost challenges persist

A valuable statistic is where resources companies sit on their respective global cost curves. A global cost curve in this context refers to a graph of the production costs for all the mines or companies in that particular industry. This curve allows an individual mine or resources operation to see how its production costs relate to competitors. Cost curves are important in industries like resources where most producers receive the same or similar prices for their products. Companies will often refer to the quartile of the cost curve in which they sit. It is highly desirable for companies to be in the lowest first (1st) quartile – the 25 percent of the industry with the lowest costs. The QRC surveyed the CEOs of full members (across all sectors) to divulge cash operating cost curve information and ascertain where the same operations sat in 2008 and 2013. Of those surveyed in 2013, 19 companies responded with 25 operations in total. The exercise was repeated in March 2014, this time with 21 companies and 30 operations in total. These operations were a mix of mining, minerals processing, oil and gas production and ‘other’ activities. In 2008, and very positively, over 80 percent of operations sat in the 1st and 2nd quartiles meaning only 20 per cent were exposed to higher risks in the upper 3rd and 4th quartiles. In 2013, following a sustained period of high prices and considerable competition for business inputs, the balance shifted and only 40 percent of operations remained in the lower 1st and 2nd quartiles. This meant the majority of producers were under serious competitive threat if they could not reduce their cost profiles. In 2014, 30 percent of those high risk operations successfully reduced costs to fall back into quartiles 1 or 2 (total 70 percent) reflecting comparable cost profiles to the 2008 results (refer Chart 1). These cost reductions have come in the main from considerable reductions in operating costs (i.e. letting go of direct employees and contractors) and productivity gains. These survey findings provide clear evidence that the resources sector is working hard to address cost problems that emerged over the past half decade. Industry has not sat around waiting for others such as government to ‘come to the rescue’. At the same time, industry believes all stakeholders have a role to play in improving the competitiveness of the sector in increasingly difficult operating environments.

2 Including GST Distribution Review (Greiner 2012)

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Chart 1: Queensland resource operations cost curve quartile comparison 2008-2013-2014

3.3 A quarter of Queensland’s coal production is running at a loss

Queensland coal producers continue to experience their most difficult operating conditions in more than a decade with low prices (exacerbated by the persistent strength of the $AU against the $US) and comparative high costs despite the substantial cost management programs being pursued across all companies. This situation poses a number of risks to the state, notably the real risk of more job losses if taxes are raised.

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Chart 2: Global coal prices ($US/t)

Thermal coal From a high of $AU122 per tonne in September 2011 (6,000kc NAR), thermal coal spot prices today are around $AU73/t (refer Chart 2 above). Given predictions of continued moderate demand growth, but continued oversupply (exacerbated by considerable new supply from mines committed during the high price period), indications are that thermal coal prices may have reached their ebb in the current cycle but price recovery is not expected to be strong. Despite vigorous cost cutting, at current spot prices some 49 percent (30mt of 60mt) of the thermal coal currently produced in Queensland is being produced at a loss (FOB cash cost basis – refer Chart 3). Further, 20 percent (12mt of 60mt) of the thermal coal currently produced in Queensland is being produced at a loss greater than $14 per tonne and must be at extreme risk of mine closure. Producers are continuing to focus on lowering unit costs by producing more tonnes in servicing take-or-pay contracts. However, we could see more mines close as companies decide that the superior option for minimising losses is to cease operations.

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Chart 3: 2014 Seaborne thermal coal FOB cash cost curve

Metallurgical coal From a high of more than $US300/t in September 2011 to a low of around $US113/t currently for top premium metallurgical coal (refer Chart 2) – and less for PCI and semi-soft brands – these markets continue to suffer from oversupply and weaker Chinese demand as it attempts to control steel production overcapacity and adjust to slowing industrial growth. As with the thermal coal analysis, despite vigorous cost cutting 14 percent (21mt of 150mt) of metallurgical coal currently produced in Queensland is being produced at a loss (FOB cash cost basis). Further, 5 percent (7mt of 150mt) of the metallurgical coal currently produced in Queensland is being produced at a loss greater than $10/t, thereby risking shutdown (refer Chart 4).

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Chart 4: 2014 Seaborne metallurgical coal FOB cash cost curve

With prices for semi-soft and semi-hard and PCI brands around $US30/t lower than for prime product, a number of these producers would not be recovering cash costs at current levels. Like thermal coal, these producers will continue to focus on lowering unit costs by producing more tonnes and to service take-or-pay contracts. Also of concern is that considerable new tonnes will enter the market over the next period (a legacy of mines committed during the high price period). The difficult decisions by Queensland coal companies to lay off in excess of 8,000 direct and contractor workers over the past 12-18 months and vigorously pursue reductions in operational expenditures in the Bowen and Surat Basins illustrates the pressures facing producers. In summary Despite vigorous cost cutting by all coal mines, 25 percent of all coal currently produced in Queensland is being done so at a loss (measured on an FOB cash cost basis) including half of all thermal coal production. Using economic modelling by Lawrence Consulting it can be concluded that if these mines are forced to shut, the direct loss of coal company spending on wages and goods and services purchased in the Queensland economy would total $4.2 billion and the total loss to Gross State Product would exceed $9.7 billion, or 3.2 per cent of the entire Queensland economy. Over 60,000 jobs throughout Queensland would be lost. The loss of state government royalties would amount to around $330 million a year. One out of every 10 tonnes of coal currently produced in Queensland is incurring a loss of more than $14 per tonne, and these mines are at extreme risk of shutdown. Shutdowns would result in the loss of $1.8 billion of spending power in the Queensland economy and the total loss to Gross State Product would exceed $3.6 billion, or 1.2 per cent of the entire Queensland economy. More than 22,000 jobs across Queensland would be lost. The loss of royalties would amount to $120 million a year.

Page 11QRC b i i3.4 Government’s commitment to the coal sector in September 2012

In its 2008 budget the ALP state government introduced a tiered coal royalty rate regime with a new rate of 10 percent applying above $A100 per tonne, and the then existing 7 per cent rate applying on the portion of the coal price up to $A100 per tonne. In its 2012 budget, the Newman Government lifted the 10 percent royalty rate to 12.5 percent for coal valued above $100 per tonne and less than $150 per tonne, as well as an added marginal rate of 15 percent for prices above $AU150 a tonne. Regrettably, the failure to index this threshold means that the real effective royalty rate increases year on year. In his 2012 budget speech Treasurer Nicholls gave an unequivocal commitment to the coal sector when he said: ‘To give certainty to industry the government will guarantee no change to the royalty rates for coal for ten years from 1 October 2012.’ The Treasurer’s commitment was reinforced by Deputy Premier Jeff Seeney on 11 September 2012: ‘Coal mining is critically important to Queensland and this guarantee to keep royalties unchanged for the next decade allows companies to make investment decisions with total confidence.’ The QRC also appreciates the clarifying statement from the Newman Government in explanatory notes accompanying the Strong Choices survey: ‘The Queensland Government increased coal royalty rates in the 2012-13 Budget and has committed to not changing the rates for 10 years. Increasing mining royalty rates at a time of lower commodity prices may impact on the national and international competitiveness for Queensland mines and will impact on jobs. Increasing royalties may make resources companies less competitive on the world market. Ultimately, these companies may choose to close some projects, and abandon the development of others, affecting jobs and other investment in Queensland.’

3.5 The difficulties confronting the metals sector

The Queensland metals sector continues to experience difficult market conditions with prices for copper, gold, lead, zinc and silver lower than 12 months ago as global supply catches demand. It is a sector also having difficulties reining in costs and finding productivity gains against the geological challenge of deeper deposits. Queensland copper and zinc producers are precariously positioned on their respective global cost curves. Of five copper producers analysed, all sit in quartiles 3 and 4, meaning they are vulnerable to being replaced by lower cost new mines (refer Chart 6). More favourably, the three Queensland zinc mines that were analysed were positioned in quartiles 2 and 3 (refer Chart 7). Queensland’s North West Mineral Province (NWMP) has a reputation as one of the world’s most prospective metals regions. The issue for NWMP is that a new generation of deep surface exploration technologies must be deployed to aid major new discoveries. Furthermore, significant improvements in hard infrastructure (e.g. water, rail, road and energy) and soft infrastructure (quality of social amenity) are needed to encourage significant additional investment in exploration and development, and to sustain local communities.

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Queensland copper and zinc producers are precariously positioned on their respective global cost curves and in no shape to absorb a further royalty hit. Chart 6: 2014 copper mine composite cost curve

Chart 7: 2014 zinc mine composite cost curve

Page 13QRC b i i3.6 The Queensland CSG/LNG sector is losing its global competitive position

The CSG/LNG industry is continuing to progress its upstream and downstream activities with first gas scheduled for export in the last quarter of 2014. Drilling in the Surat and Bowen Basins has increased, complemented by the commissioning of compressor stations, processing plants, water treatment systems and worker accommodation. Downstream, construction of the liquefaction (LNG) plants on Curtis Island is progressing with pipelines largely buried and subject to strength and integrity testing. Community perceptions of the Queensland gas industry are improving as government and developers more effectively communicate social and environmental impacts. Nearby communities are experiencing the benefits of employment creation, social investment and landholder compensation agreements. However, the industry is experiencing significant problems in converting gas resources to reserves, given the substantial increase in regulatory (mainly complex and heavily conditioned approvals) and operating costs (drilling equipment, pipelines, roads, processing facilities and labour). Chart 8 shows that CSG and unconventional gas resources will become increasingly costly to develop. Costs will increase as development and production moves from existing conventional and known unconventional gas reserves to less certain resources (deeper and more distant from supporting infrastructure). The current average cost of development for new unconventional and CSG gas is already approaching $AU5/GJ (IES 2013) and will continue to rise. Chart 8: Development costs for unconventional gas ($/GJ)

Perhaps indicative of cost concerns in Queensland and Australia, Arrow/Shell has deferred a final investment decision on its proposed CSG-LNG project at Curtis Island. This is in order to seek additional project value that reflects the existing high cost environment and the need for Australian projects to innovate in order to successfully compete for scarce capital funding against global opportunities. Some $60 billion is being invested by the sector in the reasonable expectation of royalty stability.

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3.7 Alumina and aluminium smelting and refining making negligible returns

The QRC continues holds serious concerns about the commercial sustainability of the state’s refining and smelting operations. A strong Australian dollar, softening prices and high energy costs are weighing heavily on these industries. In this context, any state government policy changes that increase costs (e.g. bauxite royalties, including the royalty for domestically consumed bauxite) would represent a considerable risk to the ongoing viability of these operations.

4 REFORMS THAT ENCOURAGE INVESTMENT THE RIGHT COMPLEMENT TO ASSET SALES

4.1 Huge increases in costs which can be influenced by government regulation

While percentage allocations change according to the type of resource being extracted, the main operational costs for a resource developer are taxes (including royalties), labour, transport (port and rail charges), energy (gas, diesel and NEM electricity prices), general inputs (equipment, parts) and regulatory compliance (local, state and federal government regulations and laws). Almost without exception, governments play a part in influencing the costs of these inputs. Either directly (e.g. influencing rail and electricity prices and setting new project conditions via regulatory decisions) or indirectly (e.g. setting policies that influence how skills development occurs). Poor policies can have a very large impact on the competiveness of the resources sector. Analysis shows that average annual increases in these input costs have increased dramatically between 2006 and 2014 – and certainly much higher than the Consumer Price Index (CPI - refer Chart 9):

Coal royalties have increased 5 percent a year on average over the period (assuming an average price of $AU162/t)

Electricity costs rose 12 percent a year Rail costs rose between six and 19 percent a year Labour costs rose 8 percent a year The Australian dollar (against the $US) rose by 4 percent a year.

This covers a period of mainly price falls for coal and metals. While increases in rail and electricity prices are a function of numerous complex regulatory and commercial factors, governments must be vigilant and continue to pursue reforms to ensure that these markets are delivering economically efficient and least cost outcomes. When government owns the entities supplying the inputs (e.g. Queensland Rail, Ergon and Powerlink), it is encouraged to take a long term view to ensure the long term competitiveness of Queensland industry, despite the competing objective of maximising revenues and dividends for the state.

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Chart 9: Average per annum per cent increases (decreases) in resource sector costs and prices between 2006 and 2014

4.2 Regulatory reform A significant portion of development costs is regulatory – associated mainly with exploration and gaining necessary exploration and project approvals. Resources development is subject to more regulatory requirements than all other industries. Meeting regulatory imposts is a business cost and companies have a commercial incentive to keep them as low as possible. Any unnecessary costs incurred in obtaining required regulatory approvals constitute a cost burden that undermines development competiveness and the attractiveness of Queensland as a place to invest. Regulatory efficiency is critical to the resources sector. The proposed federal-state ‘one-stop-shop’ model for environmental approvals is strongly supported by the QRC. The accreditation of state planning systems under national environmental law to create a single process covering both state and federal environmental assessment and approvals is welcome. With its underpinning by a single set of conditions and a single set of biodiversity offsets, the ‘one stop shop’ promises to deliver significant cost savings for proponents while maintaining environmental protections. Furthermore, other reforms supported by the QRC include more discipline in determining the need for regulation; more rigour in assessing options and whether a net public benefit exists; improving the capability, capacity and competency of government agencies who regulate the sector; a greater focus on outcomes based approaches; avoiding duplication among agencies; and greater use of central co-ordinating and lead assessment agencies promises to deliver significant additional savings. In Appendix Two this submission outlines the opportunities for reform in the areas of energy, rail regulation, skills and OH&S.

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4.3 Taxation and royalties reform The Queensland coal industry is very highly taxed by international comparison. The effect of recent increases in coal royalties is significant. The current Effective Taxation Rate (ETR) – the combination of federal corporate taxes and Queensland royalties – is now 50 percent. This means Queensland coal miners are paying the highest tax rate of all competing coal jurisdictions with the exception of Indonesia (50.6 per cent – refer Chart 10). While paying slightly higher taxes, Indonesia has a much lower per unit extraction cost and a freight cost advantage over Queensland. Chart 10: Effective Tax Rate Comparison of competing coal jurisdictions (Typical Tier 2 Coking Operation)

The QRC contends that to restore the coal industry’s global competitiveness and Queensland’s attractiveness as an investment destination, the Queensland Government must index coal royalty thresholds to maintain their real value; recognising that over time, more coal production will move into the higher royalty thresholds. The ‘value destruction’ of not indexing the thresholds on project value is clear. For a typical ‘tier 2’ metallurgical coal project with a mine life of 40 years and a NPV of $267 million (without royalties), the Queensland coal royalty regime (without indexation) reduces the NPV to just $36 million. This NPV would double if thresholds were indexed. In effect, indexation of the coal royalty thresholds doubles the NPV of a typical ‘tier 2’ metallurgical coal project, making it twice as attractive. QRC appreciates the work of the Resources Cabinet Committee (RCC) in developing measures to lower industry costs and drive investment towards the minerals and energy sector but the reality is that the 2012 coal royalty regime and its embedded rising effective royalty rates is harming Queensland’s chances of attracting new coal industry investment.

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5 CAPITAL RECYCLING AND PRODUCTIVITY ENHANCING INFRASTRUCTURE

The resources sector relies on a range of public and private infrastructure to deliver successful projects, including transport (roads, ports, rail and airports), power (electricity and gas distribution, and electricity transmission), water (water storage and distribution), telecommunications, accommodation and social infrastructure (waste/water treatment plants, schools, healthcare, childcare and recreation). Quality infrastructure, built and operated efficiently, can be a key driver of the financial viability of resources projects, and in turn, employment and revenue growth. The federal government recently gave the states a substantial financial incentive to sell assets and recycle capital into new infrastructure as part of its effort to boost jobs and productivity. The federal government will provide $5 billion over five years to 2018-19 to an Asset Recycling Fund which will grant a state 15 percent of the assessed value of an asset being sold for capital recycling. The possible sale of the Gladstone and Townsville Ports (including Mount Isa-Townsville rail line) offers an opportunity for government to take advantage of the federal offer, and to recycle some of these revenues (earned on the back of the sector’s past contribution) back into productivity enhancing infrastructure critical to the next wave of investment in resources projects. Assuming improvements in cost structures and commodity prices, the resources sector can be expected to continue to invest in new projects given the strength of the global demand fundamentals if they (and governments) can meet the challenges of:

Resources being more remote and deeper Projects requiring more supporting infrastructure to reach market Lower returns from new projects The inability of the smaller and mid-tier resources companies to finance the infrastructure

they require Increasingly mobile capital as new mineral resources provinces are opened up globally The necessary support, financial and non-financial (planning, streamlined approvals etc), to

build the next generation of enabling infrastructure.

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Appendix One: Detailed considerations re Gladstone and Townsville Ports, Mount Isa Railway RG Tanna Coal Terminal The RG Tanna Coal Terminal at Gladstone port is not subject to any current access regulation, with key operating conditions outlined in Port Services and Coal Handling Agreements (PSAs and CSAs).

These agreements are currently subject to good faith collective negotiations between RG Tanna users and the Gladstone Ports Corporation (GPC) to provide a high level of certainty in the terms and conditions governing use of and access to the port. Completion of this is essential not only for industry users but also for potential purchasers of the port should government decide to move down the privatisation path. We understand GPC has kept the government fully informed of the progress of these negotiations and industry looks forward to their conclusion to provide a common and clear contractual platform for all participants at the Port of Gladstone. It should be noted that through this process industry is attempting to protect the status quo, and achieve balanced conditions and protections on par with those enjoyed by users that access similar infrastructure on the eastern seaboard. If industry does not achieve a level of comfort needed as part of these processes, there may be grounds to pursue a regulatory regime. Regulation in this context means:

Independent oversight and control over prices (especially for existing leases that may expire in the short term).

Access (especially security of access to landside facilities, wharves and the channel). Ongoing performance incentives (especially in relation to maximising throughput – that is,

ports must preserve their customer base and should resist diversifying if that will be to the detriment of current users).

Effective, transparent and timely investment processes for capacity expansions including adequate investment in the facility at the regulated rate of return.

Achieving these outcomes may entail, for example, the declaration of the Gladstone Port by the relevant state minister and the implementation of compulsory undertakings by the Queensland Competition Authority (QCA). Furthermore, industry considers that government should sell the GPC’s landlord role only and transfer operations to the users of the port. This approach has the benefit of retaining the port’s sale value, while allowing users to control the quality and efficiency of technical processes. Port of Townsville and Mount Isa-Townsville railway line For users of these assets, protecting the status quo is not a satisfactory outcome, as monopolistic pricing and inefficiencies are already defining and regrettable attributes. The Mount Isa Rail Line (Rail Line) is currently the subject of a declaration made under s250 of the Queensland Competition Authority Act 1997 (Qld) (QCA Act). The Rail Line is also subject to an access undertaking applicable to Queensland Rail (QR), originally submitted by QR Network (as it was then) in 2008 and made applicable to QR in 2010 through a transfer notice under the Infrastructure Investment (Asset Restructuring and Disposal) Act 2009 (Qld). This undertaking will expire on the earlier of 30 June 2014 and the approval by the QCA of a replacement access undertaking. QR has proposed a new access undertaking, which is currently being considered by the QCA. Access seekers and access holders have made submissions to the QCA opposing the proposed new undertaking on grounds including:

Page 19QRC b i i There is no requirement for QR to provide accurate KPI reporting on performance of the line

and no linkages between performance, capital spending on upgrade and pricing. The inclusion of floor and ceiling rates is ineffective in assisting in price negotiation.

In the QRC’s view, the proposed new undertaking is unlikely to be approved by the QCA. The regulatory terms currently applying to the rail line are therefore uncertain. This will need to be resolved as part of any divestment process. The above rail services (i.e. haulage) utilising the rail line are provided by third parties. Above rail services are not subject to regulation and are not covered by the QR access undertaking. This is unlikely to change as part of any divestment process. The port is not subject to any current access regulation and port charges are not specifically covered in the lease/licence. Therefore, there is substantial risk that port charges (shipping charges, harbour dues etc) will be increased without negotiation in the future and at the sole discretion of the Port Authority or new owner. The QRC believes the Rail Line should remain subject to regulation under the QCA Act but with changes to facilitate much improved price and service visibility. This would require an amendment to the QCA Act. It would also require a transfer of the relevant undertaking (as was done from QR Network to QR in 2010 by transfer notice), plus an obligation to maintain an access undertaking in the lease (as the case with the Dalrymple Bay Coal Terminal). Alternatively, the port could be effectively regulated through relatively basic contractual provisions contained in the lease or similar. QRC strongly supports an opportunity for users to achieve price certainty in leases/licences before/if divestment occurs. A key issue for industry will be on what terms the rail line and port (separately or together) are to be expanded. There is established Queensland and interstate precedent for addressing future expansion in the context of a privatisation or similar transaction. The contractual arrangements for the long-term lease of Dalrymple Bay Coal Terminal (DBCT) to Brookfield (as it is now) have the effect of committing the infrastructure owner to expansion, subject to conditions including sufficient user funding. For DBCT, this obligation is contained in the applicable access undertaking. This reflects the chosen approach to regulation of the asset. There are other potential approaches, such as including expansion requirements within contractual arrangements. Considerations may include the level of commitment expected in relation to expansions (e.g. is it appropriate that it is tied to user funding or demand) and the degree to which government wishes to retain control or an approval right in relation to expansions, if at all. The conditions applying to future expansion of the rail line and the infrastructure collectively (if integration proceeds) are complicated by the current applicability of the QR access undertaking to the rail line. The current access undertaking requires QR to expand if it is satisfied that the expected revenue will be greater than expected costs of the expansion. QR’s draft replacement access undertaking proposes conditions which are more favourable to QR in relation to expansions (including that QR bear no cost or risk for an expansion). Stakeholders have proposed the QCA reject these conditions and include conditions in the access undertaking that are closer to those contained in the Aurizon Network access undertaking for the Central Queensland coal rail network. This would include a requirement for QR to develop a user funding framework to allow Rail Line users to require expansions or extensions to proceed as long as they are user funded.

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Appendix Two: Reform Opportunities in Energy, Rail, Skills and OH&S Energy reform Energy costs in Queensland have doubled over the past 7 years (refer Chart 11). Chart 11: Rising prices are unsustainable

Source: QLD Government, Department of Energy and Water Supply

It is estimated that approximately 50 percent of this increase is attributable to network costs (distribution and transmission), 25 percent covers ‘green’ costs (carbon tax and the Renewable Energy Target in particular), and the balance is generation costs (refer Chart 12).

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Chart 12: Breakdown of price increases (Source: Qld Department of Energy and Water Supply)

The specific cause of rising network charges has been the substantial increase in capital programs and operating costs. Firstly, costs have been increasing to meet overly deterministic reliability standards set by the Queensland Government. Secondly, both Ergon Energy and Energex have comparatively high overhead costs when benchmarked against other distribution network companies with similar network densities and operating conditions. Since reliability standards are set by government, the Australian Energy Regulator (AER) is legally required to approve capital and operating expenditure that reasonably meet these standards. This has limited the power of the AER to assess the prudence of such investments. The Queensland Government Commission of Audit and the government’s response to its recommendations were released on 30 April 2013. In relation to energy sector network costs, the report and subsequent work completed by an inter-departmental committee (IDC) found that savings of $3.6 billion in capital expenditure over a five year period could be achieved through changes to reliability standards. The report noted that the standards were overly prescriptive, resulted in over-engineering and did not involve sound analysis justifying expenditure. The report also identified a further $1.4 billion in operating cost savings over a five year period through reduced overhead costs when benchmarked against other comparable distributors. A partial merger of the two networks proposed by the government has been identified as generating $581 million in savings over the period 2015 to 2020. The next five year determination for network costs will be set from 1 July 2015 to 30 June 2020. Regulatory proposals on capital programs and operating costs will be submitted by the distributors in October 2014. It is therefore critical that the IDC’s reforms are reflected in this determination process. While the Queensland Government’s response to the IDC’s findings was generally positive (including the proposal to merge the network businesses), it appears that slow progress has been made to ensure that savings will be identified and therefore reflected in the upcoming regulatory determination. For example, despite Minister McArdle’s media release of 16 April 2014 stating that new, less prescriptive reliability standards will commence from 1 July 2014, the sector needs more clarity on

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the implementation of revised reliability standards, and assurances that proposed reforms to existing standards will be reflected in the next determination. Furthermore, the sector is seeking assurances that practical steps are being taken to merge the two network businesses to achieve the forecast savings; that efforts to curtail operating expenditure are occurring more generally; and costs savings will be passed on to network users through reduced network tariffs and not returned to government in the form of dividends to be spent elsewhere, leaving existing tariffs in place for the remainder of the determination period.

Rail regulation reform The resources sector relies on six main rail systems to move its products to port. These are the Newlands, Goonyella, Blackwater and Moura systems (Central Queensland Coal Network), the Western System (Miles to Rosewood) and the Mount Isa=Townsville line. While some competition for above rail services exists on CQCN, limited or no above rail competition exists on the Western or Mount Isa systems. Enhancements to these lines, and more tonnages, would in all likeliness encourage greater competition for above rail services and improved economic efficiency. These systems are currently the subject of a declaration made under s250 of the Queensland Competition Authority Act 1997 (Qld) (QCA Act). The rail lines are also subject to access undertakings applicable to QR (Western and Mount Isa Systems) and Aurizon Network (CQCN).

QR and Aurizon have proposed new access undertakings for all systems, which are currently being considered by the QCA. Significantly, access seekers and access holders have made submissions to the QCA opposing all the proposed new undertakings on a range of grounds.

In the QRC’s view, all the proposed new undertakings are unlikely to be approved by the QCA, resulting in an intensive, time consuming and costly process for all parties as highly technical submissions, counter submissions, and determinations are formulated.

As is convention, industry typically pays for the costs of these processes by way of a legislated levy. These costs are often exorbitant.

For example, the QRC estimates that the collective costs of Aurizon, QRC, and the QCA in working through the details of the UT4 undertaking to date range from $15-20 million. The QRC would expect another $5 million in costs before the process concludes by the end of 2014. As stated, all these costs are borne by the coal industry.

Despite regulatory oversight, there remains little incentive for parties to engage in good faith commercial negotiations ahead of a regulatory decision, and little incentive for parties to not commence the process with an ambit undertaking. The most contentious areas of an undertaking include the:

Weighted average cost of capital (WACC)

Expansion processes including user funding arrangements and what type and value of expansion should occur at the WACC

An appropriate level of costs for maintenance, overheads and operations

Ring fencing (i.e. protections against conflicts of interest – especially when the provider has an incentive to favour certain expansions over others)

Tariffs are set at levels that promote an economically efficient level of use of assets, yet provide a sufficient return that encourages reinvestment.

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The outcomes of rail tariff negotiations over the past eight years (and beyond for the CQCN and Western Systems) is shown in Chart 13. Of note is that tariffs have increased by a minimum of 83 percent (Moura) and a maximum of 169 per cent for Blackwater. This is during a time of modest expansions but higher tonnages (and therefore expected efficiency improvements) and lower costs of capital.

The QRC is eager to discuss how tariff increases can be moderated (if not reduced) with providers and the QCA via improved commercial negotiations whilst maintaining a rigorous regulatory framework to incentivise fair outcomes.

Chart 13: Various system comparisons: actual and proposed below rail charges ($/t) and percentage increases between 2006 and 2013

Skills and OH&S reforms QRC commends the strong start on skills reform made by the Newman Government in its first term, and further commends a reinvigorated and continuing VET reform agenda for its second term, driven by the Strong Choices context. The challenge in the next term is to continue the momentum that began when the Newman government boldly established the Queensland Skills and Training Taskforce in June 2012. The high labour costs experienced by industry in recent years were in part driven by a shortage of appropriately skilled people and inadequate training places for resources sector skills compounded by long lead times for training and a focus on completing qualifications to the exclusion of skills sets. More entry and exit points based on skill sets supported by government funding in high priority skills areas would see more people employable sooner for good jobs where a full qualification is simply over-training – at a cost to industry and government.

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The move to skill sets will be challenging for the VET system and many training providers will resist the move as they are comfortable with being funded for the long-standing multi-year pathway to a qualification outcome. Training places funded by government based on both full qualifications and skill sets as identified by industry needs is essential to this reform. Associated industrial reforms are still required; for example, national recognition of ticketed trades such as electricians, between states and to make the TAFE system more productive and competitive. More institutional pathways are needed to address skills in demand especially those which span industries (e.g. diesel fitters, electrical trades, and instrument technicians). The high wages in the resources sector have been driven by a shortage of skilled people, not a shortage of people wanting to work in the sector. Fees charged for these courses and fee support offered should reflect the demand in industry and the need to encourage individuals to invest in their own training. Industry itself is not adverse to co-funded arrangements. The training system still remains supply-side focused, rather than industry-demand focused. The need to ensure the VET system became more industry driven was a key recommendation of the Queensland Skills and Training Taskforce which was accepted by the Newman Government. The efforts of the Ministerial Industry Commission (MIC) to drive improvements in this area are applauded. The VET system is a confusing maze for individuals looking for entry into training for the resources sector. People are still restrained by lack of information and access to relevant programs. This will take time to turn around and needs both market and management stimulation to occur. Further reforms to attract international training providers to Queensland, enhancing competition, would also assist. In further opening up the training market there must be a continued emphasis on strategies to ensure quality. The MIC is in its first year of advising the Minister on redirection of training investment for priority industries and jobs, and is advising on these matters. As an advisory body with a limited role, the reform outcomes for VET that will contribute to reduced labour pressures are still dependent on achieving more regulatory efficiencies, continuing firm Ministerial direction, and strong VET management. The reforms commenced in the school VET sector will yield more rounded educational outcomes for young people and therefore more trades outcomes in due course, if the limited funds available are targeted to skills in demand. Coupled with the establishment of a Queensland Minerals and Energy Academy ‘flagship’ school in Brisbane through conversion of an existing school under the Independent Public Schools initiative, the training focus needs to shift to industry-informed and industry-standard training for real jobs. The number of women in trades across industries varies, but a general theme is that women remain under-represented in the trades. The traditional apprenticeship pathway and culture is demonstrably not attractive to women. This is an ongoing skills problem providing an opportunity for some lateral policy thinking and responses, and associated reforms. QRC continues to be heavily engaged in the long legislative reform journey for the state’s mining H&S legislation particularly around live proposals to significantly increase the number of statutory positions in the coal industry. QRC costs these proposals at an additional $86M/year to the coal sector, when the regulator has made no safety case whatsoever for these additional positions, rather proposing their implementation on the grounds of consistency with other states, notably NSW. Experience to date shows that applicants for statutory positions become ‘union-preferred’ or freelance ‘guns for hire’- in both cases at more cost to industry of entrenched union privilege or high contract costs to offset the regulatory risks associated with such positions.

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Additionally, it is proposed that candidates for these positions be evaluated through the Board of Examiners. This is an antiquated ‘cottage industry’ approach to educating and evaluating people for modern jobs, and at an additional cost to industry. The Board of Examiners is struggling now to handle its functions and additional statutory positions will cause it to become a greater bottleneck. If mines cannot operate without the multiple numbers of individuals needed for each statutory position across shifts, production will be impaired for no safety-related reason.