Pros and cons of a $300M royalties holiday for the Adani mega mine

The acrimonious political debate on the proposed Adani mega mine (see Brisbane Times coverage) would be well informed by a number of economic policy considerations that I discuss below. Some of these, but not all, would lend support to a royalties holiday. This is not a straightforward decision for the Queensland Government, so the reported split in Cabinet is understandable from that perspective.

Pros

Those considerations which would lend support to the royalties holiday include the following.

  1. Mining royalties are a bad way to raise revenue in the first place. You may recall Ken Henry’s tax review was scathing of them and recommended they be replaced by a resources rent tax. But the federal government of the day bungled its implementation, and we are no closer to efficient taxation of earnings from natural resources.
  2. There are quite a few credible predictions of rapid de-carbonisation of the world economy (e.g. see Dieter Helm’s Burn Out: The End Game for Fossil Fuels). So it may well be in Queensland’s economic interests to grant the royalties holiday, so the coal at the site can be extracted as soon as possible, and to get whatever royalties revenue we can, even if lower than previously expected.
  3. North Queensland economies with high rates of unemployment would benefit substantially from the mine, as I have noted previously (Why the Adani mega mine is welcome news in Townsville). This is relevant in a cost-benefit analysis to the extent that the mine employs people who would otherwise remain unemployed, and along with the royalties revenue is one of the major ways Queenslanders realise part of the net benefits of the mine.

Cons

Now for those considerations which would not support a royalties holiday.

  1. As noted above, royalties are one of the major ways Queenslanders benefit from the project, so any reduction in royalties consequently reduces the net benefits distributed to Queenslanders (and increases the net benefits to the foreign-owned Adani, if the project proceeds) and makes the project less attractive from the community’s point of view. The Government, which had previously decided the mine’s economic benefits outweigh its environmental risks, may well now take a different view.
  2. If the Government gives in to Adani on this, which mining company will it give in to next? The Treasury will be bombarded by approaches from mining companies pleading for royalties relief so they can maintain production or justify expansion. It may be desirable for the Government to maintain a hard line, to protect other royalties revenues from erosion. Royalties, after all, are worth $2-3 billion to Queensland’s Budget each year.

Conclusion

This is not a straightforward decision for the Queensland Government. I have previously supported the mega mine, but I would be willing to test just how much Adani needs the royalties holiday to make the mine viable. The Government should not meekly give in to Adani’s request for relief. A royalties holiday should only be considered as a last resort, in the case where, if it were not available, Queensland would forever lose any option of developing the resources at the site.

Disclosure: In 2015-16, I worked as a sub-contractor to an engineering company that was consulting to Adani.

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4 Responses to Pros and cons of a $300M royalties holiday for the Adani mega mine

  1. Russell Rogers says:

    Gene, I am not sure I agree with your or Ken Henry’s concern about mining royalties (I have not read Henry). I was very concerned about the original mining super profit’s tax as well….why?

    For a start mining companies pay company tax at the normal rate but in the early years they have huge depreciation deductions because mine are enormously expensive to get to a point where you can make the first dollar. They are also paying back lots of capital so net cash is low. In the coal industry there are typically no taxable profits for some time. But coal royalties are paid on the value of the coal in the ground. This is based on price less some upgrading deductions. Therefore even if no company profit or if prices are in a low cycle royalties will be paid. The QLD government also has escalation increments based on price so when in a price up part of the cycle the royalty rate goes up. I estimated that coal mines would return about 42 to 47% of their profits in company tax and royalties in good times…that is not a bad government return and is considered the price of the resource to be mined.
    So, having a royalty holiday for the first few years for Adani, only because they are a first mover in the Galilee Basin, may not be a bad compromise in my opinion. Jackie Trad and others saying we will forego $300M in royalties seems to think that we will get the other $22B in estimated royalties from this operation some other way…I doubt it. And, what about the direct jobs and the regional mine support companies and their employees and families. Thousands of people will benefit from the start of construction wight through to production. Many millions in company tax, income tax and GST will be generated even with no royalties for a while.

    Most people do not understand the economics and risk associated with large mining projects. The initial cost is enormous (really enormous) and that has to be funded by debt and/or shareholders with no net return typically for years. On top of that is price risk. Coal and iron ore are commodities they cycle up and down and the down times can be very long and the up time are very short because it is an unregulated market. Being a commodity they will ultimately trend down in price. The up cycle is short as we have seen because when the price goes up mines expand production or new mines start up that are less economical and that forces the price down and some mines to close. Thirdly, there is the resource risk. Unlike most industries one never really knows with 100% accuracy what is actually in the ground. Millions are spent on drilling, sampling and mathematical interpretation but until it is totally mined you are never really know. Coal and iron ore have less risk when drillers and geologists and geological statisticians do their job expertly, all part of the cost before production. Fourthly, or really this is first, there is sovereign risk. Mining is a typically a very long term investment with overall low rewards. You have to be sure that governments are not going to change the rules too much after you make a decision. Look how long it has taken for Adani to get to a decision point! That is going to effect any other company attempting to make the same investment.

    The original super profits tax was going to tax 40% of profit above the bond rate which then was 5%. It is much lower now. This totally misunderstood that coal mines and iron ore mines over their life if they are lucky make about 5% return on capital investment. A (coal) mine makes no money for years and is paying back capital so no cash flow then the prices are low so runs at a loss for a few years and then they get a short boom time and the government was going to steal the cream then they are back to a low income environment. Any mining company who cared about their shareholders would have sold out and gone elsewhere. Who would have bought? Well, the Chinese of course. The government would have let them otherwise most coal and iron ore mines would have closed.
    The Chinese don’t care about profit in Australia so would have used every trick in the book to lower the price to reduce company tax and royalties. An absolute disaster for Australia, government income and superannuation funds.

    • Gene Tunny says:

      Russell, you raise some very good points. Many thanks. Yes, the Rudd Government’s super profits tax was flawed, definitely in its implementation and arguably in its design for the reason you mention. I agree with you about the cash flow problems miners face. But in my view this suggests we should move away from royalties altogether and have a resources rent tax that is appropriately designed. I’m not totally against the royalties holiday and agree it could be a useful compromise, but it appears to be second or third best policy in my view. And I’m concerned that Adani appears unable to arrange sufficient finance for the project and needs a helping hand from government to get the mine and rail line up and running.

      • Russell says:

        Gene, It would be interesting to go back in history and find out how the funding for the first coal freight trunk rail line into the Bowen Basin was funded. It was government owned but I don’t know how it was funded. Also what the royalty rate was at that time. The only reason the big open cut coking coal mines first got going was because of the use of draglines which are extremely expensive. So maybe a similar situation.

  2. Gene Tunny says:

    Yes, Russell, you’re right it was government owned. Sir Leo Hielscher’s book Queensland Made provides some detail. It appears the rail lines were financed by government borrowing and the cost was recovered through higher freight charges. I’ll try to cover this history in a future post.

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