The Royalty Race
By Alena Mikhan and Andrey Dashkov, Casey Research,
In our analysis, we take political risk increasingly seriously as more and more reports about questionable new state initiatives flow in. This time news comes from Bolivia where, according to Reuters, the government “plans to raise mining royalties to take advantage of high global metals prices and bolster the state’s role in the industry.”
Earlier this year, Bolivian president Evo Morales issued a decree that annulled existing mining, banking, and investment laws. Taking into account that by that time he had already seized oil and gas industry assets, pension funds, telecoms, and electricity companies, among others, there were expectations that the mining sector would follow suit. However – and not a little ironically – threats of union strikes halted the initiative.
However, the silence is now over. The government has announced its plans to increase its take by upping mining royalties. The current average royalty of four percent of the international spot price will go up to a maximum of seven percent for gold; six percent for silver; and five percent for zinc, tin, and lead. The royalties will apply when the metals pass specific price levels.
This move does not surprise us. Commodities have been performing very well this year, and politicians have seldom been able to resist the temptation to rake a larger portion off the top when they can.
As we’ve already discussed, Venezuelan president Hugo Chavez (Morales’ close friend) announced his plans to nationalize the gold sector just several weeks ago.
Also in August, Ecuador’s President Correa claimed that new exploitation contracts with mining companies are needed. The contracts should include a provision that the miners pay 8% in mining royalties instead of the current 5%. The purpose is to create $100-200 million in revenue for the state next year. In a move of breathtaking arrogance and ignorance, the scheme calls for royalty payments to be paid in advance of production.
Peru – previously one of our favorite mining jurisdictions – raised taxes after leftist president Ollanta Humala came to power this July. At the end of August it was reported that the various players reached an agreement that forces mining companies to increase their contributions to the state by about US$1.1 billion a year. The precise royalty rate was not specified, but it’s expected to be higher than the current one to three percent.
Brazil is also considering a mining royalty increase as part of a wider reform. The new royalty rates are expected to vary between 0.5 and 10 percent of company revenue, depending on the mineral in question. For example, iron-ore royalties are expected to increase to four percent from the current two. Another proposal is to make raising or lowering mining royalties easier, depending on economic conditions and minerals prices. Under current regulations, changes to mining royalties have to be approved by the Congress.
The Chilean government was among the first to adapt to the rising gold prices. It raised mining taxes in October last year, with the announced intention being to help fund reconstruction after the country suffered a devastating earthquake. The flat-tax rate of 5% was replaced with progressive tax rates ranging from 5% to 14%.
So far, Colombia – one of our favorite mining jurisdictions in Latin America – seems to be staying out of this royalty race… but the country is undergoing an institutional transformation in the mining sector, and a tax reform is likely to follow soon. The reform will be presented to the Congress this October; there are worries that it may include provisions for tax or royalty increases.
At the beginning of the year, Colombian Mines and Energy Minister Carlos Rodado stated, “Colombia will not follow other countries that have either proposed or implemented higher mining royalties amid rising and record commodity prices.” This sounds reassuring, especially given how enthusiastic Colombia’s regional peers are about benefiting from rising commodity prices. But we all know how to tell when a politician is lying: His or her lips are moving. We’ve avoided Ecuador, Bolivia, and Venezuela for years, and now are out of Peru, but we still have exposure in Colombia and will be watching it closely.
All of these rising royalties and taxes are, if not good, then at least understandable; of course opportunistic governments will take what they can. And – as we’ve reported before – there are similar threats in the US and Canada. And truth be told, higher prices do make many projects profitable under higher royalties – up to a point.
Bottom line: No place is sacred, no place is safe – but in some places, the politicians are smarter than others, and they understand that they cannot kill the goose that lays the golden eggs if they still want eggs. Free markets and justice for miners who take such enormous risks building mines may not be a choice, but some measure of economic sanity is possible. This is what we’re looking for as we continue investing in the mining sector.
Categories: Commodities, Latin America