02/11/2016 - 14:00

Grylls on right track over royalties

02/11/2016 - 14:00

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The proposal from Nationals WA leader Brendon Grylls to increase the royalties paid by Rio Tinto and BHP Billiton is not as ‘out there’ as it sounds. I say this not as a socialist, but as a capitalist who, as a resident of Western Australia, is an indirect part owner of the state’s iron ore reserves.

Grylls on right track over royalties
Brendon Grylls’ iron ore royalty plan would benefit the state’s economy.

The proposal from Nationals WA leader Brendon Grylls to increase the royalties paid by Rio Tinto and BHP Billiton is not as ‘out there’ as it sounds. I say this not as a socialist, but as a capitalist who, as a resident of Western Australia, is an indirect part owner of the state’s iron ore reserves.

The government was desperate to attract miners when seeking to establish an iron ore industry in the 1960s, and the conditions they were to operate under reflected this.

Now, more than half a century after those deal were inked, the government needs to shift its thinking in order to receive fair value for our extensive, but ultimately finite, resources.

The iron ore miners are understandably angry at Mr Grylls’ idea. They have worked very hard to get their costs down and have achieved excellent results. They see Mr Grylls’ proposal as a grab for the profits they have worked so hard to achieve.

But the Nationals’ leader has a valid point. The royalty rate represents how the revenues from our iron ore are shared between the state government and the mining companies, and the large miners are not paying enough for the iron ore they extract from this state.

The arguments against Mr Grylls’ proposal have been forceful, but none stands up to scrutiny.

‘Too much tax’

The first point to get clear is that a royalty is not a tax. It is the price miners pay for minerals that belong to the state. Software programmers, musicians, authors and inventors all receive royalties for their work as a means of paying them based on units sold. It’s the same with iron ore. In fact, both Rio and BHP treat royalties as an operating cost in their accounts. Increasing the royalty is not increasing the tax burden on miners – it is increasing the price they pay for the iron ore, which belongs to our state.

‘Unacceptable sovereign risk’

Having your assets nationalised and your employees expelled or jailed is a sovereign risk. Increasing the royalty rate is not a sovereign risk, it is a commercial risk, no different to the risk that the workforce might demand higher wages or that the cost of transport might increase.

‘It will make WA iron ore uncompetitive’

There is a suggestion that the proposed $5/tonne royalty would be added to the price of WA iron ore, which would make it uncompetitive on the world market. The reality is that prices would continue to be set by the market and the $5/t would come out of the miners’ profits. Clearly, they don’t like that idea, but it won’t make WA iron ore uncompetitive. It will just be less profitable.

‘Look at what iron ore mining has done for WA’

Clearly mining has done an enormous amount. Iron ore mining has made WA what it is today. But WA has also made the iron ore miners what they are today – incredibly profitable world leaders in their industry. They have gained much more than they have given, and that is the heart of the issue.

‘It will jeopardise jobs’

Perhaps this is not the best argument to run at a time when the iron ore industry is one of the state’s largest ‘unemployers’. The large miners have made it clear that they want to run their operations employing as few people as possible, and they been automating processes and ruthlessly cutting jobs at all levels of their organisations – from head office to mine sites.

BHP Billiton CEO Andrew Mackenzie recently talked of his company’s ‘inexorable pursuit of reducing costs’, which is management speak for ongoing job cuts. All of those cost savings that have been achieved through eliminating jobs have made our iron ore miners very efficient producers, which is an admirable achievement, but it is not one that benefits this state. All the savings flow to their shareholders in the form of increased profits and the state gets the increased unemployment.

‘The big miners might pull out of WA and go somewhere else’

To where? The reality is that they are a permanent fixture in WA as a result of the massive volume of ore in the ground, the significant investments they have made, and the enormous profits they are making.

‘It will deter future investment’

The knowledge that a government will not seek to increase royalties until there have been 50 years of successful production is more likely to be an attraction for new mining operations than a deterrent.

‘The extra revenue will go into Commonwealth Grants Commission revenue sharing process and be redistributed to the other states’

This would be true if the increased royalty income was added to the state government’s current revenues, but Mr Grylls is proposing that it be used to reduce payroll tax, not to increase revenue.

‘Why should this royalty increase target BHP Billiton and Rio?’

For one very good reason – they have been here for a very long time and have recouped their original investments many times over. When the original royalty rates were agreed, no-one (apart from maybe Lang Hancock) would have contemplated that the mines would grow to this scale and level of profitability. In these circumstances, it is not unreasonable for the state government to seek to renegotiate the royalty arrangements.

‘It would be unfair to break such a longstanding agreement’

Opposition to governments moving the goalposts is understandable, but governments move goalposts all the time. Superannuation is a current example. The fixed royalty of 25 cents per tonne has been in place for 50 years, an extraordinarily long time and well past the time any private owner would have sought a renegotiation.

The reality is that any contract can be renegotiated. The royalty agreements date back to the 1960s when there was an embargo on iron ore exports and the state government had to beg mining companies to come to WA. There were no ports, no railways or infrastructure of any kind, and no customers. Things are a little different now.

In recent years, BHP and Rio have made very large investments in expanding their production capacity and in production efficiencies. These investments have resulted in significant reductions in the cost of production and they were made in an environment of established reserves, infrastructure and markets.

The risks of these investment programs cannot be compared to the risks involved in the developing mines from nothing. It’s a different world now and there should be a different royalty arrangement.

Ultimately, the issue for the state government is whether employers should continue paying high levels of payroll tax and homebuyers high levels of stamp duty, while the large iron ore miners pay low royalties.

Payroll tax and stamp duty are brakes on our economy. Reducing or removing them would benefit nearly everyone in this state – to a far greater extent than the trickle-down effect of iron ore operations.

Mr Grylls has proposed a feasible plan to reshape the state government’s revenue streams in a way that would be an enormous benefit to WA. His proposal is the start of a renegotiation, and the large miners’ angry outbursts and forecasts of doom are their initial responses.

It’s all posturing. The miners know that one day the royalties will be renegotiated, so their strategy is all about delaying that day. Similarly, Mr Grylls knows that he may not get an extra $5/t and whatever he does get may be phased in over time.

But he’s on the right track and it is surprising that more people haven’t supported him.

 

• Simon Withers is a non-executive director at WA Super and a former investment banker.

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