Stabilisation fund needed for mining
The Davis tax committee has rejected the introduction of new mining taxes such as windfall taxes, surcharges based on cash flows, separate flat royalty charges and rent resource taxes, saying they are not necessary, given the existing mineral royalties, which should be retained.
This may not seem significant now, given the mining industry’s dire straits, but the industry is notoriously volatile and its fortunes are bound to turn and profits recover.
This raises the question of how to put excess profits to good use when better days return.
The Davis committee has rightly recommended that a windfall tax, which simply swells state coffers but does not necessarily bring any benefit to the industry that generated the income, is inadvisable. The receipts should be used for the industry’s benefit when commodity prices slump and jobs are on the line.
I recently proposed that the government look at introducing a stabilisation fund into the platinum industry and this could be extended to other parts of the resources sector. A stabilisation fund would also strengthen the agreement reached on Monday between the industry, unions and government to stem job losses.
A stabilisation fund is a mechanism aimed at providing a degree of protection to producers from volatile resource prices.
By stabilising prices, such funds dampen the wild swings in revenue that characterise most parts of the resources industry. The mechanisms work in a relatively straightforward way: an “industry-effective” price is determined, which is a price level corresponding with a healthy return on shareholder capital, fair tax revenue, reinvestment of profits and rising employment of all factors of production. If the platinum (or other resource) price rises above this predetermined level, all “surpluses” are paid into a side pocket. If the price falls below the agreed level, funds are withdrawn from the side pocket to stabilise revenue.
Say the platinum price is $2 200 an ounce and the predetermined price is $1 500 an ounce; for each ounce sold, the mine would receive $1 500 on its income statement and the remaining $700 would be ring-fenced, to be drawn on when, or if, the platinum price dipped below $1 500 an ounce. Similarly, if the price fell to $1 000 an ounce, the platinum producers would recover an additional $500 an ounce from the fund for their production. This would still leave $200 an ounce in the fund.
The effect is to establish stable – not elevated – prices, thereby giving producers more certainty. The consequent smoothing of earnings would be an effective way to ameliorate one of the most negative effects of price volatility, namely the risk-averse and risk-chasing patterns now associated with large profit swings. The average profit before interest and tax for the total platinum industry for the past decade is R17.1-billion; the standard deviation of annual profit before interest and tax is R16.3-billion. In other words, a single standard deviation – which captures two-thirds of outcomes – takes the industry into super-profits or a loss; two standard deviations mean the difference between hyper profits or deep losses.
In turn, stabilisation of profit assists in improved planning, such as capex, more effective operations, lowering the cost of capital, bolstering profitability, encouraging reinvestment of profits, and boosting investment in the more stable labour force.
If effective, the fund should go beyond private gains and promote public gains, such as greater stability in employment and greater certainty in tax revenue collections. In turn, investment in labour and capital, in particular, should lead to productivity increases, which would translate into rising incomes.
The Chilean Copper Stabilisation Fund provides an impressive example of what is possible with the effective operation of such a fund. Created in 1985, it sought to bring stability to the copper industry specifically, and to Chile’s copper-dependent economy in general. Chile’s copper industry has been stabilised, mines have invested extensively in this more certain environment in capital and people and productivity gains have led to income gains, many other private gains and material improvements in public welfare.
To illustrate the extent of private gain, Erik Moreno, a miner in Chile’s Esperanza copper mine, after tripling his salary, said the pay was so good he’d never take another job.
The irony of Moreno’s comment cannot be lost in the context of the Marikana massacre of August 2012. Though the copper price has fallen markedly since the global financial crisis, it is commonplace for miners to earn bonuses in excess of $30 000 every two or three years, a number beyond imagining to mine workers in South Africa’s platinum industry.
In 2013, Bloomberg reported truck drivers at BHP Billiton’s Escondida mine were paid about $80 000 a year, excluding bonuses, more than their United States counterparts.
The success of the first fund led Chile to establish a second stabilisation fund to help the economy more broadly during “rainy days”. The fund in 2014 held $14-billion in surplus assets, equal to 5% of the Chilean economy. The equivalent figure in South Africa would amount to R200-billion – almost double the current market cap of Anglo Platinum, Impala Platinum and Lonmin combined.
A stabilisation fund is not hedging output. Hedging locks producers into a specific price and forces them to deliver. A stabilisation fund reprices every day; it doesn’t lock producers into delivery. Rather, it monetises production immediately. Furthermore, a stabilisation fund is easily in reach of a highly erratic industry that faces growing structural pressure.
Guided by the experiences of Chile – and Columbia, Mexico, Panama and Peru – a stabilisation fund has the capacity to support the South African mining industry, boost employment and wages, encourage investment and add to the overall wellbeing of the economy and one of its most important industries.
Adrian Saville is the chief strategist of Citadel Investment Services and holds a visiting professorship in economics and finance at the Gordon Institute of Business Science.