KGB: Mitch Hooke

The Minerals Council of Australia chief says the federal budget could see a large number of mining projects leave Australia if it includes new taxes on the industry.

The Minerals Council of Australia's Mitch Hooke tells Business Spectator's Alan Kohler, Robert Gottliebsen and Stephen Bartholomeusz:

AK: Well Mitch, welcome to KGB Interrogation.

MH: Thank you.

AK: Now, the mining tax is back on. Well, it hasn’t really been off the front pages, but it’s kind of back there with Andrew Forrest saying he was about to do a deal with Kevin Rudd that would have got rid of the original resources rent tax just before Rudd got sacked. Do you know about that – that it’s true?

MH: Oh, I knew that he was in negotiations with the prime minister and…

AK: Did you know they did a deal?

MH: No, I didn’t know that, but I fundamentally disagreed with his approach.

AK: Whose approach? Andrew’s?

MH: Andrew’s, yeah. He was about trying to essentially reconstruct the super profits tax in a different guise. We were trying to get back to the fundamental objectives of it being a rent tax, not the reintroduction of a new company tax. Even though you don’t need the minerals resource rent tax for Australians to be sharing in the benefits… and we can have a yarn about why that argument stands up.

The whole idea of a rent tax is that you actually tax the inherent value of the resource in the ground. Once you start taking account of investment, capital costs to get what you’re doing out of the ground, then you are starting to introduce essentially another company tax. The whole integrity of what we’ve done with the minerals resource rent tax is to quarantine it to a rent tax. We’ve quarantined the downstream investments in infrastructure and value adding and the like. Once you start putting those back into the mix, you’re just designing another company tax. And you’ve got the theoretical symmetry that if you’re going to have deductions on your expenditure, you’re also going to have tax.

AK: But Andrew Forrest has been fighting you all the way along, both then and now, and isn’t he a part of your council? I mean, don’t you represent him?

MH: No, he’s not a member of the Minerals Council of Australia. He was not a part of our campaign. He made no financial contribution to what we did, but we were certainly in dialogue with him in the very early stages and there was absolute unanimity and purpose in defeating that tax. Where we parted company was in the ways in which he went about it.

Now, it’s all very well if you’re a miner who owns third party infrastructure or if you’re a miner who’s a recent entrant to the industry, so that your book value and your written down book value and your market value is much the same, but if you’re a company that’s been in the industry a long time, then of course you want to start off with market value as your starting base. This gets very technical, but you guys know what I’m talking about.

AK: So basically it’s a battle between old and new miners, right?

MH: It’s a battle about the principle of retrospectivity. Nowhere in this country have we introduced tax laws where we have not started off with market value. They did it with capital gains tax. Why would you penalise long term entrants? Why would you penalise companies who have made decisions to invest in this country on the basis of the tax laws that existed at the time they made those investments? So, the idea that you would bring everybody in, but those who have been in for a long time would be at a book value, yeah…

Let’s theoretically say $20 billion dollars’ book value is written down, but the market value is at $150 billion. But if you’re a new entrant and you come in at $150 billion and that’s your starting base, that’s the level of your depreciation determinations for deductions to what is your taxable income. So the point is that if you’re a new entrant, you get a heck of a kick up if the starting base losses are at book value. As I said, this gets very complex.

AK: It’s not that complex. It’s pretty simple I think.

MH: Okay.

AK: Isn’t it? But the base being the starting place for depreciation, being book value.

MH: But the key element in all this is that we set up a whole stack of good tax design principles and the deal that was done – it’s easy to demonise that as being the three multinationals who did the deal, but let me tell you they sit on our board – and there’s no way that deal would have got the currency of support from the Minerals Council of Australia if it hadn’t met all the fundamental principles; one of which was retrospectivity and that is that you do not penalise in a retrospective sense, on account of new tax laws, those who have been in the business a long time.

You have to start off at a market base to do it and that was the point of differentiation between us and Mr Forrest, so too was taking account of the expenditure in downstream activities. Now, we quarantined that from the inclusion in the minerals resource rent tax because if you don’t, then you’re just going back to the super profits tax, you’re just introducing another company tax.

RG: Let’s assume that commodity prices stay as they are. What do you think that tax that you negotiated will raise? Is it going to raise $10 billion or is it going to raise nothing?

MH: We don’t get in that space. I have purposefully…

RG: You know though, don’t you?

MH: …and deliberately stayed out of that space.

RG: But you know.

MH: Well, no. No, I don’t.

RG: Okay.

MH: Because I’m not privy to the commercial circumstances of the individual companies. And nor have we attempted to second-guess Treasury’s assumptions and modelling. My role and responsibility was to get the policy parameters right. My role and responsibility was to ensure that if you’re going to have a rent tax, have it as a rent tax.

There are two buckets of value to come out of the mine. That bucket is the inherent value of the resource. The other bucket is the value added expertise and entrepreneurial capability of the miner. The super profits tax lumped them in together. It was a very poor proxy for a rent tax; that is, a tax on the inherent value of the resource in the ground. That’s what we set about trying to fix in the MRRT, the minerals resource rent tax, and we’ve done that. So, it’s a cash flow positive – a net positive cash flow tax on the in situ inherent value of the resource in the ground. That’s what we have designed.

AK: And do you think that’s better than an ad valorem royalty?

MH: No, I don’t. The concept of profits based royalties is one we put on the table as a principle in the Henry Review. The idea that that meant you had to be automatically centralised in the federal government was completely wrong. We said all along, 'well that’s the theory'. You’re better off having a joint venture arrangement between the owner of the minerals and those people who are going to develop it. I mean, it’s only dirt in the ground.

AK: The owner of the minerals being the state governments.

MH: Being the states, right, the sovereign state. They own the minerals. Why wouldn’t they enter into a joint venture? The argument is, well, they would say: "we’re going to rent you that. You know, you can develop it. We’ll take a royalty. It’s a royalty model. That’s our materials. You go off and develop it." But there is an argument for a joint sharing in the risk and reward. You see, when you have an ad valorem royalty, it becomes a charge on the cost of doing business upfront, irrespective of your profit. So your effective tax rate, if you’re a start-up, before you’re earning profits goes through the roof.

What we did with the MRRT was to effectively cap that effective tax rate at forty-five cents in the dollar by getting all of those royalties credited against it. So, if a company has a higher effective tax rate than forty-five cents in the dollar, it’s on account of the fact that the royalties are a charge on the cost of doing business upfront. So, there’s a difference between the MRRT applicability and the MRRT liability. It may apply, but your liability will only be up to forty-five cents. And if your effective tax rate is higher than that, it’s because you don’t have the cost, the deductions and the profit to offset the charge that you’re getting on your royalties upfront.

SB: To go back to what Bob asked in terms of how much the tax is going to raise, is it possible for anyone to know with any kind of precision what it will raise given that the inputs vary from day to day, the fluctuating commodity prices and the dollar?

MH: No, I don’t think anybody can know that with any precision. I think what you guys were saying on Sunday on Inside Business is absolutely spot on; it’s highly volatile. And it will be highly volatile because it’s a profits tax. So, the concept of a profits tax is important. You have to have the states in the game. They didn’t. You can’t do it without having the states in the game and they didn’t have it.

What we now have is a top up tax. This is not tax reform. This is a top up tax. And we struck the deal, ok. Those guys negotiated it because it was all about the commercial figures. They had to go in there and open up their books. I might add we made that offer all the way through the whole reform process and it wasn’t taken up. So when they were looking down the barrel – and nothing focuses the mind more sharply than looking down the barrel – they started working with the companies to go through those figures, and they got a better understanding of the commercial circumstances of what happens if you hit the industry.

Back then, they were proposing to put a tax on the industry of fifty-eight cents in the dollar for every dollar you’d earn over what you would get if you put your money in the savings bank. Now, that was a massive destruction on their present value in projects. It wiped it out on all base metals and precious metals and cut it in half for all coal and iron ore projects that are in what we call the second tier; in other words, the second quartile of the cost curve. So, we modelled those on the basis of under any circumstances all things being equal those projects would go ahead. And we found that that fifty-eight cents effective tax rate on the super profits tax would have wiped out the value of those projects and halved it in coal and iron ore. That’s a massive hit.

And regarding your question, "can you predict what will be the revenue take with any certainty", no of course you can’t. I mean, look at what has happened since that deal was struck in terms of what forex is doing and what prices have done. We always knew commodity prices would ease. They were running at quite a substantial margin to the long term run of marginal costs of production which is basically where commodity prices track. And they were up there because of the buoyancy in the capital markets, a massive amount of capital flowing into exchange traded products and exchange traded funds. There was this risk premium.

Everybody’s running around thinking "the boom, you know, away we go" and all the capital markets, so there it always overshoots up and it always overshoots on the down. So, we’ve seen an ease in commodity prices. Forex, foreign exchange, is having a massive impact on commodity prices and we’re seeing cost inflation now running 3, 4, 5 per cent and even up to 10 per cent in some places which of course means that your costs are going to be deducted, your prices are coming down and, as I said, it is a net positive cash flow tax. There’s the inherent source of your volatility.

SB: Plus royalties have also got up in some places. So, if you take all those things and put them together, you’d say the tax is probably going to raise less than they anticipated and yet they’ve dedicated…

MH: I’m not saying that. You may be.

SB: Well , I’ll say it. And they’ve dedicated the revenue from that tax to recurrent spending. That means, doesn’t it, that your industry is going to be the focus of different types of attempts to garner revenue?

MH: Yes. Quite right. And that’s our fear at the moment.

SB: The diesel fuel rebate?

MH: Correct. And even though there’s media speculation that some of the legitimate business tax deductions are not on the agenda, they are on the agenda; it’s only a matter of timing. They are under consideration and given that this is a business audience, they’ll understand what change in cap rules means, they’ll understand what taking exploration expenditure and making it as a capital deduction rather than an expense deduction in the year it’s expended, they’ll understand what changing the accelerated depreciation arrangements means particularly for the oil and gas industry. They’ll understand what changing overburden arrangements is where they are actually expensed in the year in which you spend the money or deduct it in the year in which you expense them. But to make those and to put those in as a capital expenditure and amortise it as an appreciation item means that that affects revenue.

AK: Is that a possibility?

MH: Oh yes.

SB: Yeah.

RG: That destroys Olympic Dam doesn’t it?

MH: I never get into talking about individual projects, you know that, but it certainly will have major ramifications for those projects that are very overburdened expenditure.

RG: Yes. Of which there’s none greater than that one.

MH: It’s pretty big.

SB: If you had a project where you had to spend $5 billion dollars just to clear the overburden and use a lot of trucks, so you’d use a lot of diesel, the economics would change dramatically under the circumstances you’re talking about, wouldn’t they?

MH: Well, you need to put that question to the company involved, but you know in the words of Forrest Gump "I’m not a smart man, but even I can work that one out".

But you also raised the diesel fuel rebate. Now, the diesel fuel rebate is not a subsidy. Treasury says it’s not a subsidy. We all know that it was an administrative arrangement to essentially take the excise which was for administrative ease was paid up front, but to take it off those who were not subject to the excise in the first place because it was brought in as a road user charge. So, to essentially take away those offset credits, you’re introducing a new tax and you’re introducing a new tax for people who are using diesel off road.

So not only are you compromising the bipartisan agreement that you don’t tax production inputs – everybody knows that. I mean, if you want to reduce the dead weight loss to the economy of tax you stick them as far out to the point of consumption as you can. So, we’ve had that bipartisan support all along, but equally you’re compromising the very basis upon which this excise was introduced in the first place – and that is that it’s a road user charge, so why would you now seek to tax people who are using it off road?

AK: But it’s also a tax on exports.

MH: Correct.

RG: Your view is that all these things are about bridging the supposed gap between what they thought the mining tax was going to bring in and what it’s likely to bring in.

MH: Well, yes, but I also think it goes to the fundamental issue that they think that we’re just a bottomless pit to be taxed. It goes back to the theory, the flawed assumptions in the original super profits tax, and that is that our activities are immobile and that you can tax them and we can’t respond to the effects of the tax.

But they forget that this is probably now one of the most globally integrated industries getting around, that our capital – our people and our financial capital and our technological capital – move at the speed of light and they will be deployed where it is strategically opportune to do so. They don’t understand that business leaders make decisions on the long-term margin and they make decisions on what are going to be the post tax adjusted cash returns; that’s the marginal cost between supply and demand, taking a discount factor for the weighted average cost of capital.

Now, that is basically the formula for net present value. It’s a long-run decision that they make. They’ll make it today and they’re gone tomorrow. These executives, these companies don’t run through interdepartmental committees to make all these decisions. They make the decision and they move on. And so it’s where we sit in the relative rankings throughout the world which determines whether or not companies are going to invest in Australia. In other words, our capital is mobile. That’s the point I’m trying to make.

RG: Once it’s invested, it’s not.

MH: Well, no, it is. You’re seeing that already. You’re seeing that companies are either scaling down, putting operations into mothballs or not gearing. Now, look at what Australia has been doing. We’ve got a massive level of investment coming into the mining industry and yet our export volumes haven’t actually been increasing since 2000. Our export values have, of course. But it’s been an era of price growth. We need to shift to an era of volume growth. The profits are not going to come from margins. The profits are going to come from volumes.

The relationship between marginal costs of production and profits is defined more in volumes for our industry than it is in the margin. You know, if you’re doing a gram a tonne, a gram of gold and a tonne of ore for gold and your opex, your operating expenditure is $800 to $1000 and your capex is $200 to $400, you need to have $1600 to make it work. The margin hasn’t changed. It’s the volumes that are going to drive profits. So, if they don’t have the confidence to invest, and as you know business confidence to invest is highly elastic, and if the sovereign risk becomes something that we haven’t dealt with because they keep changing the circumstances of our tax regime, you would have thought we’d have had some respite after the MRRT, the carbon tax, a 500 per cent increase.

Since the boom started back in 2003, we’re paying about $4 billion in tax, the company tax and royalties.It’s now $24 billion. That’s a five hundred per cent increase. To suggest that you need another tax for Australians to be sharing in the benefits of the boom is actually a bit laughable when you see that kind of increase. But we are going to get another tax. Treasury’s estimate said either that will be $3 billion or $4 billion bucks. Then throw on the carbon tax, which is another $3 billion to $4 billion. You’re going to be ripping about $30 billion odd out of this industry. And still they come, but it’s the sovereign risk associated with this continual carping away at an industry that is undermining the capacity for us to invest today to get the rent tomorrow.

RG: So, there’s a series of Australian projects that are not beyond the point of no return like Queensland Coal, like Olympic Dam, like some of the iron ore expansion programs in Western Australia that are now in jeopardy?

MH: Well, we said all the way through – and with the carbon tax, we said you if put this kind of overload, this kind of impost, you’re going to see smelting and refining in this country come under real pressure. Well, you’ve seen two of them in Tasmania and Point Henry in Victoria is under review. We also said well you start adding in the inflexibility of the labour market and wage costs increasing, you’re going to start adding to the costs. So, it’s labour, it’s energy, it’s transport, it’s construction, they’re all increasing massively.

We don’t have the productivity improvements as offsets, notwithstanding the lag effects of our capital investment to the productivity indicators. We’re not getting the productivity offsets. We’ve got the CEOs telling me that they’re now running upwards of two times cost structure for some of their operations, compared with operations offshore. So, we’re starting to run ourselves out of the equation of competitiveness in costs.

I mean, you know what the kingmakers are. They’re where you sit on the global cost curve. They’re what your productivity is running at. It’s your sovereign risk and your social licence. They’re the four kingmakers. We’ll come back to the social licence. But the sovereign risk issues are profound. And the tax becomes an issue where companies are looking at it and saying "well, you know, what’s next?"

You’ve got these four issues, which are legitimate business tax deductions, that you’re looking at taking away. You’re throwing the overburden in as a consideration and you’ve got diesel fuel rebate on the agenda, all of which don’t have any solid basis in rational economic consideration or the bipartisan approach to which businesses deduct legitimate expenditures. And why are you even discriminating against the mining industry compared with everybody else? Investors are standing back and saying "this is a cost environment that is high and potentially and prospectively so". We’ve got a sovereign risk issue here because we’re not sure where governments are going to go and we’re actually penalising the industrial transformation of value-adding activities on the sort of faint hope that we’re actually going to do something about reducing global emissions.

Read the second half of the KGB Interrogation with Mitch Hooke here.

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