Queensland's loopy royalties logic

The announcement that the Queensland government intends to increase coal royalties as the obviously stressed industry cuts jobs and closes mines beggars belief.

Politicians, it would appear, live in a different universe to the rest of us.

A day after BHP Billiton announced the closure of its Gregory mine in Queensland and Xstrata announced 600 job losses and raised a question mark over the future of its $6 billion Wandoan coal project, and only a few days after Peabody Energy mothballed the planned expansion of its Codrilla coal project the Queensland budget contains an increase in coal royalties.

One can sympathise with Campbell Newman and his treasurer, Tim Nicholls. They have inherited an unsustainable fiscal position and that necessitates some harsh and unpopular measures.

Queensland’s coal sector, however, is fundamental to the state’s future finances and it is now under severe stress as a result of plummeting prices, soaring costs, an inflated Australian dollar and new competition from US coal mines forced into export markets by the shale gas boom.

Adding $1.6 billion to the sector’s cost base over the next four years by raising the royalty rate for coal valued at between $100 and $150 from 10 to 12.5 per cent a tonne and from 12.5 to 15 per cent if the price is higher is hardly conducive to encouraging growth in the sector.

The mine closures – BHP had previously closed the Norwich Park mine in Queensland and there are a host of existing and proposed mines now on miners’ watch lists – are signals of the stress the miners are under.

Nicholls appears to believe Queensland has been given a free kick. Under the Federal Government’s Minerals Resource Rent Tax royalties are credited against MRRT liabilities and therefore, while Wayne Swan has threatened to punish states that raise their royalty rates, in theory the Queensland increases (should the coal price reach levels that trigger them) should be offset by reduced MRRT payments.

That pre-supposes, of course, that the miners will face meaningful MRRT liabilities. The MRRT was designed at the peak of the resources boom to capture super profits. The boom has ended and the prices for both thermal and metallurgical coal are down more than 40 per cent from their peaks last year.

With, using BHP as an example, a $US1 a tonne movement in coal prices having a $US25 million impact on its net profit, the massive plunge in coal prices could wipe billions from its bottom line alone.

The tumbling prices will turn mines that were once solidly profitable into marginal or loss-making projects and deter the tens of billions of prospective investment that was in train before China’s economic slowdown punctured the commodity price bubble.

Whether it is the MRRT, state royalties or the carbon tax the coal miners are being squeezed on both sides, with the prices they receive slashed but their costs continuing to rise. There are plenty of coal producers and potential producers elsewhere that are operating in lower-cost and lower-tax jurisdictions that will be keen to displace the Australian producers from their markets.

Royalties, of course, unlike the returns-based MRRT, are volume based even though the mining states have built pricing triggers into their rate structures. They aren’t taxing profit and therefore the jump from the base royalty rate from 7 per cent while coal prices are below $100 a tonne to 12.5 per cent when the price is above $100 a tonne could act as quite a disincentive for investment or production even if prices recover somewhat.

The problem with the attitudes of both federal and state governments to the resources sector has been that in seeking to cash in on its perceived super-profitability to solve fiscal fissures of their own making (in Queensland’s case Newman’s predecessors’ making) they have chosen to ignore the issue of the industry's long-term sustainability and they have consistently refused to acknowledge that the miners operate in a globally competitive sector.

Maybe it didn’t matter when commodity prices were at stratospherically high level; levels high enough to accommodate the escalating costs and increasing tax and royalty takes.

Now that they’ve come down to earth, however, the miners will have no choice but to look for ways to slash the costs that they can (the mining services companies and contractors are in for a tough time ahead) or else to shut down projects that don’t generate appropriate returns.

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