THE DISTILLERY: Divided miners

It's a slow day on the commentary hustings so this column thought it would take a look at comment and analysis surrounding one of its favourite indicators, the Baltic Dry Index (BDI), which is fast approaching its April lows in a plunge of 30 per cent over the past couple of weeks. According to Pragmatic Capitalist, the BDI is dominated by capesize vessels which are, in turn, dominated by iron ore and metallurgic coal which constitute roughly half the loads. It is therefore an excellent proxy for Australia's most crucial exports. Barclays Capital offers the understatement that the index is likely to test its April lows. 

This column understands that the index has its flaws – try Business Insider for a good description of them – but it has proved a reasonable leading indicator for commodity demand, especially for coal and iron ore. 

So what do we make of its current collapse? China might be easing up on purchases as the quarterly pricing stoush is underway again. Or, it could be an early warning that the same nation is already proving effective in slowing its fixed-investment boom. Too early to tell, but a couple more days of plunging and it will have violated the technical pattern of higher highs and lows in place since late 2008, which doesn't bode too well for the dollar, ASX or the selling of the resource super profits tax (RSPT). For more on the index, try wikinvest.

On the subject of the RSPT, a couple of new pieces today are interesting. At Business Spectator, Munif Mohammed, GM for finance projects for a major retailer in Sydney, argues the "main distraction” in the debate so far has been "... the 'effective tax rate' (ETR) figure that mining companies are using to argue against the tax. It is a mistake to compare 'effective tax rates' directly between industries because it does not tell us exactly how profitable the industry is overall, but only what slice of those indeterminate profits are paid as tax.” Munif argues a better guide is Return of Capital Employed (ROCE) and provides an excellent table indicating the impact of the tax is much lower for "... the amount of money to be distributed as dividends or reinvested.” "It is nowhere near the '40 per cent' headline figure used to calculate the RSPT, and shows even more clearly how misleading the 'effective tax rate of 56.8 per cent' being promoted by the mining industry is. That figure is not wrong – but it gives a misleading impression of the true impact of the tax on the return investors make on their money.”

This column will add a couple of points. First, Munif's argument does not incorporate the higher cost of capital that miners have argued will be a consequence of the tax. Basically it argues that no such premium will be needed. At the same time, Munif makes the excellent point that much funding for mining is equity, not debt. This brings to mind Alan Kohler's recent model of a typical iron ore mine under the tax and how its net present value will be affected by the tax. The Kohler model was based on finance from banks which he argued don't accept the value of the government-guaranteed 40 per cent rebate. This column is wondering if equity capital would be any more accepting of the guarantee.

According to Stephen Gray, Professor of Finance at UQ Business School, in an Australian Financial Review op-ed, not likely. Gray argues that the principal flaw in the tax is the 40 per cent guarantee, which he couches as a "margin loan” from the miners to the government: "Consider a mining company with shares that are valued at $100. Now suppose the government borrows $40 to buy 40 per cent of the shares in that company, with the understanding that if the stock price crashes it will need to immediately repay the loan, plus interest ... Under the RSPT, the government in effect acquires a 40 per cent interest in all mining ventures in return for the provision of a government 'bond'. True government bonds are binding contracts with the commonwealth that guarantee payment. Under the RSPT, there is not so much a legally binding guarantee as a promise that policy won't change again in the future ... The second feature of the RSPT is that it is also a vendor financing arrangement, which exacerbates the pressure on government budgets during economic downturns, leading to either less funds for stimulus spending or higher government debt.”

This column will point out that Robert Gottliebsen of Business Spectator argued yesterday that the RSPT could endanger house prices by raising sovereign risk. This column did disagree with Gottliebsen's framing of the issue. The whole point of the tax is to redirect mining income away from private sector exuberance – so it isn't blown on something like a housing bubble – and toward greater savings and productive investment. If house prices are lower than they would have been as result, that's good. However, it can see a possibility that the RSPT drags housing into crisis if the government balance sheet comes under added pressure in a downturn, owing to large mining rebates. In that event, the government's already-existing guarantees of the banks' wholesale debt may come under ratings' downgrade pressure (not to mention new guarantees) making all finance for the economy more expensive. This column maintains its support for the concept of a resource rent tax but reckons the co-investment model should go.

Still on the tax, Elizabeth Knight of The Sydney Morning Herald looks into whether or not the current round of government negotiations can divide the mining sector. She sees the possibility for compromise for the coal-seam gas sector but concludes: "The divide-and-conquer strategy may win the government some ground but it is not a foolproof plan.The problem of this strategy is that the anti-mining tax campaign is being funded by the big boys – the companies that will need to contribute most of the tax. Playing around at the edges will mean nothing to them. These are BHP Billiton, Rio Tinto and Xstrata.”


Matthew Stevens of The Australian agrees.

In other comment, Bryan Frith of The Australian looks into a stoush between Aquila Resources and Vale. Tony Boyd (Chanticleer) of the AFR analyses Guinness Peat. 

Finally, this column must acknowledge that in its condemnation of commentators for their overlooking of the great Australian bank bailout, it ignored Henry Thornton of The Australian, who has been the most vociferous critic for years, with more today.