Unearthing an MRRT pricing puzzle

The most interesting aspect of the mining tax inquiry will be finding out just what led the government and Treasury to so badly misread commodity prices.

For the Coalition and the Greens the establishment of a Senate inquiry into the minerals resource rent tax is an opportunity to needle and embarrass the Gillard government in the lead-up to the next election. For the rest of us it may provide a better understanding of how the government and its advisers in Treasury got their estimates of MRRT revenues so badly wrong.

While the inquiry will look at the actual design of the tax, in many respects because it is – relative to the resources super profits tax that it displaced – a fairly straightforward tax, that will be the least interesting aspect of the findings.

Unlike the RSPT, which had elements of retrospectivity and expropriation as well as some fundamental conflicts between its untried theory and the impacts it would have had in practice, the MRRT is a genuine super profits tax.

If there are no super profits, there is no tax. As it happens, the collapse in iron ore and coal prices during its first six months meant that the big miners’ profits weren’t that super – hence the meagre $126 million of revenue raised. You don’t need an inquiry to explain that outcome – just look at Rio Tinto and BHP Billiton’s results for the December half-year.

With commodity prices stronger so far this year the MRRT should, of course, do better in the second half but the basic premise of the tax is that it only applies to super profitability.

It was, however, always peculiar that a tax that was so much narrower in scope than the proposed resources super profits tax it displaced, which had a far lower effective tax rate and which gave the big miners the option of using market rather than book value as the basis of their tax calculations could originally have been forecast to raise $10.5 billion in revenue by 2013-2014 – only $1.5 billion less than the RSPT. (In last year’s budget the forecast revenues for the first two years was revised down, to a still-optimistic $6.5 billion).

It subsequently emerged, of course, that between the dumping of the RSPT and the forecasting of the MRRT revenues Treasury changed its assumptions about iron ore and coal prices to reflect ‘’the most up-to-date information’’ available to it. That revision appears to have added about $6 billion to the original forecast of MRRT revenues.

There have been suggestions that Treasury based its assumptions on information provided to it by the miners. Presumably the inquiry will probe that. Even if that were the case, however, you’d expect the government and its advisers to treat industry numbers with some caution, test the assumptions rigorously and discount them for risk and uncertainty.

The practical problem, of course, is not so much that Treasury got its numbers wrong to the point where the first six months of the MRRT generated virtually no revenue, but that Wayne Swan went out and ‘spent’ the forecast revenue before it arrived.

It didn’t help that Swan and Gillard committed to the miners that they could offset any increase in state royalties against their MRRT liabilities – which prompted the resource states to increase their royalty rates.

What’s odd about the revisions Treasury made to the commodity price assumptions underpinning its revenue forecasts is that in July 2010, when the MRRT and its revenue forecasts were announced, iron ore prices were at their lowest levels in more than three months, having dropped back from more than $US170 a tonne in April to around $US130 a tonne.

Ironically, as the MRRT was unveiled, prices then climbed back to record levels by early 2011 (almost $US190 a tonne) before falling steeply to a low of about $US87 a tonne last September. In recent weeks iron ore has climbed back to around $US150 a tonne.

There’s an interesting question about why revenue assumptions were rising when the price had been falling which will presumably be asked and answered by the inquiry. It is also curious that, given the known volatility of commodity prices, that the price assumptions appear to have been set at such apparently optimistic levels.

If Swan hadn’t gone out and locked in spending commitments against the forecast revenue – if MRRT revenue had been dedicated to the Future Fund or a new sovereign wealth fund, for instance – the early but substantial shortfall in revenue raised and the prospect that the brief moment of super-profitability for the miners has passed wouldn’t have been of major consequence.

The tax has operated as it was designed to operate. It’s the big disparity between the iron ore and coal prices originally projected and the experience so far, as well as the Gillard government’s inability to strike a deal with the states to freeze their royalties, that has resulted in the tax essentially raising no meaningful revenues at this early stage of its existence. The inquiry will presumably help us understand how the government could have got it so wrong.

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