Royalty grab might miss

Queensland’s royalty play might hurt small miners, but not the big players

The new Queensland government used its first budget to increase coal royalties, forecasting that this will net the state some $480 million in extra revenue for each full year of operation.

Queensland Resources Council Chief Executive Michael Roche said, “The worse than feared hike in coal royalties announced in today’s Queensland budget means more job losses, the risk of further mine closures, and the near certainty that numerous major new coal projects will not see the light of day.” He went on to say, “The combination of company income tax and the new royalty rates will mean Queensland carries an effective taxation rate of 50% on a typical coking coal operation.”

The council has around 90 full members, including mining giants such as BHP Billiton (ASX: BHP), Rio Tinto (ASX: RIO), Vale (NYSE: VALE), and Xstrata (LSE: XTA), other miners like Santos (ASX: STO) and Whitehaven Coal (ASX: WHC), and numerous mining services companies, so it represents a broad spread of industry feelings.

The government charges royalties on each tonne of coal sold at 7% on sales up to $100/tonne and 10% thereafter. As of the 1st October, the rate remains 7% on sales up to $100 but increases to 12.5% on the next $50 per tonne and 15% thereafter.

Spot prices for coal have declined recently and profit margins for miners are being squeezed. Some existing mines are marginal with high production costs leading to a very low profit per tonne. Additional royalties can represent a marked difference in the viability of such operations because this “ad valorem” method of assessing royalties ignores costs completely and directly impacts profits. As with all resource projects, a company can always leave the coal in the ground and wait until the economics look more favourable if it chooses.

To meet the government revenue forecasts, the price of coal has to remain firm and miners have to keep mining it at an increasing rate. Judging from recent statements such as that from BHP Billiton announcing it is closing the 33-year old, open-cut Gregory coal mine, these do not look like realistic expectations. At a recent luncheon, BHP Billiton Chairman Jac Nasser said that the royalty increase “… reintroduces this level of uncertainty for long-term investments.”

In trying to reassure the industry, the Queensland government committed to these royalty rates for the next 10 years. However Mr Roche said that this was simply rubbing salt into the industry’s wounds as the government had also refused a plea to index coal royalty thresholds. “Like tax bracket creep, over time royalty thresholds erode with inflation and indexation is a way of offsetting the negative project value impacts of higher royalties over the 20-year-plus life of a coal mine investment.” Since the royalty rates were last set in 2008, the consumer price index has increased by 15% but the thresholds have stayed the same.

Foolish takeaway

The large, internationally diversified companies have plenty of choices as to where to invest in new projects and there is plenty of coal around the world so this isn’t going to impact the bottom line for any of them, but may have more of an impact on local miners with operations heavily weighted to Queensland.

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Motley Fool contributor Tony Reardon owns shares in Rio Tinto. The Motley Fool‘s purpose is to help the world invest, better. Take Stock is The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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