First published on nortonrosefulbright.com August 2013.
Kinross Gold Corporation's recent announcement that it will not proceed with further development of the Fruta del Norte project in Ecuador has refocused attention on the perennial debate about the equitable allocation of natural resource wealth among key stakeholders.
This debate is also the focus of the 2013 Africa Progress Report issued by the Africa Progress Panel. The report identifies the obtaining of a fair share of natural resource wealth and equitable allocation of the proceeds by African governments as "two of the most pressing governance challenges in the extractive sector" across the African continent.
These issues are a growing concern for many of Canada's mining companies with mineral assets in developing countries.
The details of the fiscal regime to apply to a mining project are often the subject of lengthy negotiation between host governments and mining companies. Such negotiations typically include many separate items such as corporation tax, withholding taxes, royalties, resource rent taxes, turnover tax, capital allowances, capital gains, GST or VAT related taxes, valuation fees, import and export duties and the period of time for which they are stabilized (life of the project or some other negotiated period) as well as the host government's right to participate in the project. The mining company's investment in infrastructure, its community development obligations and similar costs are also often the subject of intense negotiation.
From a host government's perspective the objective is to maximize revenues and ancillary economic benefits, and provide an investment climate which can attract future revenue streams while protecting communities and the environment. From the mining company's perspective the objective is to obtain a fiscal regime and resulting internal rate of return which are attractive to outside investors and allow for a financeable project. Not only are mining companies and their investors concerned with the specifics of the fiscal regime such as the overall effective rate of tax, they expect reasonable assurance that the regime will not be fundamentally altered before they have had a chance to recoup their investment. Investor perceptions of risk (uncertainty of the commodity price, operational risk, development risk, policy risk and so forth) and the availability of developed infrastructure, cheap energy and skilled labour also have a bearing on the appropriate level of taxation.
Aligning the disparate objectives of host governments, communities and the mining companies can be technically challenging and changes in underlying market conditions often add to the complexity. In some cases, it may be that these objectives are irreconcilable and the development of the mine must at a minimum be postponed until more favourable conditions exist.
Impact of Current Market Climate
Host governments in many resource rich developing countries have been slow to react to the current crisis in the mining industry reflected in rising costs, commodity price volatility, falling share prices and decimated market capitalizations. Notwithstanding the sensitivity of internal rates of return to commodity prices, many developing countries are paradoxically demanding higher returns from natural resource development.
For mining companies seeking fiscal concessions from governments during this period of rapidly declining market conditions, it is important that the impact of softening commodity prices on project economics be conveyed to the host government in as close to real time as practicable. In addition to providing market information, this may also include adjustments to the financial model such as revising base case revenue projections.
When the negotiations occur at a time when market conditions are unfavourable, consideration may be given to watering down stabilization clauses in an effort to obtain greater up-front concessions. For example, instead of having a stabilization clause that extends for the life of the project, the parties could agree to a review of the negotiated concessions in the event of a material change in project economics. As the mining company will want to limit the possibility of a review being triggered by a simple reconsideration of the deal by the government, care will need to be taken to ensure that the materiality threshold that would trigger a possible review is quite high.
The Africa Progress Report 2013 calls for governments to reform tax regimes to be more responsive to market conditions. The report calls for royalty rates for example to be indexed to commodity prices to ensure a more equitable participation in revenues by governments especially during periods of economic boom. This would also allow for governments to share the pain during periods of market decline.
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