WORLD BANK MINING FISCAL ISSUES WORKSHOP WASHINGTON 5 OCTOBER 2006

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WORLD BANKMINING FISCAL ISSUES
WORKSHOPWASHINGTON 5 OCTOBER 2006

• Mineral royalty administration
• The acid test of policy?
• By
• Pietro Guj

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CONTENT OF TALK

• Balancing conflicting policy objectives
• Drafting sophisticated legislation is easy -
  effectively enforcing and administering it is
  hard
• What generates administrative complexity,
  disputes and potential abuse and how to prevent
  them

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CONFLICTING RANKING OF ROYALTY METHODS BY
DIFFERENT CRITERIA
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FACTORS AFFECTING THE CHOISE OF A ROYALTY METHOD

• Main factors
• Size of operations
• Price of commodity
• Volatility of commodity price
• In general
• Most mineral regulatory regimes use unit-based
  and ad-valorem royalties
• Few profit-based and hybrids
• None resources rent (only for petroleum) and
• Small producers and artisan miners do not pay
  royalty

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UNIT AND AD-VALOREM ROYALTIES

• Unit and ad-valorem royalties, while economically
  inefficient, are easy to administer because
• Actual sales invoices provide accurate and
  unambiguous volumes and values on which to base
  royalties
• Minimise potential errors, avoidance and disputes
  
• But expose government to both the up and
  down-side risk of forward sales
• Not at arms-length and transfer sales by contrast
  generate
• Considerable ambiguity particularly for
  polymetallic ores and concentrates
• An undesirable need for ministerial discretion in
  deeming their values
• Frequent and long-protracted legal disputes

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HYBRID AND PROFIT BASED ROYALTIES

• Profit-based royalties while more economically
  efficient are much more complex to administer
  because
• The profit on which they are based is generally
  not the standard financial accounting measure of
  profit
• They are levied on a project-by-project basis
• Of different capital recovery methods, deductible
  items and distribution of overheads
• No royalty may be levied in case of a loss even
  though the project may be generating very high
  cash flows
• Difficult to audit
• Lack of appropriate skills and general
  under-resourcing of administering authorities

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ROYALTY RELIEF

• Unit and ad-valorem based royalties
• Affect gross revenue therefore increasing cut-off
  grades and reducing economically minable reserves
• Prevent development of marginal deposits
• Render narrow-margin operations unprofitable if
  prices fall creating the need for royalty relief
  or deferral
• Royalty relief provisions are
• Difficult to draft and administer
• Often require significant ministerial discretion
• Not transparent and potentially open to abuse
• Profit-based royalty regimes in theory at least
  should not generate the need for relief

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ROYALTY RATES AND INCENTIVES

• Negotiation of lower royalty rates on a
  project-by-project basis as an incentive to
  investment is undesirable because
• It creates a precedent which makes it difficult
  and inequitable to negotiate higher rates for
  later projects setting a de facto floor
• Given commodity price volatility the amount of
  incentive is open-ended, hence inferior to a
  direct subsidy
• An across-the-board initial royalty holiday or
  decreases in royalty rates for increasing levels
  of mineral processing are by contrast justifiable
  incentives to investment in down-stream
  processing

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PENALTY PROVISIONS

• Royalty payment is a key condition and
  non-compliance should result in forfeiture of a
  mining title
• If no specific penalty provisions exist, in
  theory, any error should lead to forfeiture. In
  practice, significant and at times ultra vires
  ministerial discretion is used to remedy
  insignificant issues
• By contrast some draconian regimes include
  immediate disproportionate fines and in some
  cases even jail terms, which are also difficult
  to administer without a degree of ministerial
  discretion
• Ideally sanctions should rise over periods of
  non-compliance from progressively higher penalty
  interest, to graduated fines and finally to
  forfeiture

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THE PRINCIPLE OF NO SURPRISES

• The long-term nature of mining investments makes
  predictability and stability of regulatory and
  fiscal regimes almost more important to industry
  than the actual rate of royalty
• Unexpected royalty reviews and changes may raise
  the perception of sovereign risk and discourage
  further investment in the country
• It is imperative that government
• Anticipates, pre-empts and minimises the need for
  change
• But if change is necessary continuously liaises
  with industry and clearly communicates and
  justifies the need for it
• Phases changes in over time giving industry the
  time to adjust to them
• There must be no surprises

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LEGISLATIVE AND ADMINISTRATIVE POWERS

• It is better if legislative and administrative
  powers reside at the same level of government
  whether central or state/provincial
• Rising dissatisfaction and political pressure at
  the local/community level with the manner in
  which royalties are appropriated and
  re-distributed to the region affected by the
  mining operations has led in some cases to
  extreme decentralisation of royalty
  administration and collection
• In the absence of significant institutional
  strengthening these changes may generate
  confusion and inefficiency

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CONCLUSIONS

• In summary royalty policy must
• Be clear, transparent, predictable and stable.
• Achieve ease of administration and government
  revenue stability without excessively
  compromising economic efficiency and equity
• Be based as far as possible on actual sales
  volumes and values
• Be matched by adequately skilled and resourced
  administrative agencies
• Apply across-the-board rates, not negotiated on
  a project-by-project basis as an investment
  incentive

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CONCLUSIONS (Cont.)

• Impose penalties for non-compliance which should
  be proportionate and progressive with title
  forfeiture at their extreme
• Make use of limited and well-defined ministerial
  discretionary powers
• Anticipate, minimise and pre-empt the need for
  future amendments which should be based on
  continuous consultation with industry and the
  principle of no surprises