The Super Profits Tax

by Dave Forest
May 3, 2010

Australia sent the major miners into a tailspin overnight.

The Rudd government announced Sunday night that it will impose a new "resource super profits" tax on mining, oil and gas, geothermal and other resource extraction in the nation.

Under the scheme, resource companies will pay a 40% tax on profits. Implementation is scheduled for July 1, 2012.

The fall-out was immediate.

BHP announced it expects its effective tax rate to rise to 57%, from a current 43%. Citigroup said the new rules could cause the effective tax rate for northern Australia's large liquefied natural gas projects to rise by several percent.

Stocks were down nearly across the board.

A few observations.

One of the few "saving graces" of the new rules is that the tax is on profits. A company has to be making money in order to pay, and producers will pay in accordance with how much cash they're making.

This is better than a royalty scheme, of the kind other governments have tried. Royalties come off the top, whether a company is making a little money or a lot. This can kill marginal projects quickly.

But even under the proposed profits tax, marginal projects will suffer. Extra tax could push a borderline project into negative NPV territory. Low-grade, deep or engineering-challenged projects will likely see less investment.

One interesting aspect of the new rules is a tax break for exploration.

The government opted not to go with a flow-through tax program, which many in the mining community had been calling for.

Instead, they will grant a "resource exploration rebate". Whereby companies can write off approximately 30% of their exploration expenses against future revenue.

This will help major miners a little. The big guys have both exploration expenses and cash flow to write credits off against.

For smaller companies, the arrangement is more challenging. Most junior exploration companies have no cash flow. Essentially making the tax credit useless.

Some sub-groups of explorers could benefit. Geothermal explorers, for example, may be able to use the credits if they discover and develop a viable project through to production.

One outcome could be that juniors will become prized for their tax pools. We saw this in the Canadian oil and gas sector. Junior companies with tens of millions in tax losses are often acquired by larger producers largely for the tax benefit.

Bottom line: the new laws will be a test of the "world-class-ness" of Australia's resource assets. Projects that are stellar will still be worthwhile even with increased tax.

But any projects on the bubble could get the axe. Developers may simply have more profitable places to sink their money.

Time to separate the wheat from the chaff.

Here's to survival of the fittest,

Dave Forest