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Edited by
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The University of Sydney, Australia
Selection and editorial content © Nigel Finch 2012
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10 9 8 7 6 5 4 3 2 1
21 20 19 18 17 16 15 14 13 12
Contents
Acknowledgements ix
Notes on Contributors x
Overview 1
v
vi Contents
Index 197
Tables
vii
Figures
viii
Acknowledgements
We would like to thank Lisa von Fircks at Palgrave Macmillan for guid-
ing us through the project. We would also like to thank Siew-Ching
Lim for the excellent work in editing this manuscript. Thanks also to
the anonymous referees who assisted in the selection of articles for this
book and to each of the authors for their generous contribution of time,
knowledge and expertise. While all care has been taken, neither the
publisher nor the editor is responsible for the accuracy of each chapter
written by the contributors.
The editor would like to thank the Australian Bureau of Agricultural
and Resource Economics and Sciences for their generous permission in
allowing the use of Figure 2.1 ‘Australia’s Terms of Trade and Resource
Exports’.
ix
Contributors
x
Notes on Contributors xi
Grantley Taylor worked for several years in the mining industry and
the Australian Taxation Office before joining Curtin University in
2005. He completed his Ph.D. in 2008 and has published extensively
and successfully supervised several postgraduate students. His research
interests include governance, disclosures, issues relating to the resources
industries, taxation and financial accounting.
This chapter examines the role of the mining industry in the Australian
economy. First, it indicates the contribution that the industry makes to
economic aggregates such as gross domestic product (GDP), investment,
1
2 Contemporary Issues in Mining
The Australian mining industry does not have a good record in report-
ing on the future costs of restoring mine sites. This chapter notes that
Australian miners have often failed to comply with accounting stand-
ards and statutory requirements for reporting on their (domestic) obli-
gations, and discusses recent reporting practices in this area and their
shortcomings. It briefly reviews some recent proposals for the issue of
an international accounting standard dealing with ‘stripping costs’.
Finally, it offers some recommendations about how practices could be
improved – particularly for those entities engaged in mining activities
at a number of sites or in different countries. The merits of capitalising
projected costs of site rehabilitation, along with the capitalisation of
mine development expenditure, are questioned.
1.1 Introduction
Anatomically, modern humans have existed at least for the last 200,000
years. For 95 per cent of the history of our species, up until about 10,000
years ago, human technology was limited to what could be made out of
bone, stone, wood and other easily rendered organic matter. Then, in
the period archaeologists refer to as the Bronze Age, humanity began to
make tools out of metals. From then on the relationship between min-
ing, metals and technology and the contribution to economic growth
have been intimately connected. While complex, the impact of this
relationship in its broadest sense is fairly clear: without mining the
development of technology would have been slow to non-existent, the
development of a monetary economy would probably not have hap-
pened at all and the main sources of fuel (coal and later oil) and raw
materials required for industrial activity would not have been obtain-
able. Without mining there could not have been an industrial revolu-
tion, and from that stems, in part, the basis of all economic activity
which has led to the economy of the present (Diamond, 1997; Clark,
2007). Minerals and fuels extracted by mining are an essential part
of the global economy – without them there would and could be no
cars, computers or consumer durables; construction techniques would
have been different and in many respects more limited; and buildings
themselves would have been harder to light and heat. It is therefore
true to say that mining enterprise has played and continues to play a
major role in shaping the history of humanity, and its significance and
impact is and has been enormous. Understanding the history of mining
9
10 Simon Mollan and David Kelsey
As Table 1.1 indicates, there has been a significant and substantial increase
in the world production of non-ferrous metals between 1851 and 2009.
The combined tonnage produced of bauxite, aluminium, chromium,
copper, lead, manganese, nickel, tin, tungsten and zinc increased by
1,180.63 per cent between 1851 and 1900, by 649.31 per cent between
1900 and 1950 and by 1381.5 per cent between 1950 and 2009. Between
1851 and 2009, the overall increase in the measured output of the met-
als listed above was well over 10,000 per cent. Though the two world
wars and the great depression dented the outward expansion of produc-
tion, it is clear that in the last century and a half the mining industry
has continued to grow in response to the needs of the world economy.
The great surge in the production and consumption of minerals from
the 1850s onwards was because of the process of industrialisation in
Table 1.1 World production of selected non-ferrous metals, 1851–2009 (thousand tonnes, except where stated)
1851
1858
1865
1875
1879
1886
1893
1900
1907
1914
1921
1928
1935
1942
1949
1956
1963
1970
1977
1984
1991
1998
2005
1851
1858
1865
1875
1879
1886
1893
1900
1907
1914
1921
1928
1935
1942
1949
1956
1963
1970
1977
1984
1991
1998
2005
5000 Zinc US$ per tonne 2009 prices 50000 Tin US$ per tonne 2009 prices
4500 45000
4000 40000
3500 35000
3000 30000
2500 25000
2000 20000
1500 15000
1000 10000
500 5000
0 0
1851
1858
1865
1872
1879
1886
1893
1900
1907
1914
1921
1928
1935
1942
1949
1956
1963
1970
1977
1984
1991
1998
2005
1851
1858
1865
1872
1879
1886
1893
1900
1907
1914
1921
1928
1935
1942
1949
1956
1963
1970
1977
1984
1991
1998
2005
Figure 1.1 Comparative prices (five-year moving average), selected metals, 1851–2009
Source: Schmitz, 1979 and Kelly and Matos, 2010.
An Overview of the International Mining Industry 15
$50,000 350000.0
Tin production (tonnes)
$45,000
300000.0
Tin price (2009 US$ per
$40,000
tonne)
$35,000 Value of tin produced (2009 250000.0
US$ m)
$30,000
200000.0
$25,000
150000.0
$20,000
$15,000 100000.0
$10,000
50000.0
$5,000
$0 0.0
1869
1875
1881
1887
1893
1899
1905
1911
1917
1923
1929
1935
1941
1947
1953
1959
1965
1971
1977
1983
1989
1995
2001
2007
Figure 1.2 Tin production and price, 1869–2009
Source: Schmitz, 1979 and Kelly and Matos, 2010.
As implied also in Figure 1.2, Figure 1.3 indicates the close relation-
ship between increases in production of non-ferrous metals and the
expansion (and cyclical contractions) of the world economy between
1950 and the present day. Given the central importance of raw materi-
als to industrial production, this is unsurprising. Copper is an example
of one metal that is critical to economic activity, as the ‘red metal’ is
a vital component in electrical devices and the creation of electricity
distribution networks.
0.25 0.08
–0.1 0.00
Figure 1.3 Growth in world non-ferrous metal production and world GDP,
1950–2008
Source: Schmitz, 1975; Kelly and Matos, 2010; Maddison, 2010.
to the growth of the colony, boosting its population, and fuelling the
need for all kinds of goods, much of them imported from overseas), as
well as less significant discoveries in India and elsewhere prefigured a
boom in mining investment. Once again there is a rich literature asso-
ciated with these developments, especially with reference to the share
mining bubble of the 1890s where dubious company promoters ramped
the securities markets for shares of companies with little or no realistic
prospect of producing gold in order to reap the benefit for capital gain.
The spuriousness varied from company to company. In some cases there
was clearly fraudulent intent on the part of the directors and the com-
pany promoter (Phimister and Mouat, 2003). In other cases, however, it
was informational limitations which encouraged inappropriate invest-
ments (Mollan, 2009). Thus between 1875 and 1913 the total British
foreign direct investment (FDI) in non-ferrous metal mining companies
rose from £11.3 million to £240.0 million, while the number of compa-
nies rose from 39 to over 900. However, the overall number of mining
companies launched – many with no chance of ever becoming going
concerns – was over 8,000 in this period (Harvey and Press, 1990). The
effect was to pour capital into the mining sector. While much of it was
wasted, there is good evidence to suggest that the lower costs of raising
capital caused by the enthusiasm for mining shares brought allowed
workable mines to be developed. These companies have often been
considered as FSCs following the pioneering work of Mira Wilkins in
the field of the early multinationals (Wilkins, 1989). However, from the
outset it has been noted that many companies were linked together by
common directors, company promoters, mining engineers and cross
shareholding, or some combination of these organisational ties (Harvey
and Press, 1990; Mollan, 2009). This is an important structural feature,
because it allowed risk to be managed carefully by those at the fulcrum
of what were often very complex organisational structures. While these
insiders certainly manipulated the market for their own ends, the vagar-
ies of technical evidence on the basis of which investment was made
did not often allow for large amounts of capital to be safely invested.
Instead, by using the vehicle of the FSC, risk was spread into discrete
firms. If a prospecting company hit a rich vein of ore, then the share-
holders would find that there would be a genuine capital gain (aside
from general market increases). Moreover, as the mine was developed,
new capital was often sought, making the existing shareholders rich as
the restructuring often issued them with new shares. Mining invest-
ment before 1914 was, then, a little like buying a lottery ticket. If the
firm failed then only a small amount of capital was lost relative to the
An Overview of the International Mining Industry 19
plot of land that the specific company was exploring. While this might
ruin individual investors, it was not enough to sink the insiders in the
market – especially those people at the centre of the networks of com-
panies. Thus the structure of the Victorian capital market for mining
securities before 1914 was essential to the growth of the international
mining business. One firm of mining engineers – John Taylor and
Sons – was at the centre of one such network of interlinked companies.
In 1910 the total value of the capital in this group has been estimated
at £5.59 million in paid-up capital. An atomised collection of firms, the
larger companies in this group would be seen as important. However,
in today’s prices, the value of the whole group would be £523 million,
making it at least comparable to the world’s larger mining companies of
today (Mollan, 2004). It was also in this period that corporations with
names familiar today began to emerge (see Table 1.2).
1 Anaconda (5) National Coal Board (10) Ruhrkohle (81) BHP Billiton (21)
2 De Beers (12) Anaconda (55) British Coal (219) Vale do Rio Doce (25)
3 Rio Tinto (13) American Metal (67) RTZ (258) Rio Tinto (30)
4 Utah Copper (22) ASARCO (77) CRA (370) China Shenhua Energy (52)
5 Phelps Dodge (23) Kennecott (84) De Beers (392) Anglo-American UK (81)
6 ASARCO (24) International Nickel (110) Zambia Industrial (457) Xstrata (93)
and Mining
7 Rand Mines (39) Phelps Dodge (113) Codelco-Chile (462) Barrick Gold (222)
8 Crown Mines (40) Anglo Platinum (246)
9 International Nickel (44) China Coal Energy (311)
10 Calumet and Hecla (49) Goldcorp (327)
11 Consolidated (52) Eurasian Natural Resources (364)
Gold Fields
12 Harpener Bergbau (53) Impala Platinum (374)
Source: 1912, 1956 and 1992 data are taken from Schmitz (1995). 2008 data taken from the FT Global 500, 2008 (http://www.ft.com/reports/
ft5002008). Ranking for 1912 is based on stock market valuation; rankings for 1956 and 1992 are based on gross sales; ranking for 2008 based on market
capitalisation.
An Overview of the International Mining Industry 21
and sulphur. In the period before 1914 the company was very success-
ful, this being reflected in its share price which exchanged ‘between
nine and 19 times the nominal value in the first decade of the century’
(Harvey, 1981: 2). Diversification then followed through investments
made around the world but especially in Africa. Rio Tinto eventually
pulled out of Spain in the 1950s connected to problems with Franco’s
regime (Jones, 2005). Over the next few decades the firm continued
to expand through merger and acquisition. In 1962 it merged some of
its assets with Consolidated Zinc to form CRA Ltd. This firm initially
diversified into the related areas of oil and gas as well as cement and
chemicals, though these activities were discontinued in the late 1980s.
Around the same time Rio Tinto acquired BP’s mining interests (Jones,
2005). In 1995 Rio Tinto Zinc (RTZ) and CRA were unified under a sin-
gle directorate spanning two incorporations – Rio Tinto Plc (domiciled
in Britain) and Rio Tinto Ltd (based in Australia). This dual structure
in many senses resembles the relationship between the Central Mining
and Investment Corporation (domiciled in London) and Rand Mines
(South Africa), the holding companies for the Wernher, Beit and related
mining finance houses which owned mining companies in South
Africa in the early twentieth century (Cartwright, 1965). The same type
of arrangement is also present for BHP Billton, itself a product of merg-
ers and acquisitions over the years. Amalgamation also accounts for
the other large-scale mining multinationals such as Anglo-American,
which has a long history stretching back to mergers in South Africa in
the first half of the twentieth century (Innes, 1984). In the late 1980s
Mikesell and Whitney (1987) observed that while there were thousands
of small mining companies they accounted for less than 25 per cent of
global output and tended to mine for precious stones where economies
of scale and scope were less important. This echoes the situation of a
century earlier in terms of the concentration sources of output, but a
significant difference in the intervening years has been the rising capi-
tal costs of extraction. While small companies could and continue to
engage in exploration, only those with access to large amounts of capi-
tal could develop commercially viable mines on a large scale, and this
was critical in driving the amalgamation process.
As some of these larger firms began to dominate markets, so came
the possibility of establishing cartels. The tin cartel established in the
interwar period has already been touched on, but the mid-mid-mid-
century also saw cartels in other areas, notably in copper (which was
rather short; 1935–39) and also aluminium, where four cartels existed
in the first half of the century, and intra-industry association possibly
22 Simon Mollan and David Kelsey
indicates continuity in this respect at least until the 1980s (Litvak and
Maule, 1980). Established to ensure or at least influence price stabil-
ity, cartels ultimately are rent seeking through manipulation of supply.
For Aloca this proved to be problematical when it was forced to sell
off Alcan (its Canadian subsidiary) and aluminium plants to competi-
tors following an anti-trust ruling in the United States in 1945. (Jones,
2005). As time went on, however, obvious inter-firm cartels gave way to
more complex business relationships, in particular joint ventures (JVs).
JVs, while not necessarily or always anti-competitive, can be so under
some conditions, though they can also emerge to overcome barriers to
entry, pool knowledge or reduce political risk and, are especially of rel-
evance in the international mining industry, to enhance economies of
scale at different stages of production (Hennart, 1988).
A further trend in the mining industry beginning in the 1960s and
1970s was the growth of state-owned enterprises (SOEs). This was partly
fuelled by the nationalisation of corporations in many developing coun-
tries as they pursued socialist policies, though this trend was not con-
fined, with other notable SOEs in France where all stages of aluminium
production were under state control, as well as partial stages of alumin-
ium production in West Germany, Italy, Norway and Spain. In Finland,
copper mining and refining were state-owned, while both France and
Germany had state-owned iron ore production. Radetski (1989) identi-
fies four reasons why nationalisation/state ownership occurred: to pre-
vent private profiteering and to assure mineral supplies; to avoid the
difficulty of taxing mining activities, especially in a multinational con-
text; to safeguard strategically important sources of supply; and – a little
opportunistically – to take advantage of the immobility of resources.
After all, ‘copper, like gold is only where you find it’ (Prain, 1975: 4). By
the late 1980s, as much as half of the mineral production of the devel-
oping world was conducted by SOEs, while perhaps as much as one of
global production was similarly in state hands. There were benefits to
SOEs, notably, the guarantee of state support thus avoiding or mitigat-
ing the impact of cyclical variations in world markets, the ability to bor-
row at sovereign state rates (or have the state do so for the SOE) and the
increased power of the state to direct management to improve the social
outcomes of the mining business. SOEs also avoid political risk because
of their relationship with the state, though this also incurs (different)
political risks as the SOE remains part of the political firmament of the
country in which it is located (Mikesell and Whitney, 1987). There were
also negative aspects as well, most critically the breaking of vertically
integrated supply chains and greater inefficiency in management. This
An Overview of the International Mining Industry 23
1.5 Conclusion
Canada 9
UK 9 (7)
USA 5
China and Hong Kong 5
Australia 5 (3)
South Africa 3
Russia 1
Peru 1
Mexico 1
India 1
France 1
Brazil 1
Note: RTZ and BHP Billiton are listed in both Australia and the United
Kingdom and so are double counted in this table. Figures excluding these
companies are included in brackets.
Source: PWC.
has been only dented by the recent Global Financial Crisis and world
recession. Despite harvesting a wasting asset, such resilience, longevity
and the essential relationship between natural resources and growth in
the world economy suggest that the future of the international mining
industry will continue to be both dynamic and important, just as its
past has been.
Note
1. This historiography deals with a number of debates relating to the structure
and nature of the mining industry in South Africa that cannot be entered
into here, but, nevertheless, are important to a full understanding of the his-
tory of mining in South Africa. For a summary of this field, see Richardson
and van Helten (1984).
References
Campbell, B. (2001), ‘The Role of Multilateral and Bilateral Actors in Shaping
Mining Activities in Africa’ in Mining, Development and Social Conflicts in
Africa, Third World Network, Ghana, Africa, 3–44.
Cartwright, A.P. (1965), The Corner House, Cape Town, Purnel.
Chandler, A.D. (1990), Scale and Scope, Harvard University Press, Cambridge,
MA.
Churu, F. and Obi, C. (2010), The Rise of China and India in Africa, Palgrave
Macmillan, New York.
Clark, G. (2007), A Farewell to Alms – A Brief Economic History of the World,
Princeton University Press, Princeton, NJ.
Diamond, J. (1997), Guns Germs and Steel – A Short History of Everybody for the Last
13,000 Years, Vintage, London.
FT.com (2008), The World’s Largest Companies, available at <http://www.ft.com/
reports/ft5002008> (accessed 1 February 2011).
Handley, A. (2007), ‘Business, Government and the Privatisation of the Ashanti
Goldfields Company in Ghana’, Canadian Journal of African Studies/Canadian
Journal of African Studies/Canadienne des Études Africaines, 41(1), 1–37.
Harvey, C. Harvey, C. Harvey, C. Business History, 32, 98–119.
Harvey, C. (1981), The Rio Tinto Company: An Economic History of a Leading
International Mining Concern, 1873–1954, Penzance, Alison Hodge.
Hennart, J.F. (1988), ‘A Transaction Costs Theory of Equity Joint Ventures’,
Strategic Management Journal 9(4), 361–374.
Innes, D. (1984), Anglo American and the Rise of Modern South Africa, Ravan Press,
Braamfontein.
Jones, G. (2005), Multinationals and Global Capitalism from the 19th to the 21st
Century, Oxford University Press, Oxford.
Kelly, T.D. and Matos, G.R. with major contributions made by David A.
Buckingham, Carl A. DiFrancesco, Kenneth E. Porter (2010), ‘Historical
Statistics for Mineral and Material Commodities in the United States’, avail-
able at <http://minerals.usgs.gov/ds/2005/140/> (accessed 15 January 2011).
26 Simon Mollan and David Kelsey
2.1 Introduction
27
28 Nigel Garrow and Tom Valentine
economy via its effect on such variables as exports, the current account
deficit, investment, the exchange rate and the terms of trade. It also
considers the role of the mining industry during the Global Financial
Crisis (GFC).
The third section presents a simple econometric model of the
Australian economy which takes account of the indirect as well as the
direct effects of mining in the Australian economy. It illustrates the
ubiquity of commodity prices in driving the Australian economy.
The fourth section discusses the proposed Mineral Resource Tax and
its possible effects on the mining industry.
Mining and services to mining accounted for 6.85 per cent of the gross
domestic product (GDP) (measured in chain volume) in 2009–10 with a
value of $83.8 billion up from 6.44 per cent in 2003–04, just prior to the
start of the current commodities boom. Adopting this measure for the
size of the mining and related services sector, the rate of growth for this
sector during the past six years has averaged 3.9 per cent and ranged
from 1.9 per cent per annum to 8.5 per cent per annum. In 2009–10 the
growth rate was 2.5 per cent with the services to mining falling 10.4 per
cent and mining excluding services rising 4.0 per cent.
The resources sector (minerals and energy resources) share of goods
and services exports in 2009–10 was 51.5 per cent, up from 37 per cent
15 years earlier (1994–95) and from 23.1 per cent in 1982–83.
Since mining is such a significant component of Australia’s GDP
and, specifically, Australia’s exports, one would expect a high correla-
tion between Australia’s current account deficit and mining exports,
and that is the case. A regression estimated from EViews for the period
from 1969–70 to 2009–10 showed that mining exports (MINEX) were
negatively correlated with the Australian current account deficit (CAD)
whilst the exchange rate of the Australian dollar with the US dollar (FX)
was not significantly correlated with the current account deficit.
The figures under the coefficients are t-values and asterisks indicate
the degree of significance. One asterisk indicates significance at the 5
per cent level and two asterisks indicate significance at the 1 percent
level. R² is the coefficient of determination and d is the Durbin–Watson
statistic.
During the nine-year period to 2008–09 the current account deficit
became worse whilst the level of mining exports increased (because
investment (I) was significantly higher than savings (S) during this
period), and as the exchange rate of the Australian dollar with the US
dollar increased.
In addition to its contribution to Australia’s exports, mining is a
significant and growing contributor to Australia’s new private capital
expenditure (NPCE). NPCE, Australian Bureau of Statistics Cat. No.
5625.0, refers to the acquisition of new tangible assets and includes
major improvements, alterations and additions. In 2009–10 mining,
30 Nigel Garrow and Tom Valentine
which for this purpose includes petroleum and gas, spent $34,756
million on NPCE, which represented 32.8 per cent of total NPCE in
Australia that year; mining’s expenditure was down 8.5 per cent in
2009–10 compared with the prior year. Since just before the start of the
current boom in 2003–04 mining’s expenditure on NPCE has increased
by 255 per cent, accounting for 51 per cent of Australia’s total growth
in NPCE during this period. In 2003–04 mining accounted for 17.1 per
cent of total NPCE. Mining investment as a share of GDP increased
from 1.8 per cent in 2004–05 to 3.7 per cent in 2009–10. In 2009–10
approximately 25 per cent of mining’s NPCE was spent on equipment,
plant and machinery (with the remaining 75 per cent spent on build-
ings and structures), which represented a decline on the previous year
of 12 per cent, whereas mining’s expenditure on buildings and struc-
tures fell 5.7 per cent.
Mining capital expenditure from 1969–70 to 2009–10 (CAPEX) was
significantly positively, correlated with new MINEX with a t-statistic of
4.00. Mining capital expenditure is also correlated with its lagged value
with a t-statistic of 3.58.
120 180,000
Resource Exports (RHS) Terms of Trade (LHS)
160,000
100
140,000
80 120,000
AUD million
100,000
Index
60
80,000
40 60,000
40,000
20
20,000
0 0
71 0
73 2
75 4
77 6
79 8
81 0
83 2
85 4
87 6
89 8
91 0
93 2
95 4
97 6
99 8
01 0
03 2
05 4
07 6
09 8
0
19 –7
19 –7
19 –7
19 –7
19 –7
19 –8
19 –8
19 –8
19 –8
19 –8
19 –9
19 –9
19 –9
19 –9
19 –9
20 –0
20 –0
20 –0
20 –0
20 –0
–1
69
19
demand for these commodities and not, to date, due to the effects of
financial activity in commodity derivatives markets (Dwyer, Gardner et
al. 2011). Figure 2.1 compares Australia’s terms of trade with its resource
exports. For example, since 2003–04, the price of Gold London has
increased by 180 per cent up to 2009–10, iron ore average export price
by 227 per cent, thermal coal 115 per cent and crude oil 148 per cent.
From 1969–70 to 2009–10, Australia’s current account deficit (CAD)
was negatively correlated with the terms of trade (TOT) at the 10 per
cent level and significantly positively correlated with the one-period
lagged current account deficit (CADt–1) with an R² of 0.83.
The RBA suggests that investment in this sector alone could increase
from about 0.5 per cent of GDP at present to 2.5 per cent within the next
four to five years (Reserve Bank of Australia 2009), with the potential
for LNG exports to rival coal and iron ore as a share of total exports.
Business Monitor International (BMI 2010) are forecasting average
growth for the mining industry of just over 6 per cent per annum over
the five-year period to 2014, with mining’s contribution to GDP increas-
ing from 6.79 per cent in 2009 to 8.17 per cent by 2013.
The main driver of the mining sector outlook is the continued indus-
trialisation of China with its voracious appetite for raw materials, espe-
cially in steel making, and for which iron ore is a significant component.
Alongside its demand for raw materials, China is also demonstrating an
appetite to invest in Australian mining companies. It is not only in
Australia that China is investing; China is also investing in Mongolia,
Kazakhstan and Africa.
In Australia the index for the top 200 companies listed on the Australian
Stock Exchange (ASX) fell by about 40 per cent between mid-2008 and
early March 2009 in line with the major stock markets around the
world, and the Australian dollar depreciated by about 30 per cent as
capital was withdrawn from the country and adopted a ‘flight to safety’
strategy with the US dollar acting as a magnet for such funds. These
movements reflected Australia’s sensitivity to global financial markets
rather than fundamental flaws in its economy. But Australia’s economy
then rebounded, partly aided by the monetary policy adopted by the
RBA.
Glenn Stevens, Governor of the RBA, in his opening statement to
the Senate Economic References Committee (Stevens 2009) highlighted
four factors which contributed to Australia’s better recovery from the
GFC than most other economies. They were:
Strength of demand for the mining industry’s products and the devel-
opment of the Chinese economy, assisted by its rapid economic policy
response to the GFC with a marked loosening of monetary policy and
significant injection of fiscal support, all assisted the mining sector’s larg-
est customer in avoiding the most adverse consequences of the GFC.
However, as the OECD (2010) highlighted, ‘Australia’s key challenges
are medium-term; ensuring a balanced expansion, especially in the
context of the mining boom that has gathered pace. Strengthening
supply especially in infrastructure, housing and labour markets is
needed to ensure non-inflationary growth and smooth reallocation of
resources’.
‘Australia faces a shortfall in infrastructure, which could worsen with
the demand pressures exerted by the mining boom, population growth
and environmental concerns’ (OECD 2010, p. 16). The growth in min-
ing exports has placed pressure on port and rail infrastructure with
demand for freight expected to double between 2000 and 2010 (BTRE
2006).
The projected growth rate of Australia’s economy, predominately
from mineral exports to China, will continue to place a substantial
strain on most aspects of infrastructure, notably ports, railways, energy
and water.
2.6.1 Introduction
The purpose of this subsection is to show that commodity prices are the
crucial variable affecting the Australian economy through their impact
on the mining supply chain and suppliers of goods and services to
industry participants. A simple way of demonstrating this proposition
is to calculate the principal components of measures of performance of
the economy. Principal component analysis is applied to a set of varia-
bles to determine which variables in the set form coherent independent
subsets independent of each other (see Tabachnick and Fidell 2007, ch.
13). In this case EViews was used to calculate the principal components
of the series for the unemployment rate (UR), the growth in nominal
GDP (%ΔY), the rate of inflation (INF) and the all ordinaries index (AO)
over the period 1985–2010.
The first principal component (the one explaining the largest per-
centage of the variance of the series) is:
PY W
1 W E
= + ⋅ (E = employment)
Y E Y
1 w
= +
Y Prod
where w = average earnings and Prod = output per head (productivity)
Therefore,
dP 1 d dY 1 dw w dProd
⋅ 2⋅ ⋅ ⋅
dt Y dt Y dt Prod dt Prod 2 dt
36 Nigel Garrow and Tom Valentine
1 dP ⎛ ⎞ ⎛ ⎞
⋅ ⎜⎜ 1 ⋅ d 1 ⋅ dY ⎟⎟ w ⎜⎜ 1 ⋅ dw − 1 ⋅ dProd ⎟⎟
P dt P.Y ⎝⎜ ⎟ ⎜
dt Y dt ⎠ P.Prod ⎝ w dt Prod dt ⎠⎟
w w W
and note that 1 b
P.Prod P.Y/E P.Y
GB
CPUS ER CPA
Y
UR
INF
CPUS = commodity price index in US$ Y = nominal GDP in the final quarter
CPA = commodity price index in A$ of each year
ER = A$/US$ exchange rate UR = unemployment rate
GB = government borrowing (deficit) INF = rate of inflation
Y = Y–1(1 + %ΔY)
(A0 A01 )
%ΔAO = 100
A01
RY = Y/P
ΔRY = RY – RY(–1)
CPUS
CPA = 0.652 + 0.751 R2 = 0.999
Er d = 1.95
(2.46*) (191.03**)
(CPA CPA1 )
%ΔCPA = 100
CPA1
Rι = rf + β(rm – rf )
where rι is the return on asset I, rf is the risk free-rate of return (e.g., the
long-run bond rate), rm is the market return and β is a coefficient deter-
mined by the relationship between the return on this asset and the
market return. A β of unity indicates that the return on the asset is the
market return. A β above unity indicates that the return on the asset is
more volatile than the market, that is, that the asset is riskier than the
average of the market.
CAPM also determines the cost of funding for a company which issues
the asset concerned (say, a share). The equity premium (rm – rf ) is histori-
cally around 6–7 per cent. If the β for mining is unity, its cost of fund-
ing is twice the government cost of funding (the long-term bond rate).
However, the β for mining is likely to be above unity; in March 2011,
the β for the metals and mining sector in Australia was 1.27. Therefore,
the initial approach of using the long-term bond rate is unsupportable.
This analysis refers to the ex post situation, that is, to existing min-
ing operations. However, we need to consider the ex ante decision to
undertake prospecting for and creating new mines. Such activities may
depend on the possibility of earning economic rent in the future and if
the ‘uplift rate’ is too low, mining activity could be curtailed.
The Australian economy is increasingly dependent on international
debt markets, and in consequence the escalating costs of such debt
as risk pricing increases, such that the escalating investment require-
ments of the mining industry continue to place pressure on the cur-
rent account deficit. The Organisation for Economic Cooperation and
Development (OECD) suggest that this pressure on international debt
should be eased by government adopting policies designed to increase
domestic saving, thereby facilitating the mining investment funding
from lower cost and less volatile sources of funds. Net foreign liabilities
are currently about 60 per cent of GDP, with total foreign liabilities
nearly 150 per cent of GDP. Increasing savings will serve to ease the
The Role of Mining in the Australian Economy 43
pressure on the current account deficit and potentially ease some of the
pressure on the Australian dollar, to the benefit, in particular, of non-
mining export businesses. As the economy continues to recover and
stimulus spending reduces, government expenditure should be smaller
than tax revenue, thereby increasing gross savings and further reduc-
ing the current account deficit. A buoyant mining sector will make a
significant contribution to escalating tax revenue.
The increased mining sector revenue (Australia 2009, pp. 7–12) and the
sector’s future prospects (Christie, Mitchell et al. 2011, pp. 1–7) present
challenges and opportunities for the accumulation and deployment of
the financial gain being derived from the current mining boom and fund
raised from the MRRT. One possible avenue for the government to pursue
is to pay the proceeds of the tax into a dedicated savings fund, possibly
similar to the Future Fund established in Australia in the mid-2000s as
suggested by former Australian Treasurer Peter Costello (2011, p. 63). This
has the potential to reduce the current account deficit whilst capitalising
on the gains during the ‘boom’ phase of Australia’s economic cycle.
2.8 Conclusion
Note
1. http://creativecommons.org/licenses/by/2.5/au/
44 Nigel Garrow and Tom Valentine
References
Battellino, R. (2010), ‘Mining Booms and the Australian Economy’, Bulletin of the
Reserve Bank of Australia, 63–70.
BMI (2010), ‘Australia Mining Report, Q2’, Business Monitor International,
London.
BTRE (2006), Freight Measurement and Modelling in Australia, Bureau of
Transport and Regional Economics, Canberra.
Christie, V.,Mitchell, B., Orsmond, D., and van Zyl, M. (2011), ‘The Iron Ore,
Coal and Gas Sectors’, Bulletin of the Reserve Bank of Australia (March Quarter,
2011), 1–7.
Costello, P. (2011), ‘Times of Plenty and Lost Opportunity’, The Weekend
Australian Financial Review.
Davidson, S. (2010), No Respect for Super-Profit Taxation, The Centre for
Independent Studies Limited. St Leonards, New South Wales, 13–25.
Dwyer, A., Gardner, G., and Williams, T. (2011), ‘Global Commodity Markets –
Price Volatility and Financialisation’, Bulletin of the Reserve Bank of Australia
(June Quarter, 2011), 49–57.
Frino, A., Chen, Z., Hill, A., Comorton-Forde, C., and Kelly, S (2006), Introduction
to Corporate Finance, Frenchs Forest, New South Wales, Pearson Education
Australia.
Minerals Council of Australia (2010), The Australian Metals Industry and the
Australian Economy, available at <http://www.minerals.org.au>.; last accessed
28 May 2012
OECD (2010), OECD Economic Surveys: Australia 2010 (OECD Economic Surveys.
2010–21, Supplement 3).
Reserve Bank of Australia (2009), The Level and Distribution of Recent Mining Sector
Revenue, January 2009, 7–12.
Reserve Bank of Australia (2009), Statement on Monetary Policy, Reserve Bank
of Australia.
Stevens, G. (2009), ‘Statement to Senate Committee’, Bulletin of the Reserve Bank
of Australia October 2009, 18–19.
Tabachnick, B. G. and Fidell, L.S. (2007), Using Multivariate Statistics, Boston,
Pearson.
Part II
Operational Perspectives
3
Transportation Issues of Australian
Coal and Iron Ore
Elizabeth Barber
3.1 Introduction
the competitive efficiencies that are needed to keep the Australian coal
export market at its peak. Calls for privatisation and collaborative dom-
inance to ensure that transport flows remain efficient have been forth-
coming and the recent announcement of the Queensland Railways (QR
National) public float reflects this need.
Australia is the fourth largest producer behind United States and India,
producing 370 Mt in 2008 and 325 Mt in 2007 (OECD/IEA, 2008).
Australia is the largest exporter of black coal in the world. In 2008,
Australian domestic consumption was 144 Mt and the majority of the
remainder was exported to Japan, Korea and China (Australian Bureau
of Statistics, Australian Year Book, 2009).
Coal production in Australia is expected to increase through to
2030 and most of this production will be exported. The two main coal
producing areas are located in Central Queensland Basin and in the
Gunnedah, Sydney and Oaklands Basins in New South Wales (NSW).
The Central Queensland coal mines are a major exporter of black coal.
In 2010, there were approximately 48 coal mines in operation. A fur-
ther projected 38 major development projects are planned up till 2013
(Australian Bureau of Agricultural and Resource Economics (ABARE),
2009–10).
There are five coalfields within the three coal basins of NSW, namely,
the Hunter, Newcastle, Western and Southern coalfields located within
the Sydney Basin, with the Oaklands basin located on the southern
border with Victoria.
Coal production levels in Australia and its export (saleable) coal have
increased steadily to peak in 2008–09. During this year exports to Japan
were 104.4 Mt; to Taiwan were 26 Mt; to China were 25 Mt and to India
were 24 Mt (www.australiancoal.com.au).
The total value of Australian coal exports for 2008–09 was $58,373
million. The average price per tonne was $221.58 (www.australiancoal.
com.au). Japan and Korea have little coal reserves of their own, unlike
China, and so it is expected that the increase in production will be
exported to these countries.
The world’s demand for coal is driven by the international coal price
and the capacity of the coal global distribution supply chains. Strong
Transportation Issues of Coal and Iron Ore 49
demand for coal continues as the demand for energy soars in Asia,
especially China. According to the Director-General’s Environmental
Assessment Report on the Kooragang Coal Terminal (April 2007),
Australia’s ability to respond to the continuing strong demand has been
limited by the constraints to capacity of land transport and port han-
dling infrastructure facilities (NSW Government, 2007).
Exports are totally reliant on rail and road transport to reach the
export facilities at the ports (ABARE, 2009). The land transport supply
chain from the mines to the export ports do not exceed 300 km with
many of the mines located within 100 km from their export ports.
Due to the proximity of the mines to the ports, short transit times can
provide a high degree of responsiveness to changes in demand. The
aim of rail transport is to meet the shipping schedules and ensure that
there is a tight loading turnaround time for the ships in port. This not
only depends on timeliness but also capacity matching to gain the
greatest efficiencies. Maritime transport accounts for approximately 90
per cent of international coal transportation. Over half of the total
delivered cost of Australian coal exported to China is apportioned to
transport costs. As coal is one of Australia’s most valuable export com-
modities, it is vital that the transport supply lines operate efficiently
and timely.
The Australian coal industry is serviced by nine coal terminals at
seven ports, all located on the east coast. Port ownership is a combi-
nation of public and private interests. The combined annual loading
capacity is currently 270.5 Mt. Time and capacity constraints exist that
point to the need for Australia to continue to improve its rail transport
from the mines to the ports, and port infrastructures must have the
capacity to meet the shipping schedules.
The following section will firstly consider the Queensland coal export
flows followed by the NSW coal export flows.
lines of overhead conveyor belts operating from the transfer point from
the unloading stations. These conveyors which are 18-m-high discharge
coal via travelling trippers, from either or both sides on to stockpiles at
a rate of 6,000 tph. This discharge rate is equal to the uploading rate.
The ship loading belts that lead from underground coal pits to stock-
piles can blend from a maximum of four different coal stockpile varieties
at any one time. The flow rate is computerised to synchronise with the
ship loading conveyors to the required blend rate. This is a value adding
function blending coal to match demand at the export port rather than
further up the supply chain. Expansion of Queensland’s Dalrymple Bay
port in 2009 increased its annual capacity to align with its blending
functions. The coal flow rates and port throughputs are seeking verti-
cally integrated structures to improve efficiency and to maximise port
capacities as competition between the ports together with regulatory
reforms and the need for expansion of the critical infrastructure sectors
is currently pushing this dynamic industry into restrictive practices
rather than commercially appropriate outcomes (COAG, Discussion
Paper, October, 2007).
Severe congestion in ports is causing stockpiling of coal at ports and
leaving ships waiting offshore for loading. Severe congestion at Newcastle
and Dalrymple Bay ports has led to delays in deliveries and price rises
(BITRE, 2008). The shortage of rail capacity from the mines to the ports
has also contributed to congestion further upstream in the coal supply
chains causing significant delays in the export coal flows (Saul, J. and
Cowling, J., 2009). Bulk shipping availability has been curbed world-
wide as Australian coal ports are not the only ones congested. Brazil
and China have also experienced high congestion restricting the sea
capacity of transportation.
PART TWO
Australia produces around 17 per cent of the world’s iron ore and is ranked
second behind China (39 per cent) (Australian Minerals, 2010 – www.
australiaminesatlas.gov.au). The major iron ore suppliers in Australia are
BHP Billiton and Rio Tinto. A smaller third supplier is Fortescue Metals
Group (FMG). All iron ore mines are open-cut and located in the Pilbara
region of Western Australia. Rio Tinto is the largest producer which
operates and maintains all its own mining, railways and port facilities.
Rio Tinto is undertaking a $10 billon expansion plan to increase its iron
ore production by nearly one-third from 220 Mtpa to 333 Mtpa by 2015
(Macdonald, C., August, 2010). FMG is the latest iron ore producer to
the area. It started production in 2008. It mines from two mining hubs,
namely, Chichester Hub which includes its initial mine at Cloudbreak,
and its most recent mine at Christmas Creek, which is located approxi-
mately 50 km east of Cloudbreak mine and the Solomon hub.
56 Elizabeth Barber
BHP Billiton Iron Ore manages the Mount Newman Joint Venture.
These companies supply more than 80 per cent of the world’s iron ore,
holding immense power in the supply chain for steel products. The vol-
ume of exports increased steadily since 2003 whilst the value of these
exports increased dramatically due to massive price increases from
2003–08. China is the world’s largest importer of iron ore. The majority
of exports are transported from mines by dedicated heavy haulage rail
to dedicated bulk ports for bulk shipment to China.
FMG produces fine high-grade iron ore from its two mine sites at
Cloudbreak and Solomon.
3.6.1 Background
Iron ore from Goldsworthy, 100 km east of Port Hedland, in the early
1960s started the iron ore supply chain through Port Hedland to Asia.
In 1967 iron ore was found at Mount Whaleback and a 426-km dedi-
cated railway line was built to haul ore from Mount Newman to Port
Hedland. In 1986 Port Hedland dredged the main channel to increase
the tonnage to accommodate larger vessels using the port to ship the
bulk iron ore to Asia.
3.7 Pricing
Over the past 40 years, the price of iron ore was negotiated between
these three major suppliers and the Chinese steel mills. It was under-
stood that once a major supplier had reached a pricing agreement with
a major steel company the rest would generally follow this set price
which would remain fixed for the remainder of the year. Negotiations
were undertaken by the China Iron and Steel Association (CISA) which
represented the collective Chinese steel mills. The benefits of such an
arrangement were greater efficiency and a strong risk reduction.
In the second half of 2008, the global economic crisis hit all major
commodity markets causing commodity prices to fall significantly.
Major price swings occurred on the iron ore spot market which enabled
some Chinese mills to profit from lower prices. When the spot market
for iron ore dropped below the contract price, some mills ignored the
contract price and used the spot market prices. When the spot market
prices rose above the contract price, some of the larger Chinese mills
purchased higher volumes to resell at a profit to smaller mills. During
2009, after passing the self-imposed June deadline, negotiations broke
down between the major three suppliers and the CISA (Pandya, 2009).
In 2009 BHP Billiton agreed to sell ore at a mixture of pricing rates
including a percentage of ore being sold at the spot market price, at a
quarterly contractually agreed price and on an indexed pricing rate.
The strategic focus on the iron ore supply chain has been one of
consolidation with the merging of some of the bigger iron ore min-
ing companies as well as the takeovers of numerous small producers.
It also enabled the Chinese manufacturers to consolidate their nego-
tiations through CISA which gave all manufacturers greater leverage
since they used a high percentage of the suppliers’ production and had
collusive bargaining power. The strategy also permitted long-term col-
laboration including potentially reward sharing negotiations due to the
consolidation and volume flows enjoying economies of scale and bulk
transportation.
With strong global demand for iron ore, the big three producers are
currently exploiting their power to maximum effect. Their aggressive
exploitation can jeopardise long-term supplier–manufacturer relation-
ships or at the very least provoke further counteractions by manufac-
turers. Australia is a small but advanced economy, and over the past
four decades has relied on its mineral wealth to provide a strong gross
domestic product (GDP). Foreign investment is used to finance its vast
mineral wealth, which has enabled the Chinese steel mills to invest in
58 Elizabeth Barber
Freight rates are a key cost component of Australian iron ore exports
with land transport and port costs accounting for similar costs as min-
ing the ore. The average Free on Board (FOB) cash cost of international
non-agglomerated iron ore production increased by over 80 per cent
between 2003 and 2007. Freight rates are a key component to profitabil-
ity. Freight rates collapsed in 2008 but surged again in early 2010.
3.9 Railways
six 6,000 horsepower locomotives to pull the trains. The trips take
approximately eight hours to transport the ore over the distance.
There is also a smaller spur line into the Finucane Island port at Port
Hedland from the Yarrie mine which is 208 km running due east. The
trains along this track are smaller and typically one locomotive will
haul about 90 ore cars (www.bhpbilliton.com).
Port Hedland’s traffic control centre controls all train movements.
Weighing of the ore wagons are undertaken as they pass this centre. Rail
operations continue every day of the year with about a dozen loaded
and unloaded trains on the tracks each day continuing the transporta-
tion flows. Rail transport from the huge ore mines in the Mt Newman
area haul 208 rail cars each with a carrying capacity of 125 tonnes. The
trains are approximately 4 km long. The single rail trip from mine to
port takes approximately eight hours.
These rail trains are seen as part of the production process as each
shipment must meet specific volumes and sequences for blending pur-
poses at the ports for the final shipped ore product. The crushed ore
from the mines are sent from the mine to the rail stockpiles. The load-
ing on rail wagons is approximately 14,000 tonnes per hour. (Note the
difference between this rate and the ship loading rate of 10,000 tonnes
per hour but the bulk ship holds have a more continuous bulk capac-
ity than the rail wagons.) All these distortions need to be taken into
account when scheduling the types of ore, the timing of rail loading
and unloading to meet customer orders to be bundled into ships which
have tight loading schedules at the wharves.
It is not just a simple matter of all iron ore being the same. The mas-
sive Mt Whaleback mine produced exceptionally high-grade ore which
is often mixed to customer needs. Ore is also shipped in different prod-
ucts from lumpy ore to finely crushed ore (www.bhpbilliton.com/bb/
ourBusinesses/ironOre/rail.jsp).
BHP broke the record for the heaviest train with a weight of 99,734
tons which travelled 275 km between Yandi and Port Hedland on the
Mt Newman line. It was controlled by a single driver (www.railway-
technology.com/projects/hamersley).
3.9.3 FMG
The Pilbara Infrastructure Pty Ltd is a wholly owned subsidiary of FMG.
It owns both rail and port assets. Its purpose-built railway is the heaviest
haul line in the world with a 40 tonne axle loading design. It runs 288
km from the Cloudbreak mine to the Herb Elliott Port at Port Hedland.
The railway was constructed in a record time period of nine months
Transportation Issues of Coal and Iron Ore 61
Although the main iron ore railways are privately owned, there is capac-
ity for third-party access to use the facilities under the State Agreement
Act in Western Australia. The main tenet states that freight from third
parties should be carried at reasonably negotiated terms and rates, under
the provision that this can be achieved without unduly prejudicing or
interfering with the owner’s existing operations. This is interpreted to
mean that where there is excess transportation capacity on any railway,
then third-party access is available. Despite this clear legal situation the
owners of the railways, Rio Tinto and BHP Billiton, are not willing to
allow third-party access, namely, FMG.
The battle for third-party access to the iron ore railway lines has been
waging since 2004 when FMG tried to gain access to BHP’s Mt Newman
line and Rio Tinto’s Hamersley line (www.ncc.gov.au). The four Pilbara
iron ore railways subject to access rights include:
FMG wanted access to the Rio Tinto line to transport iron ore from its
Solomon mine to a port (yet to be built) at Anketell. The recent battle
lines were drawn when the Treasurer, Wayne Swan, decided that:
Rio Tinto and FMG appealed these decisions. The Australian Competition
Tribunal then reviewed the Treasurers’ decisions relating to all four
applications for access by FMG and on the 30 June 2010 handed down
the following decisions:
3.12 Ports
There are two heavy bulk exports located in the Pilbara coastline of
northwest Western Australia. The most northern port is Port Hedland
64 Elizabeth Barber
which is used by Rio Tinto, and Dampier ports which lie approximately
200 km to the south is used by BHP Billiton. The value of commodi-
ties exported from Port Hedland and Dampier exceeded $40 billion in
2009–10. Competition for berths in these ports is almost as fierce as the
lengthy battles being fought between the mining companies over rail
infrastructures.
about 10,000 tonnes per hour and thus it takes about 30 hours to fully
load each ship. The turnaround time is tight in port as about 800 ships
(and this rate is increasing annually) are loaded per annum.
To keep the flow loads pouring into the bulk holds of the ships a
complex conveyor system operates from the rail dumped stockpiles to
the ship loadings at the wharves. A conveyor system runs under the
harbour (in a tunnel approximately 1 km in length) to enable ore to be
transferred from Nelson Point port across to Finucane Island port. The
ore is dumped from the rail network into four main stockpiles, each
containing 200,000 tonnes of ore. Giant buckets scoop up the ore from
the stockpiles and transfer the ore to the conveyor system which links
to the ship loaders.
Here we can see that unlike the coal networks in the eastern states the
transportation distributors are not the dominant player in the supply
chains but rather the producers of the ore. Both BHP Billiton and Rio
Tinto own the mines, the rail transport and the port facilities. This is
similar to their huge counterparts in China where the coal producers
own the mines, the rail systems, the port facilities and even the bulk
shipping lines.
The many coal mines in the eastern states of Australia are so depend-
ent on the original public rail system that individual coal producers had
limited negotiation power over rail schedules and track usage. Once the
railways became so congested that mines could not get their coal flows
to the harbour stockpiles efficiently, the urgent call for private owner-
ship and control occurred. The government interfered and backed the
call to sell the public network to a private consortium. This is the oppo-
site from the current situation in iron ore rail transportation.
The iron ore railways are privately owned by the two giant producers.
They want to keep their railways closed from other mine producers yet
66 Elizabeth Barber
3.14 Conclusion
Both black coal and iron ore are bulk resources that are vital to the
Australian economy. Few people realise how dependent these exports
are on transportation. This chapter has attempted to highlight the
potential risks associated with these domestic links. It has also high-
lighted the Australian government’s interference. This interference is
contrasted to Chinese coal supply chains, where the mines own, con-
trol and dominate the mines, transport systems and facilities, including
the import shipping lines. The government interference in these two
export private industries is inconsistent with the coal railways being
privatised whilst the iron ore railway corporations are pressured by the
government to allow public access for competing producers.
The future is unsettled regarding the regulatory changes, but it is pre-
dictable with regard to the expansion of both the production of these
minerals and the associated transport infrastructure developments.
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Growth. Coal Infrastructure in Queensland. Overview of Future Expansion.
February http://www.tmr.qld.gov.au/~/media/e8e9f0ca-7616–48f8–89ad-
a9521c98358a/pdf_coal_infrastructure_in_queensland_full_reduced.pdf.
Queensland Parliamentary Papers, June 2009.
Saul, J. and Cowhing, J. (2009), ‘Analysis – Port Bottlenecks to Lift Coal Prices,
Freight’, 10 December 2009, http://af.reuters.com/article/southAfricaNews/
idAFGEE5B81TX20091210?sp=true.
Sharples, B. (2010), April 6th, ‘Coal Shipments from Australia’s Newcastle Rise
24% as Ship Queue Shortens’, www.reuters.com.
Sydney Ports Corporation (October 2008), Logistics Review 2007–08, 12.
Sydney Ports Corporation, Trade Statistics 2007–08.
Sydney Ports Corporation, Trade Bulletin, April 2009.
Thomson, E. (2003), The Chinese Coal Industry: An Economic History, Routledge,
London.
Wallacep (2009), ‘BHP-Rio Joint Venture Comes Together’, The Australia Journal
of Mining, December 2009, http://www.theajmonline.com.au/mining_news/
news/20 09/december/december-10 – 09/ bhp -r io -joint-vent ure- comes-
together/?searchterm=On December 5th.
4
MRO Procurement: Best Practices
Framework for Capital Equipment
Ananda S. Jeeva
4.1 Introduction
69
70 Ananda S. Jeeva
PLC may be defined as the course of a product’s sales and profits during
its lifetime which involves five distinct stages (Kotler and Armstrong
2008). These five stages are Product Development, Introduction,
Growth, Maturity and Decline. Each stage has its own distinct char-
acteristics that need to be considered in procurement activities. The
most critical consideration is whether there will be availability of parts
and components in the last stage and beyond. The pricing of parts and
components during these five stages is also important. Procurement
personnel must create and implement different procurement strategies
for each of these stages. These procurement strategies must be based on
data from supplier intelligence.
The first stage of product development also known as New Product
Development (NPD) does not affect MRO directly, but OEM and suppli-
ers must have knowledge of the long term supply risk of the materials
and components that are selected in the NPD stage. The second stage
of product introduction into the consumer market also does not affect
MRO directly as the finished product would not need parts and com-
ponents for repairs yet. The stages that affect procurement most are the
growth, maturity and more importantly the decline stage. The growth
stage is marked by a growth in sales, with readily available low costs
parts and components to boost sales. During the maturity stage, sales
MRO Procurement: Best Practices Framework 73
The procurer must ensure that they carry the correct part and quantity
for their projected life span of the plant and equipment. The procurer
must also be accountable for designing a maintenance procurement
plan with specific parts list with a chronological date for the expected
life span of the plant or equipment. Likewise, the supplier/manufac-
turer must also be responsible and accountable for after-sales customer
service in ensuring the availability of spare parts. This may be an ad hoc
arrangement that the manufacturer would be willing to produce parts
if and when necessary according to inventory levels, immaterial of time
forecasts. The OEM may also need to outsource their proprietary patents
for the production of obsolete parts and components to selected manu-
facturers. This, however, may increase price and extend lead time. The
other major impact that sometimes prevents manufacturers from con-
tinuing production of specific products is that their upstream suppliers
(tier 2 or tier 3) might not be able to supply the required raw materials or
components. This indicates that the supply risk flows along the supply
chain to the extreme end of the upstream side. Procurement person-
nel at the finished goods manufacturing plant and the end customer
must have supplier intelligence during the final stages of the PLC. This
enables them to make informed decisions about sourcing and procure-
ment, which leads to sustainable competitiveness.
The inability of upstream suppliers to supply raw materials and
components may also be due to obsolescence or lack of raw materials.
Manufacturers who produce the finished product are normally account-
able for quality, factory warranty, product guarantee and replacement
from the customers’ perspective. Hence, OEM also have to have supplier
intelligence. Supplier intelligence is defined as an ‘up to date knowl-
edge base of critical suppliers incorporating the suppliers’ market intel-
ligence, business intelligence, competitive capability, financial stability
including their suppliers’ suppliers’ intelligence in the long term’ (Jeeva
2008). This intelligence and knowledge extends upstream to the last
tier supplier. Supplier intelligence should provide sufficient data and
knowledge for manufacturers to forecast and predict and strategise their
short-term and long-term plans. Supplier intelligence should also pro-
vide knowledge of the suppliers’ suppliers’ PLC data. This provides addi-
tional information for negotiating better supply service levels.
Supply risk attributes change throughout the PLC stages. Each of the
five stages of the PLC has different supply risks. This risk is influenced
MRO Procurement: Best Practices Framework 75
Research and design of new product – may continue to use some older
parts and components including refurbished parts
The status of spare parts, components are readily available, but inven-
tory levels declining slowly and increased uncertainty
● Identify and create a critical list of all plant and equipment with
purchase details
● Identify failure details, chronological order of failures
● Identify failure reasons, costs, downtime
● Identify manufacturer’s recommended mean time between failures
● Identify ease or difficulty of sourcing parts, lead time
● Classify all industrial plant and equipment operational life span at
risk
● Classify spare parts and components replacement frequency and
schedule for this critical list
● Classify suppliers into excellent, moderate, mediocre, poor in terms
of pre-agreed service level for each of the plant and equipment on
the critical list
● Create a new inventory risk classification critical list
● Create future requirements list with time schedules of critical spare
parts and components
● Create a performance matrix for each industrial plant and equip-
ment at risk
● Anticipate level of services from critical list of suppliers
● Communicate this information to maintenance and workshop staff
● Seek feedback from maintenance and workshop staff for alternate
strategies
● Update all MRO matrixes in a timely fashion
MRO Procurement: Best Practices Framework 77
From the critical list of plant and equipment, a critical list of components
and sub-assemblies must be derived because not all the components and
sub-assemblies need frequent maintenance, repairs and replacement. A
maintenance schedule is normally provided by the manufacturer for
all plant and equipment. From this schedule the maintenance staff are
able to forecast the exact requirements of components, spare parts and
sub-assemblies including time schedules over the whole operational life
of the plant and equipment. From this schedule procurement personnel
can establish a procurement plan, purchasing plan and sourcing plan as
necessary, and more importantly, a contract negotiation plan.
78 Ananda S. Jeeva
Performance risk matrix would also include failure rates, mean time
between failures, probability of failure according to usage, cost of
repair, downtime and impact to financial bottom line. The how and
why of unexpected failures and its contributing factors would further
help establish a more stable maintenance plan as well as a procurement
strategy.
Contract negotiation for the supply of spare parts, components and sub-
assemblies provide additional assurance and certainty to suppliers and
manufacturers of future sales. They are therefore able to plan their sales
and production capacity more accurately and provide greater stability
in negotiating their supply side. Negotiation elements may include serv-
ice level, lead times and costs. Together with the contract negotiation,
customers are further able to increase their negotiating power. With the
additional knowledge gained with supplier intelligence, customers will
be able to negotiate not only price but the critical aspect of continued
supply of parts and components.
Procurement personnel must also consider the implications of Force
majeure when negotiating long term supply or spare parts, components
and sub-assemblies. Mergers and acquisitions of current OEM or their
suppliers may lead to increased risk of supply of raw materials, compo-
nents and sub-assemblies along the upstream side of the supply chain.
Contingency strategies must always be envisioned.
References
Brennan, R. and Turnbull, P.W.(1999), ‘Adaptive Behaviour in Buyer–Supplier
Relationships’, Industrial Marketing Management, 28, 481–495.
Cox, A. (1996), ‘Relational Competence and Strategic Procurement Management’,
European Journal of Purchasing and Supply Management, 2(1), 57–70.
Jeeva, A. (2008), Supplier Intelligence in MRO Procurement, 2008 IEEE SOLI
International Conference, Beijing.
Jones, S.R. and Zsidisin, G.A. (2008), ‘Performance Implications of Product Life
Cycle Extension: The Case of the A-10 Aircraft’, Journal of Business Logistics,
29(2), 189–214.
Kotler, P. and Armstrong, G.(2008), Principles of Marketing, 12th edition, Prentice
Hall, Frenchs Forest.
Lysons, K. and Farrington, B.(2006), Purchasing and Supply Chain Management,
7th Edition, Prentice Hall, Essex.
Magnan, G.M., Fawcett, S.E. and Birou, L.M. (1999), ‘Benchmarking
Manufacturing Practice Using the Product Life Cycle’, Benchmarking: An
International Journal, 6(3), 239–253.
Parker, D. and Hartley, K. (2003), ‘Transaction Costs, Relational Contracting
and Public Private Partnerships: A Case Study of UK’, Journal of Purchasing and
Supply Management, 9(3), 97–109.
Seth, J. and Sharma, A. (1997), ‘Supplier Relationships: Emerging Issues and
Challenges’, Industrial Marketing Management, 26, 91–100.
Tassabehji, R. and Moorhouse, A. (2008), ‘The Changing Role of Procurement:
Developing Professional Effectiveness’, Journal of Purchasing and Supply
Management, 14(1), 55–68.
Van Weele, A.J. (2005), Purchasing & Supply Chain Management: Analysis, Strategy,
Planning and Practice, 4th edition, Thomson, London.
Van Weele, A.J. and Roszemeijer, F.A. (1996), ‘Revolution in Purchasing:
Building Competitive Power through Proactive Purchasing’, European Journal
of Purchasing & Supply Management, 2(4), 153–160.
Part III
Financial Perspectives
5
Practical Problems in Mining
Valuations
Wayne Lonergan and Hung Chu
5.1 Introduction
There are various stages in the life cycle of a mining project, which can
be broadly categorised as early stage exploration, discovery, pre-Banka-
ble Feasibility Study (pre-BFS), BFS, construction and development and
producing mine. The early stage exploration and discovery includes
exploratory drilling. The pre-BFS involves resource delineation, where
83
84 Wayne Lonergan and Hung Chu
more detailed drilling upgrades the prospect to (at least) resource status
and a preliminary feasibility study is conducted to establish whether
or not the project is likely to be economically viable. The BFS stage
involves the application of commercial mining parameters and signifi-
cant independent specialist analysis and the proving up of sufficient
resources to reserve status to justify the necessary investment in pit/
mine design, overburden removal, and expenditure on mining plant
and equipment, infrastructure and processing facilities. The outcome
of the BFS stage is a detailed feasibility study, which is reviewed by
independent geologists and mining engineers. The BFS determines the
appropriate plant size and mining equipment configurations. If the
outcome of the feasibility study is positive, it is, as its name suggests,
submitted to potential lenders for project financing. The construction
and development stage includes the construction of the ore process-
ing plant, power and water facilities, road and rail infrastructure, port
and shipping facilities (in the absence of existing facilities) and the
removal of overburden and the construction of access shafts etc.. The
recognition of the life cycle of a mining project has important implica-
tions for the applicability of the Discounted Cash Flow (DCF) approach
at various stages of the project and the implementation of that val-
uation approach once it has been selected as the primary valuation
approach.
proceeding to the stage where it gets all the necessary approvals is the
cumulative probability of at least all of the above-mentioned events
occurring.
The systematic risk of a project is allowed for in the discount rate,
which is determined using the CAPM. Given the changing risk pro-
file of the project (subject to the necessary hurdles being overcome), it
is difficult, from a conceptual perspective, to justify applying a single
discount rate to all the expected future cash flows. In practice, how-
ever, use of differential discount rates is rare for a number of reasons.
Firstly, computational complexity of the differential rates. Secondly,
lack of objective empirical data on applicable rates. Thirdly, in theory
at least, market discount rates (determined using ‘measured’ betas)
already reflect the combined effects of the differential rates over the
entire project life. Fourthly, at a more practical level, the values of most
mining projects are more sensitive to cash flow-based factors (such as
timing, probability adjustments for various hurdles being overcome,
commodity prices and exchange rates) than to discount rates. Whilst
all of these justifications have some practical merits, it is necessary to
get both the cash flows and the discount rate right if the valuation is to
be technically defensible, even though the valuation outcome is usually
more sensitive to variations in cash flow-based assumptions than to the
discount rate part.
In addition, the use of a single ‘market’ discount rate has a number of
technical problems. Firstly, the single ‘market’ discount rate is typically
derived using either the ‘measured’ beta of the (listed) company own-
ing the project or the ‘measured’ beta of ‘comparable’ companies. Such
‘measured’ beta are not only historic betas (not forward-looking betas),
but also usually portfolio betas (as opposed to individual project betas)
given that the relevant ‘comparable’ companies often hold a portfolio
of projects (which may be at various stages of development and hence
have differing risk profiles). Secondly, given significant changes in the
risk profile of a mining project over its life, the application of a single
discount rate would logically overstate the present value of pre-produc-
tion cash flows and understate the present value of post-production
cash flows. The extent to which such overstatement and understate-
ment offset each other is not transparent. Thirdly, the use of a sin-
gle discount rate produces an anomalous valuation outcome in that
the higher the systematic risk of the project, the higher the discount
rate, the lower the (absolute) present value of the initial upfront capi-
tal costs (i.e., cash outflows), and the higher the project value (other
things being equal).
88 Wayne Lonergan and Hung Chu
in the form of either severe lack of diversification (in the case of a rights
issue) or virtually perpetual significant dilution of existing ownership
(in the case of a private placement).
Substantial value can be unlocked if/when the cash-strapped junior
miner is taken over by a cashed-up bidder. Depending on the size of the
underlying project, the cashed-up bidder can be a major producer who
is seeking growth options through acquisitions or a growing mid-tier
producer who is seeking growth options and/or commodity diversifica-
tion through acquisitions. The cashed-up bidder can also be a major
commodity trading house or a potential end user of the commodity
who is seeking security of raw material supplies. For the established
miners which generate significant cash flows from their existing estab-
lished operations, acquiring successful explorers about to move into
production facilitates optimising their value creation. Such acquisitions
not only reduce the adverse valuation implications of exploration costs
but also enable established miners to profit significantly by acquiring
emerging producers relatively cheaply and resolving the stock over-
hang/dilution problems and the consequent excessive value dilution of
emerging producers which they are otherwise unable to avoid.
For emerging producers, the (otherwise) unlockable value (to them)
represents the ‘pure’ value of control, as distinct from the value of
potential synergies that can be generated in a traditional merger/takeo-
ver. This is because the ‘pure’ value of control can be derived without
the need to combine the physical operations of two entities. The sub-
stantial value can be unlocked simply by the injection of cash from the
cashed-up bidder to resolve the financing constraints faced by the tar-
get and move the underlying project into production. This is in contrast
to cases where synergies are created from, for example, the combination
of two existing producing mining companies whose mining operations
are (say) adjacent to each other or from the combination of two indus-
trial companies whose distribution networks overlap.
Conceptually, there are two ways of assessing the ‘pure’ control pre-
mium payable by the bidder to the target. One is as a share of the ‘pure’
value of control or total unlockable value (to the target) and the other
is as a share of the ‘pure’ value of control net of the appropriate costs
(including opportunity costs) (to the bidder) of unlocking the unlock-
able value. The target (i.e., the emerging producers) tends to prefer the
former approach in assessing/expecting what the size of the control pre-
mium should be, whereas the bidders tends to prefer the latter approach
because it is based on the economic residual unlockable value (to them)
which they may be willing or forced (in the presence of competition)
Practical Problems in Mining Valuations 95
to share with the target. The apparent divergence in the views of the
emerging producers and the bidders means that the control premium
payable in takeover offers for successful junior mining companies has
three unique drivers. First is the nature of the ‘pure’ value of control
(i.e., the otherwise unlockable value gap in the hands of the emerging
producer). Second is the large size of this ‘pure’ value of control or total
unlockable value gap and third is the ability of the bidding company to
minimise the amount it pays away to obtain the ‘pure’ value of control
(because often the target shareholders have little realistic opportunity
to ensure they receive it anyway).
At a theoretical level, one view is that virtually all of the unlockable
value should be paid away to the target shareholder because competi-
tion between potential cashed-up bidders (of which, in theory, there are
many) should cause this to occur (potential cashed-up bidders cannot
generally extract major unique synergies from the takeover). At a prac-
tical level, however, the control premium actually paid away generally
represents a much lower share of the (otherwise) unlockable value (to
the target) than would theoretically (and traditionally) be considered ‘as
fair’. At its most basic level this is because the bidder should be entitled
to a financial benefit for acting as a liquidity provider. There are also
several other reasons why this is so.
Firstly, there are, in practice, generally only a limited number of inter-
ested bidders, resulting in an insufficient level of competition to acquire
the emerging producer. The limited number of interested bidders can be
attributed to the non-homogeneous and non-traded nature of mining
assets, as opposed to standardised financial assets (such as listed shares)
which are regularly traded. Secondly, most mining acquisitions occur
during periods of high commodity prices. This economic cycle effect
means there are few, if any, buyers during commodity price downturns.
Thirdly, the non-homogeneous nature of mining assets (as opposed to
traded financial assets) also requires potential bidders to incur signifi-
cantly higher transaction costs and take an extended period of time to
conduct due diligence. Paying away all or a significantly large propor-
tion of unlockable value means that the successful bidder would gener-
ate no return or an inadequate return on their significant due diligence
time and costs. Fourthly, the potential bidders may have differing views
as to the true value of the underlying project and the size of the unlock-
able value as well as the uncertainty associated with its measurement.
This is particularly so for early stage (pre-BFS) mining projects given
the significant valuation uncertainty associated with such projects.
Fifthly, the successful bidder still has to bear the risk of unlocking the
96 Wayne Lonergan and Hung Chu
The market value of an asset is also determined on the basis that the
asset is put to its highest and best use. Consequently, market value is
a hypothetical or theoretical price in nature. In the case of a mining
project which has reached the BFS stage and whose BFS produces a posi-
tive outcome, the adoption of the ‘highest and best use’ principle theo-
retically implies that the market value of the asset should be determined
on the assumption of the availability of funding required to develop
Practical Problems in Mining Valuations 97
the project and bring it into production because this is the highest and
best use to which the asset should be put. A strict acceptance of the
market value definition and ‘the highest and best use’ basis on which
the market value is measured can lead a valuer to reason that the hypo-
thetical WBNAB that is fully informed of the highest and best use of
the asset is cashed up and should have the capacity to meet the funding
requirement to bring the underlying project into production without
the highly dilutive capital raising. Consequently, as the argument goes,
the market value, which is the price the hypothetical WBNAB pays for
the asset (even at the time the financing uncertainty has not yet been
resolved), should reflect the above-mentioned position. In other words,
the assessment of market value seems to assume away the significant
financing and dilution risk which the owner of the asset is actually
facing.
In order to resolve the apparent disconnect between the way the
‘theoretical’ market value would be measured on a highest and best
use basis and the obvious significant impacts of financing and dilu-
tion constraints on value in practice, it is important to recognise the
relationship between market value and liquidity. The market value defi-
nition which is widely used in practice and which underpins most judi-
cial findings has been in existence for over 100 years dating back to the
Spencer v The Commonwealth (1907) case. In comparison, the concept
of liquidity and its impact on asset value have been widely recognised
and reasonably documented in academic literature only over the last
20 years or so.7 Consequently, in a mining valuation context the long-
established market value definition may be susceptible to the (incor-
rect) interpretation that the hypothetical WBNAB and the hypothetical
WBNAS always arrive at the same time, whereas the fact that buyers and
sellers for an asset do not always arrive at the same time underpins the
importance and value of liquidity.
The appropriate way to reconcile this apparently conceptual mis-
match is to recognise that a fully informed WBNAB and a fully informed
WBNAS are aware of the importance and value of liquidity and factor
it into the negotiated price (i.e., market value) of the asset. In the case
of an advanced developing mining asset, the owner of the asset (i.e., a
junior mining company) typically faces severe restrictions in its ability
to convert the asset into cash either through outright sale of the asset
(due to the non-traded and non-homogenous nature of the asset) or by
‘monetising’ the asset by bringing it into production (due to the severe
financing and dilution constraints). Thus, the hypothetical WBNAB in
this case is not only a normal purchaser of the asset8 but it also acts as
98 Wayne Lonergan and Hung Chu
5.6 Conclusions
While use of differential discount rates for the different stages of min-
ing project development is rare in practice, it is theoretically appealing
and is worthy of serious consideration. The consideration and adop-
tion of differential discount rates in DCF valuations of mining projects
would contribute greatly to putting more science into practical min-
ing valuations. The shares of many emerging producers are materially
Practical Problems in Mining Valuations 99
Notes
1. ‘ASIC Issues Alert On Valuation’, The Australian Financial Review, 19 October
2010.
2. As defined by the JORC Code.
3. The importance of using prospective beta rather than historic beta of emerg-
ing producers is self-evident.
4. At a practical level, many early stage investors – who may have been investors
for five or ten years – become ‘stale’ or disillusioned with the long timescale
to investment return.
5. This does not necessarily increase the probability of further dilution not
occurring in subsequent rounds of financing.
6. This excludes the impact of any potential pre-bid price run-up due to antici-
pation of the impending takeover bid.
7. Liquidity refers to how quickly an asset can be converted to cash without
the asset’s owner incurring substantial transaction costs or price concession.
Liquidity is valuable to investors because the lack of liquidity causes inves-
tors to miss opportunities to allocate capital to assets with higher return.
8. Like a purchaser of a small parcel of BHP shares on the stock exchange. In
such a case the seller of the parcel of shares does not even know who the
actual purchaser of those shares may be because there are so many potential
buyers.
9. The standard version of CAPM does not allow for circumstances where the
cost of equity capital has to establish for investments that lack liquidity.
6
The Tax Accounting Interface
in the Mining Industry in the
Context of IFRS
Les Nethercott
6.1 Introduction
100
Tax Accounting Interface in the Mining Industry 101
(a) The rights to tenure of the area of interest are current; and
(b) at least one of the following conditions are met:
(i) the exploration and evaluation expenditures are expected to
be recouped through successful development and exploita-
tion of the area of interest, or alternatively by sale; and
Tax Accounting Interface in the Mining Industry 103
● Expense method
● Full cost method
● Successful efforts (or area of interest method)
Under the full cost method, all exploration and evaluation expenditure
is carried forward whether it is successful or otherwise. This is based
on a macroperspective that treats individual exploration expenditures
as part of a wide exploration activity within the entity. This is also
based on the view that it is necessary to undertake a wide-reaching
exploration programme in order to find a commercial deposit. While
potentially unsuccessful, it is a necessary part of a strategy to locate a
commercial mining deposit.
The expense method takes a conservative view. Given that most
exploration activity is likely to be unsuccessful the method adopts a
policy of treating all such expenditure as an expense when incurred. It
can be argued that both methods are deficient.
The full cost method capitalises exploration and evaluation expendi-
ture whether it is successful or not. In the case of the exploration
expenditure being unsuccessful it means the expenditure is capitalised
in the balance sheet and the income statement does not reflect the
unsuccessful outcome at the time of the unsuccessful exploration activ-
ity. This provides misleading information to investors.
The expense method adopts an opposite and conservative perspec-
tive by expensing all such expenditures. However, it means that in the
case of successful exploration and evaluation expenditure, the income
statement records as an expense expenditure which has given rise to an
asset in the form of a viable mineral deposit. Furthermore, the balance
sheet does not record or recognise the creation of an asset represented
by the expenditure which has been undertaken in the exploration and
evaluation programme.
The successful efforts method allows exploration and evaluation
expenditures to be carried forward in relation to an area of interest until
104 Les Nethercott
In this respect the Accounting Framework states that an item meets the
definition of an element if:
(a) It is probable that any future economic benefit associated with the
item will flow to the entity; and
(b) The item has a cost or value that can be measured reliably.9
Tax Accounting Interface in the Mining Industry 105
The standard recognises the difficulty of such a task by stating that the
entity shall assess the probability of expected future economic benefits
using reasonable and supportable assumptions that represent manage-
ment’s best estimate of the set of economic conditions that will exist over
the useful life of the asset. While such a proposition or view may be fine
Tax Accounting Interface in the Mining Industry 107
The higher of the fair value less costs to sell and its value in use.17
● An estimate of the cash flows the entity expects to derive from the
asset
● The time value of money, represented by the risk-free rate of interest
● The price to reflect the uncertainty inherent in the asset
● Other factors such as illiquidity
The nature of the mining industry and especially those related to explo-
ration programmes are such that each of these factors outlined above is
difficult to assess and quantify.
Firstly, the ability of an entity to determine the future cash flows aris-
ing from an exploration programme is a most difficult task.
Secondly, possible variations in the amount or timing of such flows
are again difficult to predict. Such variations may be more predictable
as the evaluation and later stages related to development and produc-
tion occur.
Thirdly, while the risk-free rate of interest may be determined, the
assessment of what might be appropriate to reflect the uncertainty is
difficult. Such an assessment could reflect uncertainty on a macro or
global scale (such as reflected in the Global Financial Crisis) or those
Tax Accounting Interface in the Mining Industry 109
While the above analysis has considered the main accounting stand-
ards relating to the issue of how exploration costs should be accounted
for, there is a different outcome when tax is considered. In this respect it
Tax Accounting Interface in the Mining Industry 111
You can deduct from your assessable income any loss or outgoing to
the extent that:
(a) it is incurred in gaining or producing your assessable income;
or
(b) it is necessarily incurred in carrying on a business for the pur-
pose of gaining or producing your assessable income.
(These are known as the positive limbs.)
You cannot deduct a loss or outgoing under this section to the extent
that
(a) it is a loss or outgoing of capital, or of a capital nature.
(This is known as a negative limb of the section.)
Where the conditions of the first positive limb are not satisfied it is
possible that the expenditure on exploration and evaluation may come
within the scope of the second positive limb of S 8–1. While the second
positive limb is more liberal than the first limb insofar as the nexus
test is not applied, the second positive limb is broader and covers the
situation where the production of income is more problematic and may
be more uncertain. However, for such expenditure to be an allowable
deduction under the second positive limb it is necessary that the:
The leading case which examines this issue is the decision in Sun
Newspapers.31 In this case the taxpayer paid 86,500 pounds to a rival
newspaper not to publish a newspaper within 300 miles of Sydney. The
Court held that the outgoing was of a capital nature because it related
to the profit-making structure of the firm. In this respect the Court
observed that:
However, in the case of a deferred tax asset arising from the treatment
of exploration and evaluation (i.e., where the expenditure has expensed
for accounting purposes but capitalised for tax purposes), it is argua-
ble that an asset does not exist. This is because the future economic
benefits cannot be predicted or measured with any certainty until the
entity is able to determine that the exploration site will be commercial
in nature.
Conversely, in the case of a deferred tax liability (i.e., where the explo-
ration and evaluation expenditure has been capitalised for accounting
purposes but written off for tax purposes), it may be argued that a liabil-
ity does not exist. In the Accounting Framework, an important charac-
teristic of a liability is that there is a present obligation by the entity.35
In this case there is no present liability as the presence of the liability
is dependent on future events which may not occur. Furthermore, the
presence of a liability is dependent on future taxable income being pro-
duced which can be measured reliably. From an Australian Tax Office
perspective, a tax liability does not exist.
Tax Accounting Interface in the Mining Industry 117
From the above discussion it can be seen that the new IFRS accounting
standards raise a number of issues concerning the accounting treatment
of exploration and evaluation expenditures. In particular, there is the
issue of whether to expense such expenditure as incurred or to carry it
forward until a decision can be made as to whether the expenditure will
be recoverable by the future cash flows attributable to the exploration.
Where the latter choice is made, this essentially means that an asset will
be recognised. The difficulty with this outcome is that it is hard to estab-
lish or justify the presence of an asset. This is because the exploration
activities and expenditure related to it does not meet the definition of
an accounting asset, within the context of the Accounting Framework,
but also because there is considerable uncertainty as to whether there
will be a successful outcome from the exploration activity.
From a tax point of view, the determination of whether exploration
expenditures are an allowable deduction, or may be recognised as an
asset, is dependent on tax law which has different principles. As a result
there is not likely to be any congruence between the accounting meas-
ure of income and that of taxable income.
Where such differences occur due to the presence of timing differ-
ences AASB 112 requires the recognition of a deferred asset or a liability.
However, as indicated earlier, it may be argued that such a liability or
asset should not be recognised due to the fact the asset or liability is
based on future events which are uncertain.
In the case of an established mining operation which has a posi-
tive cash flow and earnings, it may be possible to argue that a liability
may exist. However, from a tax point of view, this is not the case. From
an Accounting Framework perspective, it would be difficult to argue
that there is a deferred asset or a deferred liability. In the case of a new
explorer, the argument that a deferred asset or liability does not exist is
much stronger.
As a result it may be argued that the accounting tax interface raises
a number of conceptual and practical difficulties in determining how
exploration and evaluation expenditure should be treated. In an ideal
Tax Accounting Interface in the Mining Industry 119
6.8 Conclusion
The adoption of IFRS has raised a number of accounting issues for enti-
ties engaged in the mining industry, especially concerning the treat-
ment of exploration and evaluation expenditures. This produces a result
where entities are given a choice of how to account for exploration and
evaluation expenditures prior to production. As a result, the account-
ing for these expenditures may produce different asset and expense
outcomes.
From a tax perspective, where there is a divergence between taxable
and accounting income due to the different treatment of exploration
and evaluation expenditure, this raises the possibility that a deferred
asset or liability should be recognised for accounting purposes when
there is no asset or liability strictly at law.
The outcome of this divergence is the recognition of assets and liabili-
ties which are questionable in nature and the production of financial
statements that may be misleading and not reflective of the entity’s
financial position.
In view of the move to adopt IFRS it would seem that any congruence
between accounting and taxable concepts of income is remote. In the
case of the mining industry the outcome is to increase the complexity
of financial reporting and as a result the tax interface.
120 Les Nethercott
Notes
1. Henderson, S. and Pierson, G. (2010), Issues in Financial Accounting, Pearson
Prentice Hall, Chapter 22, 2010.
2. Financial and Reporting Handbook (2010), Wiley, and R Picker et al. (2006),
Australian Accounting Standards, John Wiley and Sons Australia Ltd.
3. See Financial and Reporting Handbook (2010), Wiley.
4. Financial and Reporting Handbook (2005), Wiley.
5. AASB 6, para 7.
6. Henderson, S. and Pierson, G. (2010), Issues in Financial Accounting, Pearson
Prentice Hall, chapter 22.
7. See ‘Framework for the Preparation and Presentation of Financial Statements’
in the Financial and Reporting Handbook (2010), Wiley.
8. ‘Framework for the Preparation and Presentation of Financial Statements’,
para 83.
9. ‘Framework for the Preparation and Presentation of Financial Statements’,
para 83.
10. AASB 138, para 12.
11. AASB 138, para 8.
12. AASB 138, para 12.
13. AASB 138, para 21.
14. AASB 6, para 12.
15. Nethercott, L. and Anamourlis, T. (2009), ‘Impairment of Assets: A Tax
Accounting Interface’, Journal of Law and Financial Management, 8(1), pp.
14–19
16. AASB 136, para 6.
17. AASB 136, para 6.
18. AASB 136, para 9.
19. AASB 136, paras 110 and 114.
20. AASB 101, ‘Presentation of Financial Statements’ refers to a requirement to
provide a ‘Statement of Comprehensive Income’, that is, a profit and loss
statement and a requirement to provide a ‘Statement of Financial Position’,
that is, a balance sheet.
21. See Nethercott, L. and Hanlon, D. (Spring 2005), ‘The Taxation Consequences
of Adopting International Financial Reporting Standards in Australia’, Asian
Pacific Journal of Taxation, 9(1), pp. 34–49.
De Zilva, A. (2003), ‘The Alignment of Tax and Financial Accounting
Rules: Is It Feasible?’ Australian Tax Forum, 18, pp. 264–284.
Freedman, J. (2004), ‘Aligning Taxable Profits and Accounting Profits:
Accounting Standards, Legislators and Judges’, eJournal of Tax Research, 2(1),
pp. 71–79.
DÁscenzo, M. and England, D., The Tax and Accounting Interface: 2003
Proceedings of 15th Australian Tax Teachers Conference, University of
Wollongong.
22. See Woellner, Barkcoczy, Murphy, Evans and Pinto (2010), Australian Tax
Law, CCH, 567–605.
23. See Amalgamated Zinc (de Bavay’s) Ltd v FCT (1935) 54 CLR 295; Herald and
Weekly Times Ltd v FCT( (1932) 48 CLR 113.
24. Amalgamated Zinc (de Bavay’s) Ltd v FCT (1935) 54 CLR 295 at 303.
Tax Accounting Interface in the Mining Industry 121
25. Charles Moore & Co (WA) Pty Ltd v FCT (1956) 95CLR 344.
26. Softwood Pulp and Paper 76 ATC 4439.
27. Ronpibon Tin NL v FCT (1949) 78 CLR 47; also see FCT v Snowden and Wilson
Pty Ltd (1958) 99 CLR 431.
28. Softwood Pulp and Paper v FCT 76 ATC 4439.
29. Travelodge Papua New Guinea v Chief Collector of Taxes 85 ATC 4432.
30. See Woellner, Barkcoczy, Murphy, Evans and Pinto (2010), Australian Tax
Law, CCH, 606–619.
31. Sun Newspapers Ltd and Associated Newspapers Ltd v FCT (1938) 61 CLR 337.
32. Sun Newspapers Ltd and Associated Newspapers Ltd v FCT (1938) 61 CLR 337,
359.
33. AASB 112, para 5.
34. ‘Framework for the Preparation and Presentation of Financial Statements’,
para 53.
35. ‘Framework for the Preparation and Presentation of Financial Statements’,
para 60.
36. Nethercott, L. (2005), ‘Consolidations: An Accounting Tax Interface’, The
Tax Specialist, 8(3), 152.
37. See C of T v Executor Trustee and Agency Company of South Australia (1938) 63
CLR 108.
38. De Zilva, A. (2003), ‘The Alignment of Tax and Financial Accounting Rules:
Is It Feasible?’ Australian Tax Forum, 18, 265.
Hill, G. (Feb 2003), ‘The Interface between Tax Law and Accounting Concepts
and Practice as seen by the Courts’, 15th Annual Australasian Tax Teachers
Association Conference, Faculty of Law, University of Wollongong.
39. ‘Framework for the Preparation and Presentation of Financial Statements’,
para 12.
7
Carbon Tax: Economic Impact
on the Latrobe Valley
Mereana Barrett, Svetlana Maslyuk and Daniel Pambudi
7.1 Introduction
122
Carbon Tax: Economic Impact on the Latrobe Valley 123
Coal seam
thickness Overburden
Mine Mine area (metres) depth (metres) Mining technique
Source: Table is based on PowerWorks: Industry Overview. Available online at: http://www.
powerworks.com.au/information/industry-overview.
Table 7.2 Estimated resident population in the Latrobe Valley, the state of Victoria
and Australia
Source: ABS, 3218.0 – Regional Population Growth, Australia, 2008–09, retrieved from http://
www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPage/3218.02008–09?OpenDocument and ABS,
3101.0 – Australian Demographic Statistics, retrieved from http://www.abs.gov.au/ausstats/
abs@.nsf/mf/3101.0.
Employed full time 18,930 15,915 15,617 16,960 1249626 1,285,053 1,354,647 1,445,460
Employed part time 7,292 7,846 9,121 10,136 466133 556,422 663,221 682,604
Employed not stated 1,376 515 795 755 94277 43,405 64,348 146,383
Total employed 27,598 24,276 25,533 27,851 1810036 1,884,880 2,082,216 2,274,447
Total unemployed 4,291 4,644 3,541 2,584 247,132 196,189 151,859 130,158
Unemployment rate (%) 8.16 9.16 6.90 4.83 7.47 5.72 4.14 3.27
Total labour force 31,890 28,920 29,074 30,435 2057168 2,081,069 2,234,075 2,404,605
Labour force 60.63 57.03 56.61 56.92 62.17 60.69 60.90 60.39
participation rate (%)
Total not in labour force 19,421 20,548 20,374 19,964 1173309 1,269,348 1,277,942 1,330,370
Not stated 1,290 1,238 1,908 3,072 78667 78,358 156,367 247,061
Total working age 52,601 50,706 51,356 53,471 3309144 3,428,775 3,668,384 3,982,036
population
Source: ABS, Census of Population and Housing, 2006, 2001, 1996, and 1991. Available online at: http://www.abs.gov.au/websitedbs/d3310114.nsf/
Home/census.
Carbon Tax: Economic Impact on the Latrobe Valley 129
Source: based on the ABS (2010) ‘Wage and Salary Earner Statistics for Small Areas, Time
Series, 2003–04 to 2007–08’. Available online at: http://www.abs.gov.au/ausstats/abs@.nsf/
mf/5673.0.55.003.
Victoria (SECV) (Barrett et al., 2009). Following Owen (2009), until the
mid-1990s generation, transmission, distribution and electricity retail-
ing were undertaken within a single, vertically integrated, monop-
oly business. These huge monopoly businesses operated not only in
Victoria but also in Tasmania and South Australia. In the 1990s, the
electricity industry in Victoria was privatised mainly due to the vast
financial crisis and large level of outstanding debt of the state govern-
ment. Privatisation also corresponded to severe economic recession.
The industry underwent a major restructuring with the objective of
unbundling these four functions into separate businesses (Barrett et al.,
2009). Electricity generation was horizontally privatised ending up in
five electricity generation plants controlled by the private domestic and
international corporations. Table 7.5 contains comparison of the power
plants currently operating in the Valley. Overall, electricity generation
plants in the Valley use outdated technology requiring large amounts of
water and are unsustainable in the future due to large amounts of GHGs
produced. According to the Australian Electricity Generation Report
(2009), of the power stations emitting the most GHG emissions in
Australia in 2009, the top three were Victorian Loy Yang A, Hazelwood
and Yallourn W.
There are several policy tools that governments can use to achieve reduc-
tion in the GHG emissions. These include intensity-based approaches
(e.g., setting a baseline limit on emissions above/below which compa-
nies will be penalised/subsidised), a flat tax on emissions, creating a
market for emissions (e.g., ETS) and a hybrid approach (e.g., combination
of a tax and ETS, which, for example, was introduced in Switzerland)
(Jones et al., 2007).. Any approach to cut the GHG emissions and put
130 Mereana Barrett, Svetlana Maslyuk and Daniel Pambudi
Source: Based on the electricity generators websites. Great Energy Alliance Corporation
includes Australian Gas Light Company (AGL), the Tokyo Electric Power Company (TEPCO),
Transfield Services Ltd and superannuation funds MTAA Super, state-wide Superannuation
Trust and Westscheme (the Age, 2006). Emissions and emissions intensity data is taken
from Australian Electricity Generation Report (2009). Emissions are in million tonnes
of carbon dioxide equivalent (MmtCO2 -e) and emission intensity is in tonnes of carbon
dioxide equivalent per Megawatt hour (tCO2 -e/MWh).
Advantages Disadvantages
The CGE models have become the standard tools of analysis of the
economy-wide impacts of environmental policies such as introduc-
tion of the ETS and carbon taxes on the resources allocation and the
well-being of the market participants (Weyant, 1999). This approach
provides a consistent and comprehensive framework for studying price-
dependent interactions between the energy system and the rest of the
economy (Bohringer et al., 2009, p. 51).
In this chapter, the Australian ‘The Enormous Regional Model’
(TERM) and the CGE Model were used for analysing the impact of
the introduction of the CPRS on the Latrobe Valley and deriving esti-
mates. It is a ‘bottom-up’ CGE model of Australia, which treats each
region of a country as a separate economy (Horridge et al., 2005) and
is developed by the Monash University Centre of Policy Studies. The
advantages of this model include its ability to deal with highly disag-
gregated regional data and analyse the impacts of shocks that may be
region-specific (Horridge et al., 2005). The original TERM model was
modified to reflect regional specifics of Gippsland regional and the
Latrobe Valley. It contains 19 sectors of the economy, 56 bottom-up
regions, and 1,337 subregions across Australia. Production, consump-
tion and investment decisions in the TERM are modelled under the
assumption of competitive markets and a given production technol-
ogy used by the producers. Producers are assumed to maximise profits
and choose inputs in order to minimise costs of production, while
consumers are maximising utility subject to their respective budget
constraints.
The main characteristics of the TERM used in this chapter include:
Simulation results of the 5 per cent and 15 per cent on production tax
scenarios are given in Table 7.7, which contains results of a shock on
macroeconomic variables for Latrobe Valley and the Australian nation
in general. These results are compared to the business-as-usual scenario
in which no carbon tax was introduced. Results are given in percentage
changes.
On the expenditure side of GDP, an increase in the production tax
by 5 per cent (15 per cent) leads to a 2.75 per cent (8.25 per cent) fall
in real household expenditures and 7.67 per cent (23.01 per cent) fall
in real investment. Since domestic demand is expected to drop, import
volumes would also contract by 4.61 per cent (13.83 per cent).
However, a tax increase also leads to an increase in GDP price index by
a moderate 0.73 per cent (2.18 per cent). Other price indexes including
consumer price index (CPI), government price index and investment
prices fall by less than 1 per cent, respectively. The government price
index mainly falls due to the fact that local governments in Australia
primarily use government services, which are a labour-intensive sector.
So when local wages fall, so does the output price and the government
price index.
On the income side of GDP, introduction of a tax leads to a moderate
fall in aggregate employment levels (1.36 per cent and 4.08 per, cent
respectively) and a large fall in aggregate capital stock (7.59 per cent and
22.76 per cent, respectively). Overall, real regional GDP shrinks by either
Carbon Tax: Economic Impact on the Latrobe Valley 135
Table 7.7 Carbon tax impact on brown coal mining and electricity generation:
simulation results
5% simulation 15 % simulation
Latrobe Latrobe
Main Macroeconomic Valley Australia Valley Australia
Variables (1) (2) (3) (4)
References
ACIL Tasman (2011), ‘Energy Security and the Introduction of GHG Emissions
Pricing’, available at <http://www.aciltasman.com.au/cms_files/2ACIL_
Tasman_Maintaining_Energy_Security_while_pursuing_emissions_reduc-
tion_targets_20110323.pdf> (accessed 10 May 2011).
Australian Bureau of Statistics (ABS), Census of Population & Housing (Census
Periods: 2006, 2001, 1996 and 1991), available at http://www.abs.gov.au/web-
sitedbs/d3310114.nsf/Home/census (accessed 15 December 2010).
Australian Government (2011), Securing A Clean Energy Future: The Australian
Government’s Climate Change Plan, available at http://www.cleanenergyfu-
ture.gov.au/wpcontent/uploads/2011/07/Consolidated-Final.pdf (accessed 15
December 2010).
Australian Government, Department of Climate Change (2011), ‘CPRS Overview
and Design Features’ and ‘Energy Efficiency’, available at <http://www.cli-
matechange.gov.au/government/initiatives/cprs/carbon-price-design/over-
view.aspx> (accessed 28 January 2011).
Australian Government (2008), ‘Carbon Pollution Reduction Scheme: Australia’s
Low Pollution Future. White paper’, available at www.wcraq.com.au/docu-
ments/CPRSReport%20Vol1.pdf (accessed 15 December 2010).
138 Mereana Barrett, Svetlana Maslyuk and Daniel Pambudi
GHD International (2005), ‘Latrobe Valley 2100 Coal Resource Project’, available
athttp://www.ret.gov.au/resources/Documents/Industry%20Consultation/
Regional%20Minerals%20Program/Latrobe%20Valley%202100%20Coal%20
Resources%20Project/R MP_ Latrobe_Valley_ 210 0_Coal_ Resources.pdf
(accessed 27 May 2012).
Global Footprint Network (2008). The Living Planet Report 2008. Available at
assets.panda.org/downloads/living_planet_report_2008.pdf (accessed 27 May
2012).
Green, R. (2008), ‘Carbon Tax or Carbon Permits: The Impact on Generators’
Risks’, Energy Journal, 29(3), 67–89.
Horridge, J.M., Madden, J.R. and Wittwer G. (2005), ‘The Impact of the 2002–03
Drought on Australia’, Journal of Policy Modeling, 27(3), 285–308.
Humphreys, J. (2007), Exploring A Carbon Tax for Australia, Perspectives on Tax
Reform (14), CIS Policy Monograph 80, The Centre for Independent Studies,
St. Leonards NSW.
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<http://www.ipplc.com.au> (accessed August 2010).
Jones, B., Keen, M., Norregaard, J. and Strand, J. (2007), Climate Change: Economic
Impact and Policy Responses, IMF.
Jotzo, F. (2011), ‘Australia’s Clean Energy Future’, Environmental Finance, Dec
2011/Jan 2012 issue, pp. 14–15.
Kazakevitch, G., Foster, B. and Stone, S. (1997), The Effect of Economic Restructuring
on Population Movements in the La Trobe Valley, Department of Immigration
and Multicultural Affairs, Canberra, ACT.
Lambie, N.R. (2010), ‘Understanding the Effect of an Emissions Trading Scheme
on Electricity Generator Investment and Retirement Behaviour: The Proposed
Carbon Pollution Reduction Scheme’, Australian Journal of Agricultural and
Resource Economics, 54(2), 203–217.
Latrobe City Council (2010), ‘Employment and Industry Survey 2010’,
available at <http://www.latrobe.vic.gov.au/EconomicDevelopment/
LatrobeCityBusinessDevelopment/EmploymentandIndustrySurvey2010/>(ac
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Future’, <http://www.latrobe.vic.gov.au/WebFiles/EcoDev/Positioning%20
LC%20for%20a%20Low%20Carbon%20Emissions%20Future%20Policy%20
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at <http://www.indiaenvironmentportal.org.in/files/India%20Taking%20
140 Mereana Barrett, Svetlana Maslyuk and Daniel Pambudi
8.1 Introduction
143
144 R. G. Walker
Note that these rules required the establishment of provisions for site
restoration, but did not specify how the dollar amount of those pro-
visions should be calculated. They also contemplated the inclusion of
future expenditure on mine closure and site clean-up as part of the ‘his-
toric’ cost of the development phase of a mining operation.
It might be recalled that in the 1970s, liabilities (including provi-
sions) were customarily valued at their face amount. It would be some
time before there were any Australian Accounting Standards prescrib-
ing the use of present values – arguably the first to appear was AAS
17 ‘Accounting for Leases’ in 1984. Indeed, even for long-term mon-
etary liabilities, local accounting standards did not prescribe the use of
present values for several years after that. The impetus for change was
the Accounting Guidance Release AAG 10, ‘Measurement of Monetary
Assets and Liabilities’ (April 1988), a publication that surprised many
readers when it asserted that it was ‘generally accepted’ that non-cur-
rent monetary items should be measured at ‘present values’. Prior to
1988, few (if any) companies had measured monetary items at present
values.
It may also be recalled that at this time, the accounting profession
had yet to issue a ‘conceptual framework’ articulating definitions of
key concepts such as ‘asset’ or ‘liability’. The profession’s Statement of
Accounting Concepts’ ‘Definition and Recognition of the Elements of
Financial Statements’ (SAC 4) did not appear until 1992.
DS 12 was newly numbered AAS 7 ‘Accounting for the Extractive
Industries’ (1977), a relabelled series of profession-sponsored account-
ing standards. In 1989 similar standards became regulations in terms
of the Corporations Law with the release by the Australian Accounting
Standards Board (AASB) 1022 ‘Accounting for the Extractive Industries’,
albeit with some modifications. Whereas DS 12 and AAS 7 had required
the establishment of provisions when there was an obligation or intention
to restore ‘an area of interest’, AASB 1022 changed this to ‘where there is
an expectation that an area of interest will be restored’ (emphasis added).
One can speculate that the change, while subtle, could be interpreted
as relieving miners from establishing provisions if state governments
did not enforce licensing conditions for site restoration. Certainly there
were suggestions that, in some cases, state governments were more
Reporting of Clean-Up Costs 145
‘belt and braces’ approach in the legislation, they failed to disclose the
dollar value of commitments for mine restoration.
External complaints prompted the ASC to issue a media release
headed ‘Mining Companies: Disclosure of Exploration Expenditure
Commitments’ (ASC Information Release 95/16). This explained that in
the course of the ASC’s surveillance programme, it had been noted that
a number of companies had provided notes to the accounts in very gen-
eral terms without quoting actual dollar amounts or providing details
of the timing of commitments. The ASC held the view
Plainly the language used in these standards was less than explicit, per-
haps deliberately so.
Reporting of Clean-Up Costs 149
The removal and restoration costs must be incurred for the enter-
prise to obtain any future economic benefits from the rig itself, that
is, they are necessary to prepare (sic) the asset for its intended use
(paragraph 8.14).
Mark the curious use of the word ‘prepare’. The fact that an oil rig, upon
installation, was sufficiently ‘prepared’ to commence production was
disregarded. So too was any discussion of the conventional concept of
historic cost as encompassing those costs incurred to bring an item of
equipment ‘ready for use’. The only support presented for the contention
that removal and restoration costs were part of the (historic) cost of an
asset was the invocation of the authority of a statement issued by a UK
committee representing the industry. Yet Statement of Recommended
Practice (Oil Industry Accounting Committee, 2001) had made a some-
what different assertion:
150 R. G. Walker
But perhaps a clearer explanation of the reasons for the IASC to accept
and propose adoption of this stance was given in the course of a review
of the main options for treating an offsetting charge when a provision
for restoration costs was recorded. The identified options were:
benefits thereafter. But the IASC avoided any such discussion. Pursuing
the illustration of an oil rig (though the discussion was also relevant to
mine sites and mine equipment), the paper noted that
On the other hand, what does not get reported may be more signifi-
cant. The activities of Lihir Gold were the subject of claims about the
deleterious effects of its practice of dumping mine waste materials into
the ocean. Yet its statement of accounting policies referred to ‘restora-
tion and rehabilitation to be undertaken after mine closure’ as includ-
ing ‘the removal of residual material and the remediation of disturbed
areas’ (2009, p. 62) – without reference to its policy of ‘Deep Sea Tailings
Disposal’.3
It seems noteworthy that many miners claim to be concerned about
the environment and to recognise their social responsibilities. Yet the
annual reports of multinational miners typically fail to identify what
provisions have been established for site restoration in different coun-
tries. There are of course some exceptions:
But one would expect that miners would be competing on the price
of extracted materials, not on how their financial statements reported
profits.
On the other hand, if balance sheets failed to show all of a mining
company’s financial commitments, there is a risk that miners might
exploit natural resources, abandon mine sites, and leave taxpayers with
the bill for clean-up costs. If Australian miners were operating in foreign
countries, then it might be considered in their interests not to high-
light a failure to provide for site restoration since that would be leaving
156 R. G. Walker
Notes
1. Some argue that expenditure on mining exploration is not in itself an ‘asset’.
Indeed, in the 1930s the U Securities and Exchange Commission took strong
action against mining companies that wrote up the value of mine sites and
associated infrastructure (see Walker, 1992); as noted below, SEC staff report-
edly continue to hold the view that expenditure on mine exploration is not
in itself an ‘asset’.
2. From 1990, compliance with Statements of Accounting Concepts in general
purpose financial reports was said to be mandatory, in terms of ethical rules
of the accounting profession, as contained in Miscellaneous Professional
Statement APS 1 ‘Conformity with Statements of Accounting Concepts and
Accounting Standards’ (1990) issued jointly by the Australian Society of
Certified Practising Accountants and the Institute of Chartered Accountants
in Australia. This stance was somewhat relaxed in 1992, when a revised ver-
sion of APS 1 stated that ‘application of the concepts set out in Statements
of Accounting Concepts is mandatory except where there is incompatibility
between an Accounting Standard and a Statement of Accounting Concepts,
in which case the Accounting Standard prevails’ and ‘application of the
standards set out in Accounting Standards is mandatory’. The professional
bodies’ stance towards compliance with Statements of Accounting Concepts
was further relaxed in 1993 when a revised version of APS 1 described
Statements of Accounting Concepts as being a ‘source of guidance’ (rather
than mandatory).
3. The former chairman of Lihir Gold Limited responded to a television report
on these practices by explaining inter alia that information about the impact
of these practices on the marine environment was made available to the pub-
lic by the company, the Papua New Guinea Government and independent
agencies. ‘The risk assessment and engineering studies showed that marine
Reporting of Clean-Up Costs 157
disposal was the best option available for the project on grounds of environ-
mental impact and risk.’
References
Australian Accounting Research Foundation (April 1998), Accounting Guidance
Release AAG 1: Measurement of Monetary Assets and Liabilities.
Australian Accounting Research Foundation (1995), Urgent Issues Group, UIG
Abstract 4: Disclosure of Accounting Policies for Restoration Obligations in the
Extractive Industries.
Australian Accounting Standards Board (1985), ASRB 1001: Accounting Policies –
Disclosure.
Australian Accounting Standards Board (1989), AASB 1022: Accounting for the
Extractive Industries.
(Australian Accounting Standards Board (2004), AASB 137: Provisions, Contingent
Liabilities and Contingent Assets.
Australian Society of Accountants and The Institute of Chartered Accountants
in Australia (1976), DS 12: Accounting for the Extractive Industries.
Australian Society of Accountants and The Institute of Chartered Accountants
in Australia (1977), AAS 7: Accounting for the Extractive Industries.
Australian Society of Accountants and The Institute of Chartered Accountants
in Australia (1992), Statement of Accounting Concepts SAC 4: Definition and
Recognition of the Elements of Financial Statements.
Australian Securities Commission, ASC Information Release 95/16 (9 June 1995),
‘Mining Companies: Disclosure of Exploration Expenditure Commitments’.
Gowland, D. (1995), ‘The Mining Industry in Australia and the Environment’,
QUT Accounting Research Journal, 7(1), 37–42.
International Accounting Standards Committee (2000), Extractive Industries – An
Issues Paper.
International Accounting Standards Committee (2010), Draft Interpretation
DI/2010/1: Stripping Costs in the Production Phase of a Surface Mine’.
Jones, S. and Walker, R.G. (2003), ‘Measurement: A Way Forward’, Abacus, 39(3),
356–374.
Micaleff, F. (2001), ‘A Black Hole – Financial Reporting for Extractive Industries
is a Minefield’, Australian CPA, 71(11), 72–73.
Oil Industry Accounting Committee (January 2000, revised June 2001), Statement
of Recommended Practice (SORP) on Accounting for Oil and Gas Exploration,
Development, Production and Decommissioning Activities.
Walker, R.G. (1992), ‘The SEC’s Ban of Upward Asset Revaluations and the
Disclosure of Current Values’, Abacus, 28(1), 3–35.
Walker, R.G. (2008), ‘Disclosure of Financial Commitments’, Australian
Accounting Review, 18(2), 161–172.
9
Capital Management Determinants
of Financial Instrument Disclosures
in the Extractive Industries:
Evidence from Australian Firms
Grantley Taylor and Greg Tower
9.1 Introduction
The extractive mining, oil and gas industries are of major global eco-
nomic importance. Given the capital-intensive nature of the extractive
industry, resource firms commonly seek access to domestic and interna-
tional financial markets to fund the acquisition of assets or entities or
to provide working capital for current operations and new project devel-
opments. In such a situation, it is expected that capital management
considerations will have a bearing on the financial disclosure policy
decisions of extractive resource firms through the potential impact on
a company’s cash flow, payment of dividends, capacity to service debt
and meet financial covenant constraints, maintenance or improvement
of credit ratings, exposure to risk and to retain flexibility to pursue
attractive investment opportunities including acquisitions. Resource
firms may utilise specific financial instruments to achieve a target capi-
tal structure and cost of capital and thus to optimise financial returns
to stakeholders (Botosan, 1991).
The use of and complexity of financial instruments has increased
markedly over the past decade in line with financing arrangements
to ameliorate a firm’s business risks (Nguyen and Faff, 2002; Nguyen
and Faff, 2003; Benson and Oliver 2004). For example, average daily
turnover in Australian over-the-counter derivatives activity increased
from US$3.8 billion in April 1995 to US$17.6 billion in April 2004.1
Australian extractive resource (mining, and oil and gas) firms routinely
engage in activities that involve complex, often poorly understood
158
Grantley Taylor and Greg Tower 159
H1: All else being equal, there is a positive association between capi-
tal management exposure and the extent of financial instrument
disclosures by Australian resource firms.
H2: All else being equal, there is a positive association between those
firms that are listed in more than one jurisdiction and the extent of
financial instrument disclosures by Australian resource firms.
166 Capital Management Determinants
Intercept –36.571 –6.916 0.000* –1.017 –0.185 0.853 –68.739 –11.469 0.000
CMS 0.064 3.652 0.000* 0.057 3.166 0.002* 0.069 3.508 0.001*
OVLIST –3.581 –3.518 0.000* –4.332 –4.089 0.000* –2.902 –2.515 0.012**
SIZE 3.730 12.108 0.000* 2.594 8.092 0.000* 4.759 13.627 0.000*
LEV 2.374 10.517 0.000* 2.571 10.944 0.000* 2.196 8.585 0.000*
SUBIND 0.282 0.246 0.806 0.505 0.423 0.673 0.081 0.063 0.950
TOP20 0.024 0.966 0.334 –0.005 –0.191 0.848 0.050 1.783 0.075***
ROA 0.050 2.413 0.016** 0.080 3.696 0.000* 0.023 0.986 0.325
Yr2–Yr1 –12.120 –9.563 0.000* –10.419 –7.901 0.000* –13.658 –9.508 0.000*
Yr3–Yr2 –10.677 –8.647 0.000* –9.029 –7.027 0.000* –12.169 –8.694 0.000*
Yr4–Yr3 –7.823 –6.311 0.000* –6.813 –5.282 0.000* –8.737 –6.218 0.000*
Model summary Adjusted R square 0.684 Adjusted R square 0.592 Adjusted R square 0.688
Observations 427 Observations 427 Observations 427
F-statistic 94.272 F-statistic 63.387 F-statistic 96.157
Significance 0.000* Significance 0.000* Significance 0.000*
Grantley Taylor and Greg Tower 169
FIDs. Hypothesis 2 is not supported by the results. Firm size and lever-
age are control variables consistently positively associated with FIDI.
Shareholder concentration is significantly positively associated with
discFIDI only. ROA is a positive and significant predictor variable of
total FIDs and mandatory disclosures over the study period. In respect
of mandatory and voluntary FIDs, the same variables are generally sig-
nificant. The predictive adjusted r-squared range is 68.4 per cent for
total disclosure, 59.2 per cent for mandatory disclosure and 68.8 per
cent for voluntary disclosure. These are measures concerning how well
the model explains differences in disclosure across various companies.
The regression equation (model 9.1) is stated as:
9.5 Conclusions
Healy and Palepu (2001) state that contracts between the firm and
its creditors (debt contracts) and contracts between management and
shareholders (compensation contracts) and political and legal issues
such as management’s concern regarding taxation, reputation and regu-
lation drive managements motives for making financial disclosure deci-
sions. Capital management strategies and events are important factors
affecting decisions by managers on financial reporting and disclosure
of financial instrument information.
Using a sample of 111 Australian listed resource firms, a significant
positive association is found between firm capital management struc-
ture and FIDs over the four-year study period. Hypothesis 1 is supported
by these results. Disclosure in relation to financial instruments may
170 Capital Management Determinants
ratios such as ROA are often used as a measure of default risk where
lower ROA values reflect greater default risk (Ashbaugh-Skaife et al.
2006). A firm’s disclosure policy may vary according to ROA as a high
level of default risk may necessitate restructuring of loan agreements,
a review of credit rating status and further capital raisings and use of
financial instruments. Malone et al. (1993) and Watson et al. (2002)
suggest that firm management might be willing to disclose more infor-
mation with higher earnings to support management compensation
contracts and to assure investors of the profitability of the firm. Higher
costs of disclosure are also justified with higher levels of earnings. Sub-
industry and shareholder concentration were generally not predictor
variables of FIDs.
Overall, this chapter provides a wealth of empirical insights to explain
the extent of FIDs by Australian listed extractive resource companies.
There are clear positive relationships between the extent of disclosure
and the amount of capital management initiatives, firm size, profit
and the level of firm borrowings. These findings contribute to a bet-
ter understanding of the extent, trends and rationale behind resource
firms’ FID practices in Australia.
Notes
1. www.rba.gov.au, media release survey of foreign exchange and OTC deriva-
tive turnover, 29 September 2004.
2. The first is the capital markets transactions hypothesis where voluntary
disclosure of information is made by management who anticipate mak-
ing capital market transactions to reduce information asymmetry and to
reduce the cost of external financing. The second is the corporate control
contest hypothesis where information is voluntarily disclosed to increase
firm valuation and to explain poor earnings performance. The third is the
stock compensation hypothesis where information is voluntarily disclosed
by recipients of stock compensation to reduce the likelihood of insider trad-
ing allegations, to correct any perceived undervaluation of the firm and to
reduce contracting costs between the firm and its management. The fourth
is the litigation cost hypothesis where management has the incentive to
disclose bad news to reduce the likelihood of legal action for inadequate or
untimely disclosures. The fifth is the management talent signalling hypoth-
esis where talented managers may voluntarily disclose information such as
earnings forecasts to signal to investors as early as possible that manage-
ment can anticipate future changes in the firm’s economic environment.
The sixth is the proprietary cost hypothesis where disclosures might be con-
strained if information is deemed to provide competitor firms with propri-
etary information.
3. Examples include the takeover of WMC Resources by BHP Billiton and the
takeover of Portman by Cleveland-Cliffs.
172 Capital Management Determinants
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Characteristics and Disclosure Levels in Annual Reports: A Meta-Analysis’,
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Corporate Governance on Firms’ Credit Ratings’. Journal of Accounting and
Economics, 42(1/2), 203–243.
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Derivatives in Australia’, Australian Journal of Management, 29 (2), 225–242.
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Financial Instrument Use in Australia’, Accounting and Finance, 42, 97–109.
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Accounting Review, 72(3), 323–350.
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Disclosure and Recognition of Derivatives’, Australian Accounting Review, 10(2),
40–50.
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10
Transnational Corruption and
Conflict Minerals
David Chaikin
10.1 Introduction
174
Transnational Corruption and Conflict Minerals 175
The World Bank estimates that more than $1 trillion of bribes are paid
annually which is then laundered ‘both domestically and increasingly
in the international financial system’ (Chaikin and Sharman 2007, p.
3). However, any calculation of the extent of corruption in the min-
ing industry or any other sector of a country’s economy is inherently
subjective: corruption is a difficult activity to accurately ascertain due
to its (necessarily) secret nature. There are a number of useful proxies
of the corruption problem such as the the Global Financial Integrity
Report (2011) which issue ‘scorecards on national level anti-corruption
institutions in over 100 countries’. There are also the annual indexes
of corruption produced by TI, which is the leading Non-Governmental
Organisation (NGO) devoted to combating corruption. All these indexes
and the accompanying qualitative information produced by these
organisations should be used by corporations in determining their cor-
ruption risks when investing in specific countries.
This chapter concentrates on the TI indexes because they have become
extremely influential in moulding public opinion throughout its 100
national chapters. The oldest index (from 1995) is TI’s Corruption
Perceptions Index (CPI), which measures perceptions of demand-level
176 David Chaikin
in bribery overseas. While the OECD countries dominate the top rank-
ings with the majority above 7.9, Italy is ranked slightly lower at 7.4.
While a score between 7 and 9 indicates OECD countries engage in cor-
ruption overseas at a minimal level, it is clear that these countries, to a
degree, participate in corrupt activities. Given that no country received
a ranking of 9 or 10, this would suggest that ‘all of the world’s most
influential economies were viewed, to some degree, as exporting cor-
ruption’ (Transparency International 2008). Whereas OECD countries
comprise a large number of the 22 countries surveyed, it is interesting
to note the countries in the Asian region (excluding China) scored fairly
well, between 7.5 and 8.1. The BRIC countries occupied the bottom of
the index, with scores ranging between 5.9 (Russia with the lowest score
in the BPI) and 7.4 (Brazil), indicating that improvement is needed to
combat corruption in these emerging economies.
sometimes ‘take the expedient way and bribe public officials to obtain
exploration rights or other approvals’.
Junior companies will frequently then sell their mining rights to a
major mining company in circumstances where the major does not fully
appreciate that the junior has become entangled in corrupt activity. It is
imperative that major multinational mining companies perform a com-
prehensive due diligence exercise when acquiring any mining interest
so as to avoid reputational damage that would arise because of the con-
duct of the previous owner. The major must take steps to ensure that
some ‘rogue employee’ does not continue the former corrupt practices.
The typical situation is where the employee relies on bribery because
of a belief that this is in the company’s best interest and that this will
‘improve one’s chances of promotion by becoming known as someone
who can get things done’(Marshall 2001, p. 17).
Other factors contributing to corruption risks, include:
The first level of operation includes a few large mines that produce
the ore, process and export it; the second level includes many small
companies (called jalabos) that have no mines but have legal licences
to sell ore or process metal; and the third level includes the mar-
kets (mostly Chinese), the large companies and the international
markets. Organised criminals infiltrate these levels, stealing ore and
processed minerals and committing fraud by supplying stolen equip-
ment and spare parts.
and mining reserves, production data and their contractual terms will
improve governance and fiscal management, as well as prevent public
sector corruption.
There have been a series of initiatives, including the Revenue Watch
Index (Revenue Watch Institute 2011) which compiles data on 41 coun-
tries, among the ‘world’s top producers of gold, copper and diamonds’.
There is also the Extractive Industries Transparency Initiative (EITI),
which has become the major vehicle for improving transparency in the
relationship between mining companies and host governments.
The EITI was developed in 2003 by the World Bank and the British
Department for International Development so as to improve the trans-
parency of payment and revenue streams in the resources sectors, par-
ticularly in developing and transient economies. The EITI established
a global framework for verification and publication of payments made
by oil, gas and mineral companies to governments. Under the EITI gov-
ernments, companies, institutional investors and international organi-
sations adhere to a Statement of Principles and Agreed Actions. The
International Council on Mining and Metals, which represents 20 of
the world’s leading ‘mining and metals companies and 30 national
and regional mining associations and global commodity associations’,
has also committed to implement the EITI through its membership
(International Council on Mining and Metals 2012).
The key idea of EITI is that governments of resource-rich countries
will publish information about the revenues that they have received
from the extractive industries, and that this will be compared to the
payments (taxes, duties, royalties and bonuses) made by these compa-
nies to those governments (Ölcer 2009, p. 13). Under EITI all companies
are required to produce the data; it makes no difference if the company
is state-owned or private, or whether it is a local or foreign. The infor-
mation concerning corporate payments and government receipts is
then subject to an examination by an independent auditor. The auditor
is expected to apply international accounting standards in reconciling
the data and to publish any discrepancies in the figures.
There has been a gradual implementation of the EITI, with interna-
tional organisations and multinational corporations putting pressure
on governments to adopt and enforce the EITI requirements (Hakobyan
2004, p. 2). Indeed, according to the website of EITI (2012) the following
12 countries have become compliant in their implementation of EITI:
Azerbaijan, the Central African Republic, Ghana, the Kyrgyz Republic,
Liberia, Mali, Mongolia, Niger, Nigeria, Norway, Peru and Timor-Leste;
Yemen was compliant but has been suspended. Important mining
Transnational Corruption and Conflict Minerals 185
countries which are candidates for membership but which require fur-
ther validation before they are considered compliant include Albania,
Cote d’Ivoire, DRC, Guinea, Indonesia, Mozambique, Republic of the
Congo, Sierra Leone, Tanzania and Zambia.
The theory of the EITI makes good sense, but there are several weak-
nesses. None of the Organisation of the Petroleum Exporting Countries
(OPEC) – with the exception of Nigeria– are members or candidates for
membership of EITI. Further, in some countries where there are high
levels of corruption, powerful political and business elites have resisted
subscription to and/or implementation of EITI. The case of BP in Angola
is frequently cited as an example, where BP’s attempt to publicly disclose
oil revenue payments that it had made under its contract was thwarted
by the host government of Angola (Hakobyan 2004, p. 3). Given that
the EITI relies on voluntary reporting by companies and governments,
it does not mandate a level-playing field between companies in extrac-
tive industries (ibid., p. 2).
There is a lack of consistency on issues such as the type of revenue
payments covered by the EITI, the absence of a definition of a mate-
rial payment and the poor quality of government revenue disclosures
(Ölcer 2009, p. 17; Global Witness 2011, p. 5). There is the bigger issue
whether transparency per se will work since the assumption is that the
international community and civil society will be able to change the
behaviour of corrupt governments.
There have been some efforts by the European Union (2009 to increase
the effectiveness of the KP. The most significant national development
is the enactment of section 1502 of the Dodd–Frank Act. Section 1502
is modelled on the KP but goes further by covering a wider range of
minerals than uncut diamonds, regulating large parts of the miner-
als processing industry including its users, and targeting not only the
DRC but also its neighbouring countries which have allegedly exploited
loopholes in the KP.
The key aim of section 1502 is to deter the ‘exploitation and trade
of conflict minerals’ that have ‘financed conflicts characterized by
extreme levels of violence in the eastern DRC, particularly sexual- and
gender-based violence, and contributing to an emergency humanitar-
ian situation’. In this sense section 1502 should not be regarded as a
mechanism to increase protection to investors, but rather as an instru-
ment to improve corporate behaviour based on ‘social criteria’. This is
a reflection of societal expectations that mining companies actively
assist in the prevention of violations of human rights in foreign coun-
tries (Drimmer and Phillips 2011).
Conflict minerals are defined in section 1502(e) as certain miner-
als sourced from the DRC and its nine neighbouring states, namely,
Angola, Burundi, the Central African Republic, Republic of the Congo,
Rwanda, Sudan, Tanzania, Uganda and Zambia (DRC countries). The
conflict minerals are:
Since the list of conflict minerals are commonly used in the manufac-
ture of a wide range of products, the proposed SEC rule is expected to
have a significant impact on US manufacturing industries (World Trade
Lawyers 2011). Further, the law will apply to ‘companies that have influ-
ence over contract manufacturers, as well as generic products under a
company’s own brand name’ (Heim 2011).
The SEC is mandated to issue rules implementing section 1502. Under
a SEC draft rule, issued on 23 December 2010, it is proposed that compa-
nies subject to US SEC jurisdiction would be required to file an annual
Conflict Minerals report concerning whether their use of conflict min-
erals are sourced from DRC countries. The companies would be obliged
to state whether their use of conflict minerals ‘directly or indirectly
finance or benefit’ armed groups in the DRC countries. In order to meet
this filing requirement, reporting companies would be required to carry
out a ‘reasonable country of origin inquiry’ concerning the minerals
that they use in manufacturing. This will entail ‘supply chain due dili-
gence’ supported by verification and certification procedures. There is a
specific requirement that reporting companies appoint an independent
private sector auditor who will apply audit standards established by the
Comptroller General of the United States.
The precise scope of the proposed SEC rule is yet to be determined.
There has been criticism of the proposed rule. For example, the gold
industry has pointed out that it will be extremely difficult to make a
‘supply chain determination’ where a refiner has used newly minted
and recycled gold (Securities Exchange Commission 2010B, par 80961).
Indeed, it has been argued that the commingling of gold at both the
smelter and refining stages will make it impossible to determine the
‘specific mine that was the source for the specific smelter or refiner
output’ (Barrick Gold Corporation 2011). Some mining companies have
questioned whether the rule should apply to their industry on the basis
that the legislative intent in section 1502 is to impose reporting require-
ments only on manufacturing companies that use the conflict miner-
als, not those that extract those minerals (ibid.).
192 David Chaikin
Whatever the ultimate outcome, the financial costs of the new rule
will be high, affecting both SEC-regulated companies and suppliers
to those companies. The SEC estimates that 1,199 companies will be
obliged to file a full Conflict Minerals Report and that the paperwork
burden on those companies will be 153,864 hours of personnel time, plus
$71,243,000 in hiring outside professionals (Securities and Exchange
Commission 2010B, par 80965). Although the SEC has not estimated
how many suppliers will be affected by the new rule, a conservative
estimate is that 12,000 suppliers will be impacted (Heim 2011).
10.11 Conclusions
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194 David Chaikin
197
198 Index