Dryblower on the tyranny of rising costs

FALLING stock markets are one side of the challenge facing the industry in the early weeks of 2010. The other, which Dryblower saw first-hand at last week’s Mining Indaba conference in Cape Town, is rising costs, especially government taxes, royalties and other charges.
Dryblower on the tyranny of rising costs Dryblower on the tyranny of rising costs Dryblower on the tyranny of rising costs Dryblower on the tyranny of rising costs Dryblower on the tyranny of rising costs

 

Staff Reporter

So far most attention has been on the markets, where a price correction of 10% will make everyone feel a little poorer and make capital raising that much harder.

Painful as that might be, the real pain will come when governments start to milk the mining industry to repay its stimulus spending and assistance to troubled banks.

In South Africa, the preferred “taxing” route is via a dramatic increase in the cost of electricity. In Australia, it will be via the proposed new resource rent tax scheme which might replace state royalties.

Whichever way you look at it, the message is the same. Governments have fallen deep into debt to bail out failed parts of their economies, such as banks and construction, and are now turning to mining (and oil) as a way of recouping some of that spending.

When Dryblower first considered what’s happening he was caught up in the swirl of the Indaba gabfest, an event which probably deserves a score of 6 out of 10 for mining industry optimism, and as a pointer to better conditions ahead. It was good, but not that good.

The biggest surprise at Indaba, and one which the South African hosts carefully avoided discussing in detail, was the horrendous condition of the national electricity grid, which has been crumbling under 20 years of neglect.

Why the grid has come close to collapse is easy to understand. Government revenue has been redirected to provide basic services to the freshly liberated black majority.

The core problem is that the South African government simply does not have enough money to do everything it wants, and has only just woken up to the fact that electricity is an essential component of every advanced (or semi-advanced) economy.

The solution: whack industry with a 35% increase in annual electricity charges, not for one year, but for three successive years. When compounded that means electricity bills in South Africa will more than double by the year 2013.

Now comes the interesting bit in Dryblower’s analysis of what higher electricity bills in South Africa will mean for mining companies worldwide because the result might not be what most people expect.

The easy answer, and one preferred by some observers, is that if power costs double in one mining country then rivals, such as Australia and Canada, will steal market share because of their ability to undercut South African producers. This is especially true for value-added metal products, such as steel alloys and aluminium.

That might happen, which in the year South Africa hosts the World Cup will qualify as a spectacular own goal, with Canadian and Australian miners cheering from the sidelines.

Unfortunately, own goals and free kicks are never earned that easily. There is another possibility that could cause problems all round, which is that governments see the higher costs in South African mining as equalising taxes on their own mining industries.

In other words, a 35% hike in electricity charges on South African miners could be matched by a new resource rent tax in Australia, leading to a broadly equal uplift in costs across the mining world.

Boiled down, what Dryblower sees is governments around the world singling out the resources sector as a preferred taxing target to pay for their bank rescue and economic stimulus programs.

In theory that means the cost structure of every miner rises, hopefully at a time when metal prices also rise, with higher revenue cancelling out higher costs.

In practice, it never quite works out that way. So the message to mining is buckle up for a period of higher government taxes and charges, pray for higher metal prices, and focus on internal costs because they are the only thing you can control.