Mineral royalties remain a contentious issue across the global landscape of the resources sector. Royalties are something that everyone has an opinion on, like politics. And just like politics, some opinions are founded in economics, while others are founded in self-interest.
Strictly Boardroom takes the view that just three things are required to develop a working royalty system that is fair to both state and mining companies. The three golden rules of mineral royalties are founded in the basic principles of commodity microeconomics, in revenues and costs – but also, critically, in the nuances of global geology.
Here are the three rules. They are very simple. Why then do the vast majority of jurisdictions fail to score three out of three in implementing them? That is where the self-interest factor comes into play, which is distorting mineral policy globally, to the detriment of miners and broader society. That we can get something so simple so horribly wrong is a sad reflection on where the mining world sits within present society. Your scribe hopes for that situation to be resolved – but the likelihood of that actually happening is perhaps more a dream than reality.
‘One-size-fits-all’ royalty rates do not fit all minerals
Geology has no borders. Some countries have good deposits, such as high-grade, near-surface minerals; others do not. What is obvious is that some jurisdictions have world-class assets in some minerals, but a paucity of quality deposits in other minerals. Yet most jurisdictions set mineral royalties using a one-size-fits-all principle across the periodic table. That’s dumb. Having no regard to where a country’s assets sit on a global cost curve leaves some commodities able to carry higher royalties and others unduly penalised. Fail!
Keep it simple – so a 10-year-old can understand it
Even PhD economists struggle to articulate the nuances of an economic rent-based approach to mineral royalties. Such systems are elegant in theory – and economically the most efficient, too. But in practice, they are open to many forms of abuse (among other issues, they can rely on complex accounting edicts and agreed cost of capital). Perhaps more critically, even if the PhD economists ‘get’ economic rent-based royalties, the broader public does not. Simple revenue-based royalties as a percentage are far less prone to abuse – and can be explained to a 10-year-old. Many jurisdictions fail here, too.
Plan ahead for transparent royalty review
Things change over time in the minerals world. The minerals sector is highly volatile in price terms. New discoveries are made that change the shape of cost curves. These new discoveries may be world-class Tier 1 assets or more often, marginal Tier 3 assets. A transparent system is therefore needed such that mineral royalties can be periodically reset to accommodate movements in price and cost curve. The Chinese economic miracle has been based upon successive five-year plans. Something similar is needed for mineral royalties – for example, being subject to periodic five-year review – critically with certainty at all times in between. Most governments are prone to review royalties every time the price moves rather than at set five-year intervals. This destabilisation of the sector must stop. Five years is not a long time in mining – especially when it can take a decade or more to get a new project up and running. You guessed it: Most of the world fails on royalties policy, too.
It is all so simple really, yet such a long way from current practices. Even if governments would just keep their hands off the controls, it would be better than today’s reality. How about a five-year moratorium on royalty rates globally? Is that virtually impossible? Most probably: What do you think?
Good hunting.
Allan Trench is a Professor of Mineral Economics at Curtin Graduate School of Business and professor (Value and Risk) at the Centre for Exploration Targeting, University of Western Australia, a non-executive director of several resource sector companies and the Perth representative for CRU Strategies, a division of independent metals and mining advisory CRU group. (allan.trench@crugroup.com).
