sme conference current trends in mining finance tax and accounting issues impacting mining finance...

SME ConferenceCurrent Trends In Mining Finance

Tax and Accounting Issues Impacting Mining Finance

29 April 2013

Current Trends In Mining Finance

Disclaimer

► Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited located in the US.


Disclaimer

► Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.

► These slides are for educational purposes only and are not intended and should not be relied upon as accounting advice. A detailed analysis of the company’s specific facts and circumstances is generally required to conclude on the appropriateness of the application of US generally accepted accounting principles.



► J. Andrew Miller, PartnerErnst & Young LLP

Americas Mining & Metals Sector Leader

Tel: +1.314.290.1205

[email protected]

► Robert Stall, PartnerErnst & Young LLP

Americas Mining & Metals Sector Transaction Services Leader

Tel: +1.404.817.5474

[email protected]

mailto:[email protected]

Current Trends in Mining Finance


►Top ten business risks in 2012 – outlook for 2013 survey

►Impairments► Valuations in M&M ► What is driving the impairments that occurred in 2012► Consequences

► Resource Nationalism and Mining Finance

Top Ten Business Risks for the Mining & Metals Industry


Top ten business risks in mining and metals


Trends in Business Risk – Mining & Metals

► Capital project execution► Capital management and access► Cost inflation► Resource nationalism


Inefficient management of project execution risk resulting in significant cost overruns

Source: Publicly available information and Ernst & Young analysis

In 2011-12 average cost over-run of select projects was 56% of original project estimates


►Diminished returns►Weaker credit rating►Impairments►Margin pressure►Inflexibility►Loss of market share/missed

opportunities

►Volatile equity valuations►Severe cost inflation►Resource nationalism►Shareholder demands►Uncertain demand/price

outlook►Risk averse capital providers

Capital management and accessBuild, buy or return?

► Boards are facing a complex and uncertain environment within which to make capital allocation decisions in 2012

► The risk of sub-optimal allocation of capital can have a significant and long-lasting impact

► Current shareholder preference is to return capital rather than growth

Risk /Reward


Cost inflation — overview

► Subdued commodity prices, while costs continue to rise

► Supply-side pressures exacerbate operating and capital costs — companies revisiting robust capex plans

► Crude oil prices, wage inflation, mining services suppliers using scarcity to raise process and increasing complexity drive operating costs

► Uncontrollable costs increase due to resource nationalism etc

► Falling grades are increasing cost per unit of production

► Cost inflation compounded by strong currencies of producer nations

2006 2007 2008 2009 2010 2011-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

3%1%

4%

-2%

2% 3%

7%

4%

7%

-3%

5%

Uncontrollable costs Controllable costs

Increases in cash costs above CPI (2006-2011)

**Normalised: 5%

Note: 2006 to 2009 shown on a total Group (Anglo American) basis, excluding AngloGold Ashanti, Mondi, Highveld Steel and Tongaat Hulett/Hulamin, 2010 onwards shown for Core operations only

Source: “Preliminary results year ended 31 December 2011,” Anglo American presentation, 15 February 2012

What is driving the impairments and what are the consequences


Mining Company Impairments – Top 10

Rio Tinto Anglo American ArcelorMittal Kinross Gold BHP ANR Walter Energy Cliffs Peabody Arch Coal -

2,000

4,000

6,000

8,000

10,000

12,000

14,000

AssetsGoodwill

(USD mil)

Total Goodwill Impairment (US millions) = 20,878Total Asset Impairment (US millions) = 14,797Total Impairment (US millions) = 35,675


Mining Company Impairments – All Others

Mechel

Arrium

BlueScop

e

Molycor

p

Sims Meta

l

Thyssen

Krupp

AuRico

Gold

Lonmin

Lundin

Golden

Minerals

Severst

al

Thompso

n Cree

k

James

River

Shougan

g

CVM Mine

rals

Sable M

ining

Shaw Rive

r

Atlas Iro

n

LionG

old

Outokum

pu

Olympic

Scana

China Y

unnan

Tin

Sirius M

inerals

Schmolz

+ Bickenb

ach

Namibia

n Copp

er

Coal of

Africa

Bullabul

ling G

old

Cobalt C

oal

CI Reso

urces

Blue Note

Proto R

esourc

es -

100

200

300

400

500

600

700

800

AssetsGoodwill

(USD mil)

Total Goodwill Impairment (US millions) = 2,608Total Asset Impairment (US millions) = 190Total Impairment (US millions) = 2,798


Mining Company Impairments

Key Value Drivers:

► Capital Cost Overrun► e.g.: Anglo American

► Substitution (shale gas for thermal coal)► e.g.: ANR, Arch Coal, Walter Energy, James River

► Reserve Assumptions► e.g.: Rio Tinto

► Commodity Price Volatility► e.g.: Moly, Cliffs


Goodwill Impairment

U.S. GAAP:

► ASC 350 – Goodwill and Other Intangible Assets► Step 1: Compare current TIC to Balance Sheet carrying amounts (if

Balance Sheet is greater than TIC, proceed to Step 2)► Step 2: Measure the goodwill impairment through the application of a

hypothetical purchase price allocation under ASC 805 and ASC 820

► ASC 360 – Accounting for the Impairment or Disposal of Long Lived Assets► Step 1: Undiscounted cash flow test for the Asset Group► Step 2: Discounted cash flow measurement► Step 3: Determine fair value of each identified assets


Goodwill Impairment

Issues / Opportunities:

► Reconciling discounted cash flows from life of mine models to market capitalization:► Control premiums► Lack of visibility to other Reporting Units that have not failed► Commodity price volatility► Terminal values where full life of mine models are not available► Value of tons of ore not in LOM plan► Discount rates – variability by commodity / geographic area


Goodwill Impairment

Issues / Opportunities:

► Performing the hypothetical purchase price allocation:► Capacity rationalization issues for valuing property, plant and

equipment ► Price volatility of commodity► Market demand for volume► Valuation of all identified intangibles► Asset retirement obligation


Long-Lived Asset Impairment

U.S. GAAP:

► Step 1 of ASC 360 is performed for all Reporting Units that fail Step 1 of ASC 350 prior to the application of Step 2 of ASC 350:► ASC 360 Step 1 is an undiscounted cash flow test (Primary Asset

Group)► Life of the primary asset group► Residual value at the end of the undiscounted cash flow period

Resource Nationalism and Mining Finance


Resource nationalism and Mining Finance

Beneficiation

Taxes / royalties

Government ownership

Legend

Type of resource nationalism

Colour indicates year

2008 2009 2010 2011 2012

Source: Ernst & Young


Resource nationalism

Three key trends in resource nationalism in 2012–13:► Increased or newly imposed royalties and/or mining taxes► Mandated beneficiation and new export levies on upstream

products► Retaining or mandating state or in-country ownership of natural

resources

Resource nationalism no longer restricted to frontier and emerging markets alone


Increased or newly imposed royalties and/or mining taxes

► “Super profits” taxes considered:

► Australia in May 2010 proposed Resource Super Profits Tax.

► Scaled back and limited to coal and iron ore, but began focus on higher mining taxes (minerals resource rent tax (MRRT))

► India — March 2012 — modeled a similar proposal after Australian super profits tax proposal.

► Mineral resource rent tax of up to 50% of “super profits” earned by mining operations

► New or increased mining taxes:

► In fall 2011 Peru enacts mining tax that follows Chilean tax increase in the prior years.

► in 2011 and through the first six months of 2012, many countries have proposed or enacted new or increased taxes on the mining industry.

► Brazil, DRC, Ghana, Mongolia, Peru, Poland and the United States► Australia’s MRRT on coal and iron ore


Mandated beneficiation and new export levies on upstream products

Governments are seeking to mandate in-country beneficiation of ore prior to export.

► Create jobs and turn into producer of higher-value downstream products rather than exporter of raw materials

Countries announcing a “beneficiation” strategy include South Africa, Zimbabwe, Indonesia, Brazil and Vietnam.

In order to ensure in-country processing, governments are imposing steep export levies on unrefined ores.

► Indonesia proposes a 25% levy on mining exports in 2012 rising to 50% in 2013.


Retaining or mandating state or in-country ownership of natural resources

Argentina and the re-nationalization of YPF

South Africa — Black Economic Empowerment (26% participation):

► Considering mandatory equity participation of a state-owned mining company

Indonesia — proposing to limit foreign ownership in mining operations to no more than 49% after ten years

Zimbabwe — 51% indigenization mandate

Mongolia — 49% limit on foreign ownership of strategic mines


More recent trends in resource nationalism and taxation ...

Brazil: ► New transfer pricing regime for purposes of determining the

CFEM royalty; price based on quoted metals prices► New royalty regime in the mining states of Amapa, Minas Gerais

and Para (TFRM)

Peru — Legislative Decree 1120 in July 2012:► Imposes new transfer pricing rules for the sale of commodities to

related parties► Transfer price based on quoted metals prices

Mongolia: ► Draft legislation to unilaterally cancel double tax treaties with

Luxembourg, Netherlands, Kuwait and United Arab Emirates


Also consider corporate income tax reform proposals

Australia: ► Proposal to reduce general corporate tax rate► Offset, however, to include reduction in a range of natural

resource development tax incentives

United States:► Obama Administration proposal to eliminate percentage depletion

for fossil fuels, capitalize intangible drilling costs (IDCs) and mine development

► Mining Law of 1872 reform proposals to include 4% royalty for hard minerals (metals) mined on federal lands


International Monetary Fund“Fiscal Regimes for Extractive Industries”

►IMF report issued in August

►Extractive industry taxes are more than 50% of total tax revenue in petroleum countries and more than 20% in mining countries

►Describes tradeoffs between royalties, CIT, and rent taxes► Sales-based royalty--maximizes government revenue stability, not as simple as it

appears

► Corporate income tax--imposed on normal return and rents

► “Rent” tax--challenge is defining the normal rate of return

►Multiple taxes to achieve multiple objectives

►Regimes include general business taxes, mining-specific business taxes, and project-specific fiscal contracts


International Monetary Fund“Fiscal Regimes for Extractive Industries”

IMF simulations and “recommendations”:► “These simulations … suggest reasonably achievable ranges of discounted

AETRs that will be 40-60% for mining and 65-85% for petroleum”► AETR range was derived from “life of mine” model using a fixed price assumption

and “typical” financial profile► Actual range of results was from 35-75% for iron ore► Countries that are above average may have trouble attracting investment even if

they are within the recommended range

Unresolved issues:► Choice of normal rate of return is “a key and contentious issue” (p20) – IMF

assumes 12.5% is normal return, which implies 2/3rds of income for “typical” mine is rent

► IMF recommends taxes that vary with profitability, but in practice it is the tax regimes that vary with profitability

► What is the right time horizon?


Resource nationalism — implications

Implications

Keeping abreast of ever-changing

regulationsIncreased costs

Emerging markets represent

investment opportunities

Project pipeline could reduce

License to operate could be

jeopardizedGrowth options

could be restricted


Q&A

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