Despite the fact that it would be legislated for in a parliament that sits more than 10,000 miles away from London, a proposed super-tax on mining businesses could have a massive impact on the FTSE 100.
Combined with corporation tax, this so-called “resource super profits tax” would, by some analysts’ calculations, mean there was effectively a tax rate of 57% on large mining operations in Australia from 2012. [1]
This would damage earnings for some of the FTSE’s heaviest-hitters in the traditionally volatile mining sector, including Rio Tinto, BHP Billiton and Xstrata, all of which have significant operations in Australia.
We examine the ways in which mining shares and commodity prices may be affected by the tax.
Unjust tax or a fairer deal?
Perhaps unsurprisingly, the government and the mining firms are at loggerheads over the issue. According to Marius Kloppers, the chief executive of BHP Billiton, the tax is a grossly unjust form of “Robin Hooding” and threatens jobs as well as earnings. On the flipside, Australian Prime Minister, Kevin Rudd, sees the tax as a way of allowing the wider public to benefit from the country’s abundant natural resources.
The way the proposed levy is currently structured means it would tend to impact long-term, high-capital projects with high-margin gains. This has led to accusations that the Australian government has failed to understand the business models of key players in the mining industry and is effectively discouraging the long-term investment practices employed by miners.
There is certainly evidence to support this view. Earlier this month, Rio Tinto announced pre-tax profits of A$37.4 billion (£23.1 billion) during the period between 2000 and 2009. However, it also reinvested A$38.4 billion (£23.7 billion) over the same period, demonstrating the capital-intensive nature of the industry.
What does seem certain is that just the suggestion of this new tax proposal will have a significant effect on the financial markets.
Impact on shares and stock indices
The twin issues at stake for investors are the extent and timing of the tax’s impact on mining share prices, as well as the knock-on effect it could have for stock indices, particularly those – such as the FTSE – with a significant weighting of mining businesses.
Rio Tinto, which generated the bulk of its 2009 profit in Australia, looks set to be the hardest hit company if the proposals go through unchanged. The Anglo-Australian company is one of the FTSE’s highest-volume components and, as such, its share price often acts as a bellwether for the mining sector as a whole.
Analysts have cited BHP’s Olympic Dam project, a large copper, uranium, gold and silver mine in South Australia as a project that may have to be curbed if the tax goes ahead.
Australia’s leading stock index could also come under pressure from the tax hike; the resources sector contributes 18% of Australia’s GDP and contributes 42% to the nation’s export revenues. Paradoxically, the hike may even – in the long-run – decrease overall tax revenues from the sector (already Australia’s largest single contributor to the corporate tax pot) as investment is relocated. For example, Xstrata has already put A$600 million of investment in Australia on hold due to the tax proposal.
A key point of contention is the suggestion that the tax may be imposed on operations that have already commenced, with mining companies pointing out that their decisions to invest in certain projects were based on the assumption that profits would be taxed at the lower rate. In the short-term, this issue may well have the strongest effect on mining shares, with a decision to exempt current projects potentially boosting prices.
Commodity prices
As a rule of thumb, commodity prices and mining shares tend to have a strong positive correlation; rising metal prices boost the businesses mining them. However, this move may cause a rupture in the relationship.
The proposed tax may lower the incentive (or even reduce mining firms’ ability) to mine certain commodities, reducing global supply and artificially driving up prices.
While the most significant market movements during the inevitable political wrangling over this deal are likely to be in equity markets, it will certainly be worth keeping an eye on key commodities to spot emerging trends triggered by supply and demand.
Take a position
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Source: [1] Financial Times
Updated: 17/06/10
The above comments do not constitute investment advice and IG Index accepts no responsibility for any use that may be made of them.
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