Fiscal regime and stability: royalties, tax and resource nationalism

The regime in brief

A country's fiscal regime is the full set of terms the state applies to mining: government royalties, income tax, withholding taxes, any windfall tax, and state equity. The mechanics of how each one comes out of the cash flow are in government take. This article is about comparing regimes and the risk that they change.

Comparing regimes

Headline rates are misleading on their own. To compare countries, model the same project under each regime and compare:

• the effective government take: the state's share of the project's total pre-tax cash flow,
• the after-tax NPV and IRR to the investor,
• how the take changes at low and high prices: regimes built on revenue royalties take a larger share when prices are low; profit-based regimes take more when prices are high.

A regime that takes more in good years and less in bad years can be easier to live with than one with a lower average rate.

Why terms change

Fiscal terms tend to tighten when metal prices are high and mines are profitable, and loosen when a country wants to attract investment. Common forms of resource nationalism:

• higher royalty rates or new windfall taxes,
• a larger mandatory or free-carried state stake,
• requirements to process locally, or bans on exporting unprocessed ore,
• renegotiation of existing agreements, sometimes under pressure such as suspended exports,
• in extreme cases, expropriation.

Worked example

An invented producing mine pays a 3% royalty on $500M of net smelter return and returns about $130M a year to investors. The government doubles the royalty to 6%.

Nothing about the deposit changed. This is why the same change costs most at the production stage, when the mine cannot leave.

Protection against change

• Stability agreements: contracts with the state that fix the fiscal terms for a period, sometimes in return for a higher rate or a fee. They are only as strong as the state's willingness to honour them.
• Investment treaties: agreements between countries that can give foreign investors access to international arbitration.
• Political risk insurance: from public agencies or private insurers, covering expropriation and some breaches of contract.
• Lender involvement: development banks and export credit agencies in a financing can give a government extra reasons not to change terms.

What to take away

Model the project under the real regime, at low and high prices, and then ask how likely the terms are to change and what protects the project if they do. At early stages, the regime's reputation affects the multiple; at production, its stability affects the cash.

All figures are invented for illustration. This is educational material, not legal, tax or investment advice.