Mining industry attitudes towards taxation policy are about to confirm the adage that refusing to learn from the errors of history makes their repetition inevitable. As world iron ore and coal prices slump the inefficiencies of the state royalty regime are again being laid bare. A shift to a profits-based royalty system could lift both state government revenues and after-tax mining returns.
And so it was following the oil price shocks of the 1970s. The Australian government had procured a large share of petroleum profits by introducing and then jacking up a crude oil levy. It was a dollar amount per barrel of oil produced – in effect a production-based royalty. But it was a blunt instrument, creating disincentives to develop new fields and to fully recover oil from existing fields. In an effort to encourage the development of less profitable fields, lower crude oil levy rates were negotiated for newly discovered fields than for operating fields.
As an adviser to Resources and Energy Minister Peter Walsh, fresh from completing my PhD on the Resource Rent Tax (RRT) under Ross Garnaut’s supervision, my job was to work with Garnaut in Bob Hawke’s office to design an RRT for offshore oil production. We had hoped to negotiate an RRT with the states for onshore petroleum and mining developments, but they refused to cooperate.
Following an extensive process of industry consultation, the Bass Strait operators – BHP and ESSO – remained just as hostile to the RRT, preferring to negotiate crude oil levy rates on a field-by-field basis. At the end of an exemplary six-month consultative period the Australian Petroleum and Exploration Association told the Hawke government the industry remained opposed to a tax on resource rents as a matter of principle.
At the urging of BHP, ESSO and Treasury, the government decided to leave Bass Strait out of the coverage of the new offshore Petroleum Resource Rent Tax (PRRT). Two years later, BHP and ESSO requested that the PRRT be extended to include Bass Strait. More recently, at the request of industry, the PRRT has been extended to onshore gas development.
Western Australia soon accepted the merits of the RRT. By the mid-1980s the Barrow Island oil field, within the state’s taxing jurisdiction, was in serious decline and facing closure. The state government approached the Hawke government and we designed a Resource Rent Royalty (RRR) that enabled full economic recovery of the resource, increasing company profits as well as state and federal revenues. Instead of being shut in by the early 1990s, the Barrow Island oil field is still producing small amounts of oil to this day.
One reason why the Resource Super Profits Tax and its successor the Minerals Resource Rent Tax failed is that they did not involve an accommodation with the states. Western Australia and Queensland hiked their production-based royalty rates to collect as much of the resource rent for themselves as they could. At record high mineral prices this was manageable – every tonne of production was making good profits.
Now the states are facing disappointing revenues from falling mineral prices. They will inevitably be confronted with industry complaints that the high rates of production-based royalties are forcing them to close mines.
There is a respectable view that the best step companies operating marginal iron ore and coal projects can take is to abandon them and return to shareholders the retained earnings from better days. That would help deal with the problem of global oversupply and plummeting prices. But achieving that result through poorly designed royalty regimes would take us back to the early 1980s.
As the Barrow Island experience shows, a shift from production-based taxation to a Resource Rent Tax can be a win for the states and for mining companies. But sadly, pointing out the folly of production-based taxes and the benefits of taxes based on resource rent is just like déjà vu all over again.
Craig Emerson is an Adjunct Professor at Victoria University. As an adviser to the Hawke government he designed the Petroleum Resource Rent Tax.