Operating in the new super-cycle

Authors:

Roman Webber, Mining & Metals Leader, Deloitte North South Europe: UK

Valeria Vazquez, Mining & Metals Leader, Deloitte Mexico

For the mining and metals industry, 2021 was defined by soaring commodity prices and the prospect of a new supercycle.

By June 2021, metal prices had risen 72% relative to their pre-pandemic levels,[1] with many, such as aluminum, copper, iron ore and nickel, going on to reach multi-year highs in Q3.[2] Sustained demand for critical metals fuelled by the transition to green energy caused a number of analysts to declare the start of a new supercycle- a period where commodity prices rise above their long-term trend for between 10 and 35 years.[3]

This is good news for miners, although it’s not without its challenges. With cyclical highs come government demands for a greater share of mineral wealth.[4] As many countries began to recover from recession following COVID-19, the mining industry saw a raft of regulatory measures proposed and imposed for the period from 2020 to 2021, as well as various forms of resource nationalism.

The rise of resource nationalism

Resource nationalism can take many forms some obvious, others more subtle. Traditional measures range from the expropriation and nationalisation of strategic assets to states interjecting in operations by reviewing pre-agreed terms and implementing new forms of taxation.[5]

The direct expropriation of the Kumtor gold mine in Kyrgyzstan from Canada-based Centerra Gold[6] demonstrates how these types of measures can create significant operational risk, as well as financial difficulties. In September 2021, Centerra applied for urgent interim measures in its international arbitration against the government of the Kyrgyz Republic and shareholder Kyrgyzaltyn JSC, citing deviation from the approved mine plan in ways that could cause “irreversible damage”.[7]

According to Verisk Maplecroft’s 2021 Political Risk Outlook,[8] 34 countries, including key copper producers, such as Zambia and the Democratic Republic of Congo, witnessed a significant increase in risk during 2020 due to resource nationalism. The firm expects this threat to grow over the next 12 months, with the mining industry bearing the brunt of new measures as governments attempt to recuperate financial losses inflicted by the pandemic.

Roman WebberꟷMining & Metals Leader, Deloitte UK, explains, “In the past, resource nationalism has mainly taken the form of direct or indirect expropriation of assets. This time, we’re seeing more sophisticated methods, and mineral taxation is one way that host governments are looking to exert more control or gain better returns on their resources.”

He continues: “In many cases, the mining sector will be a key source of tax revenues for countries going forward. So, it’s unsurprising that we’ve seen local governments, for example, Chile and Peru are looking to increase tax on these companies specifically.”

In Chile, under a proposed bill, investors could face a tax burden of 82% in royalties and taxes on sales exceeding 12,000 tons annually of copper and 50,000 tons per year of lithium, up from 40.3%.[9]

Beyond changing tax regimes, we are also seeing other forms of state intervention, such as that currently being debated in Mexico. There, the government is considering legislation that would limit private participation in lithium production[10] but could also be extended into other minerals key to the energy transition. Many of these issues are being driven by concerns around security of supply.

Decisions like these are often driven by politics rather than economics, and the danger is that, if the proposed rates of taxation are too high, or if legislation limits wider industry participation, then they could potentially be counter-productive, lower long-term competitiveness, and limit mining activity in that region or country.

Valeria Vazquez Mining & Metals, Deloitte Mexico, adds, “Fiscal measures enforced without proper industry consultation could also impact mergers and acquisitions; one of the consequences of elevated risk ratings is that investors will lean toward safer jurisdictions which carry less risk of disruption.”

Future tax reforms

An additional challenge is that the international tax system is currently under reform. The Organisation for Economic Co-operation and Development (OECD) estimates that domestic tax-base erosion and profit shifting (BEPS) practies cost countries across the globe US$100-240 billion in lost revenue each year (the equivalent to 4-10% of global corporate income-tax revenue).[11] Developing countries which often have a higher reliance on corporate income tax are disproportionately affected by this.

In October 2021, using the OECD/G20 Inclusive Framework on BEPS, 136 countries and jurisdictions agreed to implement a two-pillar plan to tackle tax avoidance, improve the coherence of international tax rules, ensure a more transparent tax environment, and address the tax challenges arising from the digitalisation of the economy. The new minimum corporate tax rate of 15% applied to companies with revenue above EUR750 million (approximately US$873 million) is expected to generate around US$150 billion in additional global tax revenues annually.[12]

Countries are aiming to sign a multilateral convention during 2022, with effective implementation in 2023,[13] and mining companies must be ready for this.

As key players in the green-energy transition, mining and metals organisations must also have one eye on carbon taxes which could increase as countries look to incentivise decarbonisation. For example, the South African Carbon Tax, which was introduced in 2019,[14] has proven weighty on mining companies. The first phase only applies to Scope 1 emitters, but the second phase, which is currently under review and will be implemented in 2023, will be more expansive and could include changes to rates and tax-free thresholds.[15]

Vazquez adds: “I think we’ll see more of these types of measures introduced as the energy transition accelerates. There will be unpredictable and substantial changes in mineral taxation and/or regulation of assets over the next decade, and mining and metals companies will need to prepare for and adapt to these as best they can.”

Building flexibility and resilience in the face of regulatory uncertainty

• Seek partnerships and consultation with authorities: Many organisations’ current relationship with governments and tax authorities is dictated by past experience, whether good or bad. Some companies actively seek to create an open and engaging dialogue with authorities while, for others, a lack of trust is the defining factor in the relationship. Neither approach is right or wrong but, as in so many matters, it’s best to have a seat at the table, if not a voice, wherever possible.
  
  Being part of the consultation process for potential tax reforms brings a level of predictability that will be useful in future strategy development. Greater transparency around tax planning and through public disclosure will also help to build trust where it is lacking.
• Demonstrate value beyond tax: Companies should lean on their environmental, social and governance (ESG) efforts to better explain their value to governments, not just through economic returns but also through environmental- and social-impact initiatives.
• Increase organisational agility: Even when operating in jurisdictions that have relatively stable fiscal regimes, mining and metals companies need to factor a certain level of flexibility into their strategies so that they can adapt to and take advantage of changes in the political and economic environment.
• Embed the use of scenarios in strategic planning: Use long-range scenario planning tools to consider different regulatory regimes in geographies in which you operate and plan for possible responses.
• Diversify portfolios and supply chains: Aim to spread investments across jurisdictions with a range of risk ratings to reduce overall exposure to risk.

Future bites

Resource nationalism is borne out of a desire to protect a country’s resources through ownership and tax revenues. New models based around circularity could potentially help to overcome this issue.

For example, if a state or nation owns metals as they move through the value chain, and mining and metals companies extract, process and trade them as a service, then that could help to ease ownership concerns for governments and allow mining companies to be more agile.

It could also lead to greater governance surrounding metal circularity, because the state would be responsible for and incentivised (through royalties or returns) to ensure metals are recycled each time a product comes to the end of its life.

End notes

[1] Martin Stuermer and Nico Valckx, “Four factors behind the metals price rally”, IMF Blog, published 8 June 2021 https://blogs.imf.org/2021/06/08/four-factors-behind-the-metals-price-rally/, accessed 21 October 2021.

[2] “Industrial metals charge to fresh highs as inflation runs hot”, Bloomberg News, published 9 Sept 2021 https://www.bloomberg.com/news/articles/2021-09-09/nickel-storms-to-seven-year-high-as-demand-booms-supply-ebbs, accessed 21 October 2021.

[3] Neil Hume and Henry Sanderson, “Copper boom: how clean energy is driving a commodities supercycle”, FT.com, published 8 June 2021 https://www.ft.com/content/40907aa6-354e-42f8-8d51-8cc01f0e9687a, accessed 21 October 2021.

[4] Damien Nyer and Silvia Marchili, “Mining & metals 2021: Forces of transition and influencers of change,” published 15 September 2021https://www.whitecase.com/publications/insight/mining-metals-2021/new-wave-resource-nationalism, accessed 21 October 2021.

[5] Ludivine Wouters, “An overview of resource nationalism”, Mining Beacon, published 27 October 2019 https://www.miningbeacon.com/posts/55328-an-overview-of-resource-nationalism, accessed 21 October 2021.

[6] “Kyrgyzstan pressing ahead with removing Centerra Gold from Kumtor mine,” Reuters, published 11 August 2021 https://www.reuters.com/article/us-centerra-gold-kyrgyzstan-idUSKBN2FC0MI, accessed 21 October 2021.

[7] “Centerra gold seeks urgent relief in international arbitration to prevent the Kyrgyz Republic from destroying the integrity, value and long-term viability of the Kumtor Mine,” Centerra Gold, published 27 September 2021 https://s3.amazonaws.com/centerragold/news/September2021/pY6nBuidRu2J5KN1S6XC.pdf, accessed 30 November 2021.

[8] Jimena Blanco and Mariano Pablo Machado, “Resource nationalism surges in 2020, Covid-19 worsens outlook,” Verisk Maplecroft, published 4 March 2021 https://www.maplecroft.com/insights/analysis/resource-nationalism-surges-in-2020-covid-19-worsens-outlook/, accessed 21 October 2021.

[9] Damien Nyer and Silvia Marchili, “Mining & metals 2021: Forces of transition and influencers of change,” published 15 September 2021 https://www.whitecase.com/publications/insight/mining-metals-2021/new-wave-resource-nationalism, 21 October 2021.

[10] David Alire Garcia, “Mexico will reject private lithium deals even if reform bill fails, according to president,” Reuters, published 7 October 2021 https://www.reuters.com/world/americas/mexico-will-reject-private-lithium-deals-even-if-reform-bill-fails-president-2021-10-07/, accessed 2 December 2021.

[11] “International community strikes a ground-breaking tax deal for the digital age,” OECD.org, published 8 October 2021 https://www.oecd.org/tax/beps/international-community-strikes-a-ground-breaking-tax-deal-for-the-digital-age.htm, accessed 21 October 2021.

[12] “International community strikes a ground-breaking tax deal for the digital age,” OECD.org, published 8 October 2021 https://www.oecd.org/tax/beps/international-community-strikes-a-ground-breaking-tax-deal-for-the-digital-age.htm, accessed 21 october 2021.

[13] “International community strikes a ground-breaking tax deal for the digital age,” OECD.org, published 8 October 2021 https://www.oecd.org/tax/beps/international-community-strikes-a-ground-breaking-tax-deal-for-the-digital-age.htm, accessed 21 october 2021.

[14] “South African carbon tax,” iea.org, updated 30 June 2020 https://www.iea.org/policies/3041-south-african-carbon-tax, accessed 21 October 2021.

[15] “South African carbon tax,” iea.org, updated 30 June 2020 https://www.iea.org/policies/3041-south-african-carbon-tax, accessed 21 October 2021.