Luck's a fortune
By Paul Cleary BEc ’86
Prime Minister John Howard (LLB ’61) did it in his last three years in office – a $334 billion windfall received, 94 per cent of it spent. When the economy turned down in 2008 as a result of the global financial crisis (GFC), Labor then went into debt to the tune of $107 billion. We’ll be paying off this debt for a decade.
State governments are no better. They collect royalties – which are actually a share of capital – but they spend this capital like there’s no tomorrow, and then they run to Canberra with a begging bowl when the boom ends.
Key factors are at the heart Australia’s failure to properly manage its resource wealth: a mistaken belief that the nation has endless amounts of resources, which leads to complacency about the need to tax our resource extraction more effectively, and to save windfall revenue for when the boom ends, and for when the resources run out.
First, life expectancy: iron ore recently became Australia’s single biggest export earner. It is forecast to earn $65 billion in export revenue this financial year, having overtaken coal for the first time ever. Prices of iron ore have increased tenfold during this boom, which is encouraging massive investment in new capacity.
Over the past decade, our reserves of iron ore have fallen from 100 years to 70 years, and now companies are putting in place investment to double or even treble production over this decade. So that figure of 70 years should be divided by two or even three to provide a reliable indication of the extent of our iron ore luck. Companies might extend their known reserves, subject to native title negotiations, but the increased production is more than offsetting any increase in existing reserves.
The outlook for gas is even more misleading. Australia’s geological survey agency, Geoscience Australia, estimates our offshore reserves at 63 years at current production rates. This estimate ignores the fact that resource companies have signed contracts to treble production this decade, and to quadruple it over the next 20 years. The amount of gas sold for export is expanding even faster – four times this decade, six times over the next 20 years.
Gas exports, sold as liquefied natural gas (LNG), could soon be earning as much as coal or iron ore. Current export sales are around $10 billion, so a fourfold increase this decade will push export earnings to around $40 billion. Given that long-term export contracts have been signed and are locked in for the life of the projects, we should be dividing the life expectancy of gas by a factor of three this decade, and four over the next 20 years.
Mining booms usually prove to be periods of heightened economic effervescence that suddenly fizzle out. At the height of these frenzied times, experts predict that they will go on forever and politicians spend the money like drunken sailors.
The outlook for some of Australia’s other minerals is even shorter. They say diamonds are a girl’s best friend and that they last forever, but by the time a girl born in 2011 turns 20, Australia will have no diamonds left unless new reserves are found. Manganese resources will also be finished. Gold, now our third-biggest mineral export, will be gone by the time she turns 30, and silver and zinc by the time she turns 45 according to estimates from the national geological survey agency, Geoscience Australia.
Resource companies are finding more gas, but as soon as they find it they sell it off. Woodside’s Pluto gas field on the Northwest Shelf is a classic case in point. Discovered in 2005, it is now about to go into production after the company engaged in fast-track development that involved importing most of the steel fabrication from China.
But the same can’t be said for minerals. The last big find in Australia was Olympic Dam in 1975. Since then, we’ve not had what Geoscience Australia’s Dr Ian Lambert calls a “world-class, greenfields deposit”. The days of turning up an El Dorado are over.
Given that our known resources have shorter lives than we think, our tax policies should reflect the inherently non-renewable nature of extractive industries, which sadly they fail to do. This is a big failing on the part of federal and state governments. Treasury analysis shows that the non-mining sector actually pays higher rates of tax than the miners.
State government royalties don’t keep up with profits during mining booms because they are levied on the value of production. These imposts are truly medieval in their origins and design. New South Wales has more than 90 different types of royalties. They range from 6.2 per cent for underground coal to 8.2 per cent for open cut. Some minerals incur a 4 per cent royalty, while others incur a cents per tonne levy. It is a truly archaic mishmash that robs the people of this state of the revenue they deserve.
These are the same mining companies running television ads that promote their “generosity”.
The federal government has tried to reform minerals taxation, first by introducing a resource super-profits tax, which was knocked off by the big three mining companies (and along the way they also helped removed Prime Minister Kevin Rudd from office). These are the same mining companies running television ads that promote their “generosity”.
But the compromise negotiated by Prime Minister Julia Gillard after Rudd’s removal will barely affect the big mining companies, though smaller operators will pay more tax. The Mineral Resource Rent Tax (MRRT), which comes into effect in July 2012, only taxes iron ore and coal and it offers scope for significant tax minimisation by the bigger companies.
Treasury modelling shows that even with the MRRT, our taxes on coal will be below those of comparable mines in Indonesia, and taxes on iron ore will be below those of Brazil. The bottom line is that both state and federal governments are not capturing a share of the super-normal profits being generated by exploiting the finite wealth of the people of Australia.
These relatively low rates of tax have encouraged a stampede of investment causing an array of ill effects elsewhere in our economy. Australia currently has one of the biggest pipelines of new investment in the world – $170 billion of new projects now being built, and another $250 billion at an advanced stage of planning. In fact, while the mining sector is worth just 10 per cent of our economy, this financial year it is on track to soak up 70 per cent of all new investment.
This explains why there is a housing shortage during these boom times. In my book, Too Much Luck, I quote Treasury advice to Treasurer Wayne Swan arguing that the boom has drawn investment away from the non-mining economy. The Treasury minute to Wayne Swan said: “It is certainly true that much of the ‘heat’ in the housing market in recent years has been reflected in prices, with investment activity remaining subdued. But this has also been a period where strong profits in the mining sector have fuelled an investment boom that has drawn resources away from sectors such as housing.”
A flood of investment in the mining sector, and a drought in the rest of the economy, best explains why people outside the mining sector feel like they are doing it tough. Investment is the engine of growth, and without it, things start to unravel.
Without having proper taxes in place, Australia won’t be positioned to save some of its boom-time bonus for when commodity prices fall back to earth; and for when the resources begin to run out. Norway, which arguably has the best policies in the world, taxes its petroleum industry at a nominal rate of 70 per cent, and it has no trouble attracting investment.
Copper-rich Chile, which has a similar level of resource dependency to that of Australia, was able to quadruple its resource funds during the last boom to more than $20 billion; worth more than 10 per cent of national income. Chile created a significant buffer against a global downturn. When the GFC came along it was able to use part of its fund to weather the downturn without going into debt. Had Australia saved the same relative share of income we would now have a fund worth $130 billion.
Even without extra revenue from a new tax on mining, state and federal governments are likely to receive significant windfalls in coming years as all of the new capacity comes on stream, and our politicians are lining up to spend the lot.
There’s got to be a better way to manage this money. Australia needs to develop a sustainable rate of expenditure for its resource revenue. One model, adopted by the PNG government, involves “spending the average”. That is, simply define the average share of mining-related revenue over a long period, such as 20 years, and make this the spending limit. When revenue rises above this average, it is automatically saved in wealth funds designed for specific purposes. When it falls below the average, we can draw on the funds to boost the economy.
Australia’s Treasury officials have been working with the PNG government to set up three funds to manage revenue from the country’s huge liquid natural gas (LNG) project. The funds are designed to address three objectives: infrastructure needs, future endowment and stabilisation (managing the boom and bust cycle). But the same advice has not been applied to the LNG billions that will be collected by state and federal governments in Australia. This failure is best explained by a great sense of complacency and a mistaken belief about endless amounts
Best practice from Norway
Two decades ago Norway decided to start planning for the end of its boom. In the space of 15 years, it has accumulated almost $US600 billion in savings, even more than Saudi Arabia’s oil fund. A country of fewer than five million people – about the same population as that of Sydney – already has the world’s second-biggest sovereign wealth fund.
At the present rate of saving, Norway’s fund will double by 2020, and it will most likely keep doubling every seven to 10 years as compound interest kicks in.
Norway’s fund has already proved enormously beneficial to present-day Norwegians, even though the main aim is to hand wealth to future generations. A study by the National Institute for Economic and Industry Research (NIEIR) found that Norway had consistently generated trade surpluses since the 1980s, whereas Australia had accumulated deficits. Norway’s management of its natural resources had generated US$150,000 per person more in international financial assets than Australia had managed to accumulate.
The fund also helps Norway to maintain a diversified export base. All of its assets are invested in foreign currency, thereby taking considerable heat out of the kroner. Despite its significant oil revenue, the resources sector only accounts for half of the country’s export earnings. Norwegian exports are still affordable by other countries, and include world-renowned products such as smoked salmon and cheese, but also ships, pulp and paper products, metals, chemicals, timber and textiles.
It is pretty clear that when compared to best practice around the world, Australia falls well short.
The Norway model has now been adopted by Australia’s near neighbour, East Timor, which in the space of six years has already accumulated $US8 billion. It is the equivalent of Australia having saved $2 trillion over this period.
Even closer to home than East Timor, Indigenous communities around the country have been salting away their mining boom royalties into trust funds that are designed to pay dividends after the minerals have been exhausted. One of the best examples is in Cape York, but others can be found in the Pilbara communities. Indigenous Affairs Minister Jenny Macklin has been telling other resource-rich communities to follow suit, even though her own government doesn’t practise what she preaches.
It is pretty clear that when compared to best practice around the world, Australia falls well short. This is in spite of Australian academics having produced some of the best thinking for natural resource management in the world.
Professors Ross Garnaut and Anthony Clunies Ross invented the resource rent tax (RRT) three decades ago, which is now considered best practice around the world.
Professor Bob Gregory of the Australian National University identified the phenomena of “Dutch disease” well before The Economist magazine bestowed its catchy name. Dutch disease is a bit like the two-speed economy except that in this scenario the fast-moving resources sector actually cuts into the growth of the non-mining economy by driving up the exchange rate and the cost of doing business.