South Africa's National Treasury today released the fourth and final Mineral and Petroleum Resources Royalty Bills, for technical comment only; this proposed legislation is to be implemented on 1 May 2009.  

Compared to previous drafts, the latest proposals appear to amount to significant reductions in effective mineral royalties. Following extensive commentary, the formulae were adjusted to take into account, states National Treasury, the capital intensive nature of certain mining operations, especially gold mining and oil and gas.

As such, the final formulae will thus use earnings before interest and tax - EBIT (with 100% capital expensing), instead of EBITDA (earnings before interest, tax, depreciation and amortization), as the numerators. Given that a distinction will be drawn between refined and unrefined minerals, two royalty percentage rate formulae will be required: the refined rate is capped at 5%, while unrefined is capped at 7%. The effective rates can be a lot lower, and even zero. 

The new royalty bill is based on the old profit to revenue formula. According to a senior mining figure, on a five year cycle, all commodities would have paid less on average than under the original range of fixed percentages. He sees no chance that the implementation will be deferred beyond 1 May 2009.

In reaction to the final draft on royalties, the Chamber of Mines stated that given the specific characteristics of mining (e.g. the long lead times to develop projects) and the importance of the mining sector as a large employer (495,577 employees in 2007) and its significant export earnings (33% of merchandise exports directly in 2007), it was vital that the new royalty system capture the key issues of stability, predictability and competitiveness. The Chamber believes that the fourth draft goes some way towards reflecting these important issues. 

For illustrative purposes, National Treasury quotes from the latest available Quarterly Financial Statistics for the mining sector published by Statistics South Africa, and states that the average estimated royalty percentage rate for refined minerals would have been only 1.56% in 2006. Due to higher commodity prices this rate would have increased to 2.55% in 2007. For unrefined minerals, the average estimated royalty rates would have been 1.97 and 3.4% for 2006 and 2007 respectively. On average EBIT (with 100% capital expensing) is expected to vary between zero and 30%.

After a South African field trip in early February this year, analysts from RBC Capital Markets found that the feeling among tour participants was that the royalty payment start date may be delayed by a year or two, or that the actual royalty percentage may be reduced to compensate for the current burden on the companies that was caused by the government. 

Some South African gold companies also pointed to the fact that the combined effect of Eskom's power problems and the royalty would be to significantly increase the cost base, which, in turn, will likely see significant losses from the resource statements as large blocks of ground would no longer be viable - a situation that could escalate dramatically if the gold price started to decline from around record highs.

RBC CM found that gold companies were likely to experience the worst impact from the proposed royalty: Not only do they generally consume larger amounts of electricity but also get lower revenues per ounce of output. Then, just to put the cherry on top, the proposed royalty also seems to have a much larger impact on the earnings base.

In a detailed study of a number of recent mining company results, RBC CM established that the impact of the then-proposed royalty payments if they had been in service over the recent reporting periods for some of the companies would have reduced the earnings base of gold companies in the order of 20% on average, compared to a roughly 15% impact on platinum companies. At that stage, the proposed royalty formula for gold and platinum companies was at 8% of EBITDA.

National Treasury now claims that the revised royalty regime is investor friendly, and should be relatively easy to comply with and easy to administer, whilst it would also ensure that the fiscus receives its fair share of tax revenue.