An Analytical Framework for Evaluating Mining Royalty Regimes

A STUDY BY KPMG AND FRASER MILNER CASGRAIN LLP (FMC)

MONTREAL, July 31, 2012 /CNW Telbec/ - The strategic management consulting firm KPMG LLP (KPMG) and the law office of Fraser Milner Casgrain LLP (FMC) published today a study which presents an analytical framework permitting the evaluation of mining royalty regimes currently in place around the globe.

"After several months of research and analysis, this study has been developed as a reference to identify the key issues that need to be considered in the search for an appropriate mining royalty scheme for Quebec. In an internationally competitive context, Quebec will only profit from its mining legacy to the degree that the industry's fiscal regime is adapted to the distinctiveness of our mining sector in Quebec", emphasized Mr. Renault-François Lortie, partner with KPMG and director of the study.

This analytical framework allows for the study of the ramifications of different proposed mining royalty schemes which could be applied in Quebec and seeks to reach as such all stakeholders, including the government, mining companies, and civil society stakeholders, who are engaged in the ongoing debate.

"The model that has been developed is based on an exhaustive review of regimes currently in place in the principal mining regions of the world and reflects the output of discussions and exchanges with numerous specialists in the sector, including fiscal economists, financial analysts, as well as many industry decisions makers. We have thus been able to take into consideration the key rules and practices related to investment decision making," highlighted Mr. Michel Brunet, Chair of FMC and co-signer of the study.

"The analytical framework takes into account the complete mining cycle, which is characterized by significant price fluctuations on a global scale, while costs are generally project specific and much less volatile than pricing. This document is a valuable tool intended to further nourish the dialogue between stakeholders on this topic and enable Quebecers to put in place an optimal mining royalty scheme for our economic development," concluded Renault-François Lortie.

The study was completed by a team of professionals under the direction of Mr. Renault-François Lortie, partner with KPMG. The content was validated by a review committee comprised of Mr. Daniel Denis, economist and partner at KPMG, Mr. Marcel Boyer, associate-economist at CIRANO and Mr. Pierre Lortie, Senior Business Advisor at Fraser Milner Casgrain (FMC).

SUMMARY AND KEY FINDINGS

The Context in Quebec

• The launch of the Plan Nord by the Quebec government has provoked an important debate over the mining royalty regime in Quebec. Although the current scheme has only been in place for a few years, several alternative models have recently been proposed. The KPMG/FMC analytical framework allows for the comparison of the impacts of these different alternatives.
• Any comparison of different regimes and their impacts must take into account three factors: (i) the unique situation of the mining sector in Quebec; (ii) the decision making process of mining companies, which considers industrial projects with a lifespan of 10 to 30 years; and (iii) the volatility of metal prices on a global scale.
• Notwithstanding the strong mining potential in Quebec, and the breadth of media coverage on the Plan Nord debate, Quebec remains a region of secondary importance on the global scale. With 15 mines in production, of which only 11 are of significant size, and a production totaling $7.7B in 2011, the Quebec mining sector ranks fourth in Canada, after Ontario, Saskatchewan and British Columbia. The total value of production in Quebec represents less than 1% of global production.
• Among the 200 principal mining projects currently in development or under study globally, only four are situated in Quebec.
• In addition, known mining deposits in Quebec are generally less concentrated than those in principal mining regions and associated costs remain higher.
• Quebec is in constant competition with numerous mining regions across Canada and elsewhere in the world. From 2002 to 2011, Quebec's share of the total value of mining production in Canada changed from 18.7% to 16.1%.
• The analytical framework developed here compares profit-based royalty regimes, common in North America and currently in place in Quebec, with ad-valorem royalty schemes, based on the value of the mineral extracted, used in several countries in the Southern Hemisphere and proposed by some as an option for Quebec.

The Current Royalty Regime in Quebec

• The current royalty rate in Quebec, 16% of mining profits, places the region among those with a high profit-based royalty rate.
• The nature of the current scheme results in more balanced risk for investors during low mining cycles and therefore favors investments in mining projects located in a region of secondary importance such as Quebec.
• Given the modifications brought to the regime in 2010, Quebec has become one of the only jurisdictions having profit-based mining royalties adjusted on a mine by mine basis. Calculations in other jurisdictions are generally completed on a consolidated basis.

The Comparative Analysis

• Royalty rates calculated on extracted value (ad-valorem) are less appropriate for regions where production costs are high because risk of mine closure is much higher during bearish cycles (for metal prices).
• In fact, in periods when prices are low, unavoidable for a mine with a lifespan of 10 to 30 years, ad-valorem royalties profoundly affect the profitability of a mine which has high production costs. Any investment decision must take into account periods of both high and low prices.
• These conclusions align with those of a study on the same topic published by the World Bank in 2006, which stated that profit-based royalty regimes are predominantly applied in developed countries where fiscal administration is well developed (which is the case in Quebec). On the other hand, ad-valorem royalties are much less complex to put in place and are more common in developing countries.

Main Conclusions

• This analytical framework concludes that high mining royalties do not necessarily translate into higher fiscal revenues over the medium and long term. In other words, such initiatives could compromise future investments.
• In order to optimize benefits for Quebecers in the development of its mining potential, the chosen royalty scheme must take into consideration impacts on investors' decisions, as well as impacts on government revenues.
• With regards to the choice of an optimal regime for Quebec, the following must also be taken into consideration: (i) the unique characteristics of the Quebec mining sector; (ii) the competitive position of the sector compared to other producing regions; and (iii) the evolution of price over the entirety of mining cycles, including periods of elevated prices like those that prevailed in 2010 and 2011, as well as low prices, like those several years ago, which will inevitably return in the future.

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A copy of the study is available at: http://www.secorgroup.com/files/pdf2/SECOR-KPMG-FMC_Les-redevances_minieres_au_Quebec_Version_finale.pdf

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ABOUT KPMG

KPMG LLP, an Audit, Tax and Advisory firm (kpmg.ca) and a Canadian limited liability partnership established under the laws of Ontario, is the Canadian member firm of KPMG International Cooperative ("KPMG International"). KPMG member firms around the world have 145,000 professionals, in 152 countries.

The independent member firms of the KPMG network are affiliated with KPMG International, a Swiss entity. Each KPMG firm is a legally distinct and separate entity, and describes itself as such.

ABOUT FRASER MILNER CASGRAIN (FMC)

Fraser Milner Casgrain S.E.N.C.R.L. (FMC) is a leading law office in business law and litigation in Canada. FMC has more than 500 lawyers and offices in Montreal, Ottawa, Toronto, Edmonton, Calgary and Vancouver. Thanks to its national network of lawyers and associate experts, the office has all the necessary competencies for a complete understanding of the issues facing clients in various sectors of activity, wherever they may be located.

ABOUT CIRANO

CIRANO brings together over 180 professor-researchers active in a variety of disciplines, including economics, finance, management, information systems, computer science and operational research, psychology, sociology, political science, law, history, and medicine. These researchers belong to eight Québec academic institutions and more than ten institutions from outside the province in Canada, the United States, and Europe. Recognized internationally, they produce high-calibre scientific work and publish in the best journals — over 20 of them hold research chairs.

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SOURCE: Ryan Affaires publiques

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