WORLD BANK MINING FISCAL ISSUES WORKSHOP WASHINGTON 5 OCTOBER 2006

1. WORLD BANKMINING FISCAL ISSUES WORKSHOPWASHINGTON 5 OCTOBER 2006 Mineral royalty administration: The acid test of policy? By Pietro Guj

2. CONTENT OF TALK • Balancing conflicting policy objectives • Drafting sophisticated legislation is easy - effectively enforcing and administering it is hard • What generates administrative complexity, disputes and potential abuse and how to prevent them

3. CONFLICTING RANKING OF ROYALTY METHODS BY DIFFERENT CRITERIA

4. FACTORS AFFECTING THE CHOISE OF A ROYALTY METHOD • Main factors: • Size of operations • Price of commodity • Volatility of commodity price • In general: • Most mineral regulatory regimes use unit-based and ad-valorem royalties • Few profit-based and hybrids • None resources rent (only for petroleum) and • Small producers and artisan miners do not pay royalty

5. UNIT AND AD-VALOREM ROYALTIES • Unit and ad-valorem royalties, while economically inefficient, are easy to administer because: • Actual sales invoices provide accurate and unambiguous volumes and values on which to base royalties • Minimise potential errors, avoidance and disputes • But expose government to both the up and down-side risk of forward sales • Not at arms-length and transfer sales by contrast generate: • Considerable ambiguity particularly for polymetallic ores and concentrates • An undesirable need for ministerial discretion in “deeming” their values • Frequent and long-protracted legal disputes

6. HYBRID AND PROFIT –BASED ROYALTIES • Profit-based royalties while more economically efficient are much more complex to administer because: • The profit on which they are based is generally not the standard financial accounting measure of profit • They are levied on a project-by-project basis • Of different capital recovery methods, deductible items and distribution of overheads • No royalty may be levied in case of a loss even though the project may be generating very high cash flows • Difficult to audit • Lack of appropriate skills and general under-resourcing of administering authorities

7. ROYALTY RELIEF • Unit and ad-valorem based royalties: • Affect gross revenue therefore increasing cut-off grades and reducing economically minable reserves • Prevent development of marginal deposits • Render narrow-margin operations unprofitable if prices fall creating the need for royalty relief or deferral • Royalty relief provisions are: • Difficult to draft and administer • Often require significant ministerial discretion • Not transparent and potentially open to abuse • Profit-based royalty regimes in theory at least should not generate the need for relief

8. ROYALTY RATES AND INCENTIVES • Negotiation of lower royalty rates on a project-by-project basis as an incentive to investment is undesirable because: • It creates a precedent which makes it difficult and inequitable to negotiate higher rates for later projects setting a de facto floor • Given commodity price volatility the amount of incentive is open-ended, hence inferior to a direct subsidy • An across-the-board initial royalty holiday or decreases in royalty rates for increasing levels of mineral processing are by contrast justifiable incentives to investment in down-stream processing

9. PENALTY PROVISIONS • Royalty payment is a key condition and non-compliance should result in forfeiture of a mining title • If no specific penalty provisions exist, in theory, any error should lead to forfeiture. In practice, significant and at times “ultra vires” ministerial discretion is used to remedy insignificant issues • By contrast some draconian regimes include immediate disproportionate fines and in some cases even jail terms, which are also difficult to administer without a degree of ministerial discretion • Ideally sanctions should rise over periods of non-compliance from progressively higher penalty interest, to graduated fines and finally to forfeiture

10. THE PRINCIPLE OF “NO SURPRISES” • The long-term nature of mining investments makes predictability and stability of regulatory and fiscal regimes almost more important to industry than the actual rate of royalty • Unexpected royalty reviews and changes may raise the perception of sovereign risk and discourage further investment in the country • It is imperative that government: • Anticipates, pre-empts and minimises the need for change • But if change is necessary continuously liaises with industry and clearly communicates and justifies the need for it • Phases changes in over time giving industry the time to adjust to them • There must be no surprises

11. LEGISLATIVE AND ADMINISTRATIVE POWERS • It is better if legislative and administrative powers reside at the same level of government whether central or state/provincial • Rising dissatisfaction and political pressure at the local/community level with the manner in which royalties are appropriated and re-distributed to the region affected by the mining operations has led in some cases to extreme decentralisation of royalty administration and collection • In the absence of significant institutional strengthening these changes may generate confusion and inefficiency

12. CONCLUSIONS In summary royalty policy must: • Be clear, transparent, predictable and stable. • Achieve ease of administration and government revenue stability without excessively compromising economic efficiency and equity • Be based as far as possible on actual sales volumes and values • Be matched by adequately skilled and resourced administrative agencies • Apply across-the-board rates, not negotiated on a project-by-project basis as an investment incentive

13. CONCLUSIONS (Cont.) • Impose penalties for non-compliance which should be proportionate and progressive with title forfeiture at their extreme • Make use of limited and well-defined ministerial discretionary powers • Anticipate, minimise and pre-empt the need for future amendments which should be based on continuous consultation with industry and the principle of “no surprises”