WORLD BANK
MINING FISCAL ISSUES WORKSHOP
WASHINGTON 5 OCTOBER 2006
Mineral royalty administration:
The acid test of policy?
By
Pietro Guj
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
CONFLICTING RANKING OF ROYALTY
METHODS BY DIFFERENT CRITERIA
ECONOMIC ALLOCATIVE
EFFICIENCY AND
EQUITY/ABILITY TO PAY
ADMINISTRATIVE
EFFICIENCY AND
REVENUE STABILITY
Resources rent
Unit-based
Profit-based
Ad-valorem
Hybrid
Hybrid
Ad-valorem
Profit-based
Unit-based
Resources rent
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 advalorem royalties
 Few profit-based and hybrids
 None resources rent (only for petroleum) and
 Small producers and artisan miners do not pay royalty
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
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
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
ROYALTY RATES AND INCENTIVES
 Negotiation of lower royalty rates on a project-byproject 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
PENALTY PROVISIONS
 Royalty payment is a key condition and noncompliance 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 noncompliance from progressively higher penalty
interest, to graduated fines and finally to forfeiture
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
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 redistributed 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
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
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”