How To Evaluate Government’s Fiscal Benefits of a Mining Project

I’ve been trying very hard to find on google articles and examples of economic model for this topic. Unfortunately, it is very rare in a public domain. So, I decided to share what I have learn and developed in my line of work in this post for young people who have the same enthusiasm as me in this mining economy (attached file of the excel model used is available at the end of this post).

As part of the process to grant a mining license, the law on administration and management of mineral resources requires the Ministry in charge of granting mining license to evaluate socio-economic benefits from a mining proposal prior to granting license. One of the evaluations is the assessment of likelihood of fiscal revenues to the government based on forecast of future economy and mining operations. It is usually done by way of an economic cash flow model and analysis of possible scenarios.

The use of scenarios help to explore ways which the future may behave and make us realize that the future is uncertain and that decisions must be made within this context. In a mining project, the key uncertainties are: commodity price, ore reserve and production behavior, cost, and inflation.

Elements of Government Fiscal Revenues:

In a mining project, the mineral is processed and transformed from substance into monetary term to produce its economic value and usefulness. In such transformation, a net surplus (after deduction of transformation cost) is produced, called an economic surplus. This economic surplus is then divided between the state (government) and investor, called “Take”.

In a context of Cambodia fiscal regulations, the main sources of government take are from:

• Royalty;
• Corporate Minimum Tax and / or Income Tax;
• Additional Resource Tax / Excess Profit Tax: based on R-Factor of the project;
• Export Duty;
• Withholding Taxes on Services, Interest and Dividend repartition.
• Various Fees: Rental, Community Fund, Environmental Fund, Training Fees, etc.

 

Key Analysis of Government Take:

In analysis of government take from a mining project, two key policy measures must be considered:

• Effective Royalty (sometimes called protected revenue): It is a minimum government revenue in a given year when the project is running at lose and corporate income tax is not effective. This measure indicates how secured is the government cash flow in any event of loses. The effective royalty can be calculated by summing the government revenues that are not subject to cost and profitability of the project. In Cambodia context, those are revenues from royalty, minimum tax, and export duty.
• Progressivity or Regressivity of the Government Take: This is an analysis of how government take will behave in response to variation of economic conditions, in particular with regard to profitability of the project. It is basically an analysis of what happens to government take in the event of profitability increased or decreased.

 

How we do all these analysis:

Excel has so many amazing tools that can be fairly used to make analysis of such fiscal regime. Next, I will show an example of how we use Excel to do this. But before that, let me remind that one of the useful tools for scenario analysis is the data-table function of excel, which I used a lot in this kind of work. For example, as indicated in the picture, using data-table can provide a 2-dimensional picture of government take based on difference scenario of one or two variables (say in this case gold price and ore production).

For instance, several conclusions could be made from this picture:

• In all scenario of price and production volume, the government take is not less than 55% of the total take or economic surplus.
• When gold price is above 1,300$/Oz, the government take seems neutral with price (horizontal axis), i.e., not varies significantly as price increases or decreases.
• Government take is regressive with volume of ore production, i.e., government receives bigger relative take in the case of small deposit.
• The no meaning cases indicate no project as investor receives negative net cash flow (un-discounted).
• At gold price of 1,040$/Oz or lower, the project is not economically viable. Even gold price increase up to 1,170, the project remains not economically viable if total ore production from the deposit is less than 2.4 million metric tons.

 

Fiscal Evaluation of Mining Project using Excel

For this learning, a simplified economic model based on Excel spreadsheet was developed and used. It consists of 3 worksheets (attached file of the model is available at end of this article):

• Dashboard: present summary of model results and entry form for some key inputs as well as sensitivity parameters;
• Fiscal: present fiscal terms and entries used for model calculation. In this simplified version, the Withholding taxes are not applied. Royalty and Income Tax are given in the way that tax holiday could be also considered.
• Calculation: this is where all important calculations are done and presented.

All model required entries are made in 2 worksheets: Fiscal and Dashboard.

Example Case Study

A case study was used to to learn about this model. The summary of this case study is as below:

• Annual Ore Production: 150,000 mt (resulting in total of 3,000,000 mt for 20 years).
• Gold Grade: 3.5 gm/t
• Extraction Rate: 85%
• Total gold production for 20 years production life: 287,000 Oz
• Variable Operating Cost: 774$/Oz of Gold
• Fix Operating Cost: 1,000,000$ per year
• Capital investment prior 2015 is 800,000$
• Capital investment in 2015 is 6,050,000$
• Capital investment in 2016 is 3,600,000$
• Annual inflation: 2%
• Discount rate: 10%
• Start Production: 2016
• Valuation Date: 2015
• Gold Price: 1,300$/Oz
• Royalty rate: 3.5% of Gold produced
• Minimum Tax:1%
• Income Tax: 30%
• Capital Cost deducted through SL-depreciation method: Pre-development cost for 5 years period and development cost for 8 years period
• Additional Resource Tax: Based on R-Factor
  • R-Factor less than 1.3                      0%
  • R-Factor between 1.3 to 1.5            10%
  • R-Factor between 1.5 to 2.0            15%
  • R-Factor between 2.0 to 2.5            20%
  • R-Factor between 2.5 to 3.0            25%
  • R-Factor greater than 3.0                30%
• Export Duty: 10%

Summary Results of the model

key finding or results of the model are presented in Dashboard worksheet of the model. User can use spin control to play with different scenario of different parameters: gold price, production volume, operating cost, and capital cost to learn about model cashflow and level of government take.

Download Excel based Economic model used in this article:

MiningTax_RoyaltyModel111