The "Gillard effect" is a global phenomenon

Judging by the latest difficulties Rio Tinto is having with the Mongolian government, one might conclude that the propensity for governments to expropriate more wealth from shareholders is becoming a more popular policy initiative. The Rudd/Gillard government of Australia can take the credit for their 'initiative' in leading the  mob mentality towards expropriation.
The clear undesirability of this policy is that it entails theft of property from shareholders. It must be conceded that a legitimate case can be made for the public taking a cut in the development of a project, and for the state to act as a conduit for that. The problem is that this initiative has to be undertaken at the start; before a company has commenced exploration and established terms. They cannot arbitrarily breach terms and retain any credibility. That would constitute theft, and governments are supposed to protect people from theft, not be systematic exponents of theft. Otherwise:
1. Governments are no better than thieves
2. Provide a moral sanction for thieves in the broader community

Investors in mining stocks, particularly those with world-class projects, and most particularly the largest companies in the world, who tend to be the object of such 'revision' of terms - they are the most vulnerable. They risk being exposed to a systematic threat of sweeping reform of royalties. I call this the 'Gillard effect' after Julia Gillard, although Kevin Rudd should probably taken more credit; not to forget the  petty academic who lives on government-extorted taxpayer funds, who actually dreamed up the theme. In fairness, it was Rudd & Gillard who executed it, but he gave it the moral sanction. As John Maynard Keynes proved, a government only needs one ambivalent or misguided academic to justify a systematic extortion racket.

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Author Andrew Sheldon| Applied Critical Thinking | www.SheldonThinks.com

Correction to media reports - coal exports

If you read the press, you will hear that "Queensland (Australia) is losing up to A$100 million ($131 million) a day in coal exports because of the unprecedented floods". The reality is far less tragic, for a number of reasons:

1. Coal exporters and consumers have come to expect disruptions to coal supply. For this reason most coal consumers have 60-90 days of inventory capacity to meet their immediate needs. The implication is that, if we assume they each have an average of 70 days capacity utilisation, then the consumers have over 2 months to receive supplemental coal supplies in order to ensure normal power, steel or cement plant operation.

2. Coal producers have long and short term contracts, and those contractual obligations are set at market price, so there is no incentive to go elsewhere.

3. Coals from different mines vary in quality, so consumers do not like to disrupt supplies necessarily unless there is some commercial or supply reason to do so, otherwise they are creating technical/operational difficulties they don't need.

The implication is that Australia is not losing that amount of money; those exports are simply being deferred, though not without cost. So what costs can we expect? Well, ships are going to sit idle for 2 weeks, and for the next few months after, they will be fully booked rebalancing consumer stockpile inventories. Money will need to be expended by Queensland Rail to rehabilitate those sections of track damaged by the flood. These companies might need to employ people on overtime, however they will also have insurance to cover them for such events. The media reported that 100's of kilometres of track were destroyed...more likely just submersed....though there will be considerable damage where there is flow because saturated soil loses its cohesion, so track is more easily ripped up by flowing water.

The biggest loss is of course to agriculture and the destruction of property. It strikes me as silly that insurance companies only cover people for the effects of rain, and not flooding. I know that there has been this response before by insurance companies when houses on the South Coast of NSW were flooded. Is not the intent of insurance to protect a person from unforeseen events, and that the insurance companies are the ones to identify them, since it is a technical risk, which they are in the business of assessing. i.e. They are not fulfilling the spirit of their role. This is where you get ambivalent court rulings, because the law does not clearly establish whether a judge should rule:

1. With the letter of the law, i.e. The law is a dogma, held out of context. This is the basis of statutory law, and explains why bureaucrats are so unthinking in your dealings with them. Its the policy, and they have no power to interpret it 'in context'.

2. With the spirit of the law, i.e. The law is a philosophical construct, that it is based on principles, and those principles are held in context. This is the basis of common law, where judges make new law by applying the law to specific contexts.

If you appreciate that statutory law is being called upon to fill the 'perceived gaps' in common law, it will be apparent that we are being a more unthinking society because of such creeping dogmatism. This can continue until we finally march 'with pride in democracy' towards fascism. I would already argue that we are already there, but its a matter of degree. Some of you might want to wait until Comrade Rudd is marching with the band down Anzac Parade, but I just consider that a huge opportunity cost, more of a concern than our 'deferred' exports.

You can read more about these issues on my political blog or even my judicial website.

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Andrew Sheldon www.sheldonthinks.com

The cost of one really bad 'resource tax' decision

It is worthwhile doing an analysis of exactly what PM Kevin Rudd has done to Australia. Even if he backs down from this policy, I think he has done permanent damage to the reputation of Australia as a safe place to invest. You need to understand that Malaysia pays a higher cost of capital than Australia. The reason is that its a smaller country, developing country, with relatively undeveloped capital markets, unpredictable public policy framework. The implication is that when the Malaysian government pegged its exchange rate back in 1993 Asian Currency Crisis, it was the type of policy you would expect from a 'recalcitrant' leader of a third world economy.

The implications of Rudd threatening or planning to raise taxes on miners has the same impact on investors. He is doing something without warning, with huge detrimental implications to investors, which stretches far beyond mining companies. I estimate that his actions will cost Australia in net present value terms the equivalent of $A2o billion a year. This is a rough figure, though it is very conservative. Consider our risk exposure:

1. Lost mining investment: I would expect some $A300 billion of mining investment over the next 20 years. I believe it would fall by around 16% per annum if Rudd adopts his policy. If we assume national income is half of this investment, in terms of wages, royalties, taxes, and we prepare a NPV for this money stream, then we are looking at a loss of $A10 billion.

2. Lost general investment: Foreign investors will look at this decision and wonder whether they ought to invest in Australia, so the implications will extend beyond Australia's mining sector. The implication is that Australia's reputation will be damaged for a long time. The damage has already been done in fact because there is always the possibility of it happening again. The fear is not in people's minds; it will take years to erode. This can be expected to have a smaller impact I think because most will recognise that this is an opportunistic policy - say a cost of $1 billion a year.

3. Higher interest rates: It is probable that Australia's sovereign credit risk rating will rise if this policy is adopted, particularly on the corporate debt of miners. It will also have an impact on the cost of capital of households. The increase because of it might be of the order of 0.1%, however given the large size of Australia's household and corporate debt, this is going to be a lot of money leaving the country because of Rudd. I think household debt is around 102% of GDP, which is around $750 billion annually, so 0.1% of $A750 is another $0.75 billion.

4. Capital loss: Consider the implication of his decision on the value of all Australian mining stocks with investments in Australia. He has also opened up the prospect of similar policies being adopted overseas. Of course if his policy is copied that would be relatively good for Australia, but absolutely worse for everyone. We don't want govts controlling the money, as they are hopeless. So direct investors have probably lost $3 billion, portfolio investors and fund managers have probably lost $7 billion, and that's just to date. Another $5 billion when the policy is legislated.

5. Investment loss: What about the opportunity cost of write off's for project values which would otherwise have been sold to investors. e.g. MLX has a world class nickel resource. A Chinese company was likely to have bought a stake in the mine through development funds. The project is no longer worth as much because of the new tax imposts. Impact probably $1 billion a year, rising to $2 billion in 10 years.

6. Legal suits: Also consider the prospect of a law suit by these foreign and domestic companies which have spent money acquiring projects, only to find out that the government has overnight changed the tax regime. So taxpayers will be paying out another $5 billion in law suits.

Decades ago security of supply was a 'BIG' consideration for Japanese investors in Australia's mining sector. I actually think this fear has died because of the more globally liberalised markets evident today. Removal of tariffs has helped achieve a seamless integration of markets. The Chinese market is 10x bigger in terms of population than Japan, so they mean a great deal of investment to Australia. We are in the front seat to supply these countries, but because of Rudd, we will miss out on some of this investment. I suggest there will be more interest in Indonesian, PNG, NZ iron ore, coal, oil & gas. Oman and Yemen will become appealing to companies like Shell and Woodside. That is the impact of Rudd. He will be on par with President Chivez (?) of Venezuela, who nationalised the local oil industry. What is the difference to investors? A capital loss because of some arbitrary government policy is a loss one way or another. That is a lot of damage to Australia's balance sheet. I guess its good to know this before some 'sorry' people consider him a nation's leader for another term of government. Learn more about this issue on my taxation blog.

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Andrew Sheldon www.sheldonthinks.com