December 7, 2022 (LBO) -
Demystifying the Minerals Sector
Why is it that many entirely legitimate investments by the private sector are immediately demonised as a racket by certain commentators with ulterior motives, and then sensationalized by the media? Conspiracy theories leading to private sector verdicts of guilty unless found innocent seems to be the default far too often. It is a culture of negativity and misinformation that Sri Lanka desperately needs to replace with a “glass half full” attitude that supports entrepreneurialism, if we are to emerge from our current economic tragedy.
As mentioned in the recent budget speech, Sri Lanka has no choice but to move to an export based economy. Targets of generating a further annual $3 billion of exports and $3 billion of FDI have been set. Thus, new export generating sectors need to be initiated through FDI $ and the introduction of new technologies. Such a new export diversification sector could be minerals processing. However, the nay sayers are already active on the subject, attempting to sabotage developments and displaying their lack of understanding on a) how mineral deposits are discovered, b) land vs. mineral rights, c) Government share of revenue is generated, and d) the myth of value addition while also showcasing their inability to comprehend the bigger picture.
The first step in developing a mine, is to conduct exploration to discover and define the mineral resource. The process takes years of sampling, drilling, analysis and technical feasibility studies. It is a capital intensive and high risk activity. Commercially viable deposits are not just available off the shelf but have to be developed by a technically competent entity. Thus, within our legislation mineral exploration licences are issued after a selection process and the exploration licence holder has an exclusive right to proceed to mining and their intellectual property is protected by law.
It should be noted that mineral rights are distinct and different from landholder rights. The landholder possesses rights only to the surface (<1m) but any mineral in the ground belongs to the State. The State is compensated via royalties (see below) and nothing is due to the landholder as per the the Mines and Mineral Act of 1992 and subsequent amendments. Mineral regulation is exclusively by the Geological Survey and Mines Bureau (GSMB). Whether the landowner is private or state owned, whether the mine is underground or opencast, the landholder has no claim on the mineral rights. This is the case at Sri Lanka’s largest operating quarry where only the surface rights are on 50 year lease by the Sri Lanka Cement Corporation, and the limestone rights are entirely regulated by the GSMB. The Sri Lanka Cement Corporation has no claim whatsoever over the mineral rights.
Government revenue from minerals is generated as royalties. Royalties are payable on revenue rather than profits. Commodity prices are highly volatile and subject to cycles. Thus, there are often times when the mine is operating at a loss but royalties on the topline are still payable. This gives assured revenue to the Government. Assuming a royalty of 7% and a 25% margin, the royalty will be the equivalent of an income tax of 28%. In addition, income tax is also levied adding a further 30% under the new budget. Furthermore, dividend withholding taxes of 14% will be charged too. Thus, the total share of the economics by the Government is approx 60% with nil investment or risk. In Sri Lanka, the mineral royalties are set at 7% which is very high by international standards which are typically in the range of 2.5% to 5%. In addition, to royalties, corporate income tax, dividend withholding tax, indirect taxes (e.g. VAT, CESS etc) are also payable. The economics of any operation are fixed and the overall pie can be divided only so many ways. If the Government share of revenue is excessive, then the economic return threshold to invest in the project may not be met. A bigger Government % of a project that does not proceed, is still nil.
Value addition is another misunderstood subject even amongst the most educated and unbiased circles. There is a well-established idea that if a product that is mined for X can be sold for 3X then we should ban the sale of that product at X. What is missing in this analysis is that the cost side of the equation. While the product may indeed fetch a selling price of 3X the production cost may be 2.5X. Hence, the margin is no different to selling the product at an earlier stage of processing. More worryingly, the factors of production that are mandatory for further processing may simply not be available in our nation, at this particular time. These include cheap and reliable power, availability of chemicals (often a byproduct of another process), proprietary patented technology, proximity to the end user markets, and the capacity to dispose of hazardous waste. Take for example, Australia is the world’s biggest iron ore exporter but it does not make any steel for export. Similarly, Australia is a big exporter of mineral sands but hardly produces pigment exports. In both cases, dealing with hazardous waste anywhere inside its 7.8 million sq kms (in contrast Sri Lanka has 65,000sq kms) appears to be avoided.
A classic case of a missed opportunity for Sri Lanka is Eppawala Phosphate which was blocked from development by a Canadian company 20 years ago. Sadly, we are still importing fertilizer today and our poor farmers are suffering. Certain misguided actors interpret the Bulankulama (March 2000) Eppawala Phosphate case law to mean that it is better for the minerals to remain unutilised for future generations. Minerals do have a shelf life as alternate resources may become available in other markets e.g. oil reserves in Venezuela will be devalued by electric vehicles in the future. The Bulankulama judgment propounds the importance of comprehensive exploration and environmental clearances against an erratic development project which stance this writer wholly upholds. One must strike a balance between utilization of minerals and environmental clearances. It is certainly possible - the Central Environmental Authority has many talented and practical professionals. The Eppawala case is a blatant example of demonizing of foreign investment/investors resulting in larger disadvantages than advantages to Sri Lanka and is unfortunately just one of a long list.
The above concepts apply not only in Sri Lanka but all over the world. Unfortunately, so does rampant corruption and rent seeking by individuals in authority. Typical roadblocks arise when the landholder is state owned, the board are political appointees with limited technical credentials, who then confuse mineral vs. land rights, and the economics of what their institution is entitled to – all couched in a false value addition narrative to further their personal agenda rather than that of the nation. Let’s learn from our past mistakes and embrace the sustainable development of our natural resources.
Sri Lanka, with its strategic location, natural beauty and abundance of mineral resources definitely has a place at the table of global economy. However our blind nationalism, self serving corruption and rhetorical nay-saying has ensured that we have left that seat vacant for generations. But in order to further our standing in the world we must find our place in the line very soon.