Regarding Ecuador's windfall tax on mining

Following on from the Denver Gold Forum presentations yesterday (see link in previous post), I've so far had two people, make that three people writing in and asking me about the windfall tax (WFT) proposed by Ecuador, cos apparently there are some scare stories propagated by the uninformed going around. What follows is based on my reply to the mailers adapted into a post.

The situation is that there's a proposed WFT on metals prices that would take 70%. It still hasn't been pacted and it's also in the air whether it ever gets enacted, but the key to the whole story is the theshold level. The gov't and miners still have to agree on where the payments for windfall gains start. Here's a quick 'n' dirty example for Dynasty Metals (DMM.to) and for gold, but the situation is the same for all miners and WFT is proposed on all metals:

Let's suppose the 70% Au WFT threshold is set at $1,000/oz and DMM has cash costs of $300 /oz and let's also suppose total costs per ounce of $500/oz, so under this theoretical here's how much the company would make per ounce:

$800/oz Au = $300 profit
$900/oz Au = $400 profit
$1000/oz Au = $500 profit
$1100/oz Au = $530 profit
$1300/oz Au = $590 profit
$1500/oz Au = $650 profit

Now if the WFT threshold is set at $1200/oz the numbers work like this:

$800/oz Au = $300 profit
$900/oz Au = $400 profit
$1000/oz Au = $500 profit
$1100/oz Au = $600 profit
$1300/oz Au = $730 profit
$1500/oz Au = $790 profit

As you can see, the threshold level doesn't affect numbers below it and leaves plenty in the way of profits, but at some point it does limit the blue sky possibilities of a miner. Also, it's pretty important to know what level it kicks in. The negotiations are ongoing, but what we do know is that the threshold level cannot be set lower than spot prices. Finally, I've heard that some fools are going around screaming that companies like DMM.to have "hidden" this information from investors. This is BS. The WFT proposal has been in the public domain for over a year and a half, first published by Ecuador's gov't, via its tax ministry (not the mining ministry) in December 2007.

So people new to the story can't be bothered to do a bit of basic DD and are now running around saying that the sky is falling....well, as David Byrne would say, "same as it ever was". The best thing is to let the uninformed believe what they want to believe. They're the ones queuing up to give you their money, so just smile sweetly and let them.

Short ideas from Argentina

According to reports in the Argentine press this weekend (example here) the Klishtina government is considering imposing a windfall tax on companies that make big profits. It is being dressed up in ribbons and bows, of course, going by the name "Anticrisis Enterprise Fund", or FEA for its initials in Spanish (coincidentally, "fea" is the word for "ugly" in Spanish....if you believe in coincidences, that is).

According to legal beagles attached to the main CGT union, what it amounts to is a "tax on extraordinary profits", as it rankles the unionist rank and file that banks, steelmakers and telephone companies (amongst others) are making what they consider exorbitant profits.

The politics and ideology of this move are one thing, but leaving that debate aside the practical is what interests us here. And what this means is that there are definite shorting opportunities on offer amongst the Argentina ADRs and otherwise Argentina exposed companies. Here are four candidates with their price charts. There are other Argentine exposed stocks traded in the USA, of course, but these below seem likely choices as they fit the "high profit" profile and offer reasonable-to-good trading volume and liquidity. The rest is up to you, so DYODD, dude.

Telecom Argentina (TEO)

Tenaris (TS)

Banco Macro (BMA)

Banco Frances (BFR)

Ecuador, the mining law, royalties and the windfall tax

Two macho men, a referee and an arm-wrestling contest.

Yesterday, a small report from Alonso Soto at Reuters hit the wires and I got three separate mails about it. Here below is the report pasted out (it's not a big one) and the mail I sent to one person and pasted to another. Further Ottocomments underneath:

xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx

QUITO, Sept 29 (Reuters) - Ecuador's leftist president, Rafaela Correa, on Monday ruled out nationalizing oil companies but said he will "not allow" them to reduce investment levels.
Correa also said an 8 percent royalty on mining companies proposed in a draft mining law was "too low" and said a 70 percent windfall tax will be applied to future mining contracts. (Reporting by Alonso Soto)

Dear XXXXXXXXXX,

Correa is putting the mining companies on the defensive here. This is not the time to make them feel comfortable so he's doing a bit of "bad cop" here in his ongoing 'good cop bad cop' routine. He also made it clear in his comments that the mining law was "still in discussion" (that's a quote) and also that the publication this year "is a priority" (that's another direct quote).

Note that Correa was talking about the whole royalty band (3% to 8%) and the report only mentioned the upper limit to be charged to the big mines. It might be the lower band is raised to 5% and the upper band stays as it is. We don't know. To be honest the difference between an 8% payment and a 10% payment is not one that will break the budget of any project there.

As for the WFT, the whole thing depends on the base prices set. We'll not know those until the individual deals are made between MEM and the miners, and all that will happen in 2009 minimum (ie after the mining law is set in stone, and probably after the Presidential elections of March/April/May 2009)

Best, Otto

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After a night to cogitate on the matter, I'd add the following:

1) Correa was probably targeting the 8% upper royalty limit. However it wasn't as explicit as the Reuters article suggests. Correa is very good at leaving himself exits hatches on his statements. In fact he's developed ito a very competent politician, period.

2) If the royalty goes to 10% (for example) it won't affect Kinross at Fruta del Norte or DMM.to or IAG or CTQ.to and their plans, but it will affect those companies early in the exploration track. It's an extra layer of cost for those who would finance the operations to take into consideration. The likely result is a 'wait and see' attitude for brand new mining projects, and investment capital flowing to other countries with a more mining friendly attitude.

3) The windfall tax (WFT) is likely to remain incognito for some time to come, and now becomes the bastion of Correa's 'make 'en sweat' tactics. Remember, he wants a fair deal or Ecuador. That means he doesn't want the mining companies feeling comfortable as yet. Just look at the way he's conducted negotiations with the oil sector players (a far more powerful lobby in Ecuador) and see how he's applying the style to mining. It's roadmap for mining investors par excellence (and he's doing the same in the hydro construction deals...AND it's already worked wonders for him in the telco negotiations).

4) Soto really is good at his job. Read him, even if you don't like the message.

Ecuador and the mining windfall tax issue

Over at Ecuador Mining News Silvia Santacruz has written an interesting story on the ongoing "will-they-or-won't-they" story on the government and its plans (or non-plans) to charge a windfall tax (WFT) to the country's nascent mining industry.

Go see the whole story for yourself over at EMN, but in a nutshell gov't mining person Xavier Cordova made a speech at last week's Denver Mining bash and seemed to say that the gov't was going to scrap plans to charge the proposed WFT, citing the negative fallout that Mongolia had suffered in its mining sector since trying to introduce a WFT there. The speech was picked up in several places, but now EMN reports that it's received communication from José Serrano, (Cordova's boss) that says Ecuador still plans to charge the WFT. Silvia's piece does a good job in presenting the whole story, and adds links to relevant articles about the whole issue. Recommended reading.

So what's going on here? For a start, we're one week before a key election in Ecuador. This means that the gov't may be acting politically to shore up support amongst those who oppose mining in the country and might change their referendum vote to "no" on the 28th because of the whole issue. Or in other words, anything said by the Studmuffin gov't right now needs to be taken with a pinch of salt. Words words words.....this is LatAm! Gimme a signed piece of paper, then you have my real attention.

More importantly, as José Serrano seems to have pointed out in his mail to Silvia, the windfall tax is not a law that is controlled by the mining (and petroleum) ministry. It is strictly a fiscal law that comes from the taxation sector of Correa's government. Therefore Cordova can say what he likes about a WFT being bad or good in Mongolia. Serrano can, too. It's not up to them.

My feeling is that the truth lies somewhere in between the two positions. The WFT is not part of the new mining law (due out in October) but I'm pretty sure that the WFT will make it to the legislative books in Ecuador as part of the new fiscal package. However the practical application of the WFT is the most important part of all this. The WFT is slated as to be applied on a case-by-case basis, which means miner X may well end up paying more than miner Y, and for myriad reasons.

Also, the WFT is applied to a base case price for the metal, and that is open to adjustment from the mining ministry (presumably in conjunction with Studmuffin Correa himself). This means that if Ecuador so decides, it can say "Ok minerguys, if gold goes above $950/oz, or if copper goes above $3.50/lb you pay the WFT", but it could also say "Ok minerguys, no need to worry about the WFT until copper breaks $4.50/lb and gold's at $1,100/oz."

To sum all that up
1) Let's wait til after the 28th to find out the real story.
2) Let's see what the new mining law brings.
3) Even then, the mining law doesn't control the WFT.
4) And even when the gov't says "yes, we'll apply the 70% WFT as planned", the whole thing is still open to wide-ranging interpretation.

The bottom line is that anyone who expects the next few weeks will bring total closure on the market doubts about the future Ecuador's mining industry is going to be disappointed. I am confident that the whole package will be resolved in way that's fair to both sides at some point in the future. Just don't ask me 'when', ok?