Does rising country risk threaten mining investment in Queensland?

Nick Rees, Co-Founder & Managing Director, Bridgend Capital Advisory

"A Cottager and his wife had a Hen, which laid every day a golden egg. They supposed that it must contain a great lump of gold on its inside and killed it in order that they might get it, when, to their surprise, they found that the Hen differed in no respect from their other hens. The foolish pair, thus hoping to become rich all at once, deprived themselves of the gain of which they were day by day assured.”

From Aesop's Fables translated by George Fyler Townsend, 1867

Mining is a highly capital-intensive business, and as a result, it requires a long-term lens on investment and capital return decisions and a stable policy and regulatory backdrop to enable efficient long-term capital management through commodity price cycles. The intense capital demands of mining emanate from the large up-front development capital required for mining projects and associated infrastructure, as well as the ongoing working capital and sustaining capital needed for day-to-day operations.

Government policy drives growth - or slows it

Over time, the Australian natural resources industry has leveraged an enviable resource endowment, world-class technical skills, an experienced labour market, entrepreneurial spirit and strong government support to become one of the world’s largest commodity exporters.

This growth has come with an historical dependency on offshore capital markets to meet the significant capital demands, with investors very much aligned to an understanding of Australia’s risk profile in these important supply chains.

For Australia’s natural resources industries to continue to flourish and safeguard the country’s economic prosperity, there is a requirement for stable government policy settings that are genuinely supportive of the industry, well understood by investors with the conviction to make long-term investment decisions, and as a result, conducive to the attraction of long-term global capital on competitive terms.

Where adverse changes in government policies create headwinds, as we have seen in recent years, these erode Australia’s competitive advantage in a global market, heavily competing for economic and human capital to develop new projects.

A big call from the Big Australian

For the first time in its 65-year history, the World Mining Congress was held in Australia in June 2023. Brisbane played host to this triennial gathering of the global mining industry that brought together thousands of delegates from more than 70 countries to address the many challenges and opportunities the industry now faces.

The event began in the usual fashion, with official welcomes from congress conveners and government representatives, including Queensland Premier Anastasia Palaszczuk. However, as BHP’s Chief Executive Mike Henry took the stage for the opening plenary session, delegates were to hear firsthand the continuing fallout from the Queensland Government’s unprecedented increase in coal royalty rates the previous year. Reflecting on both the unreasonable financial impact of the changes, and a decision devoid of industry consultation, Henry announced that BHP would no longer invest any growth capital in Queensland under these conditions.

While the Queensland Government was quick to brush aside this critique, the sobering reality of the damage done to Queensland’s standing as a preferred destination for mining capital investment was not lost on anyone attending. To have the Chief Executive of the world’s largest and most respected mining company announcing at a global industry gathering that his company would no longer invest in Queensland cannot easily be downplayed or ignored.

Regrettably, this royalty rate increase is not an isolated example but just one in a series of actions and policy shifts by State and Federal governments in recent years that have ‘shifted the goalposts’ for existing investments and risk eroding confidence in Australia as a stable and supportive jurisdiction for long term capital deployment.

Some other such examples include:

1. Energy Price Relief Plan

In December 2022, the Federal government announced what was euphemistically titled its ‘Energy Price Relief Plan’ but was, in fact, the most significant regulatory intervention into domestic coal and gas markets in living memory.

An arbitrary cap of A$12 per gigajoule (GJ) was unilaterally imposed on the East Coast domestic wholesale gas market by the Federal government, together with the imposition of a punitive mandatory Gas Code.

Meanwhile, the NSW and QLD governments used existing powers or amended legislation to cap coal prices for domestic thermal coal supply at A$125 per tonne. The NSW government went further in requiring coal producers – even those not supplying the domestic market – to reserve up to 10% of production for domestic use.

These are actions sometimes seen in developing countries, not mature developed free-market economies such as Australia. There is an old adage that ‘the best cure for high prices is high prices’, meaning that as the price for a commodity increases, the high price leads to demand destruction (for example, via substitution) or the economic enticement to new supply, in either case leading to a reduction in prices. This is foundational to supply/ demand economics.

Market interventions like this in the form of price caps may serve some short-term economic or political purpose but are counter-productive in the long term by increasing market demand while at the same time reducing the incentive to add new supply through investment in exploration and development activities.

2. Safeguard Mechanism

In March 2023, the Federal government amended the national ‘Safeguard Mechanism’, which applies to some 215 mining, oil and gas, manufacturing, transport and waste facilities nationally that each emit more than 100,000 tonnes of carbon dioxide equivalent each year. Notably, approximately one-third of these facilities are in Queensland.

The changes set legislated targets, known as baselines, on the net emissions from Safeguard facilities to drive progressive emissions reduction from Australia’s largest industrial facilities in line with Australia’s 2030 emission reduction target and commitment to net zero by 2050.

While the government has made some support available for emissions reduction activities and for trade-exposed industries, the Safeguard Mechanism will impose a growing cost burden on many mining, oil and gas, and metal processing and refining operations, especially those with difficult-to-abate emissions.

At a time of high inflation, where rising costs already cause significant pressure, these additional compliance costs will further erode profitability and returns on capital and likely lead to early closures. The government makes it clear that the progressive adoption of ‘industry average emissions intensity values’ is designed to “provide an incentive for production to occur where emissions are lowest”, meaning there will be winners and losers.

3. Cultural Heritage Protection

In the wake of the tragic destruction of the Juukan Gorge rock shelters in the Pilbara region of Western Australia in May 2020, the Western Australian government enacted a new Aboriginal cultural heritage protection regime, which was to commence in mid-2023. However, after widespread backlash from landowners, farmers, explorers and even some Indigenous groups, the government acknowledged the new legislation had gone too far and was too prescriptive and complicated. Just five weeks after taking effect, the planned repeal of the Act was announced.

The sequence of events highlighted not only the complexity of these issues and the difficulty in striking the right balance but also the potential for unintended consequences from regulatory overreach or Pavlovian policymaking.

4. Workplace Relations Reform

Much has been written about the Federal government’s sweeping workplace relations reforms omnibus bill currently before parliament. While some uncontentious elements of the bill enjoy broad support from government, unions and businesses, many proposed changes raise serious concerns across the mining industry, particularly in areas such as casual employment, labour hire and ‘same job, same pay’ provisions.

Far from being modest reforms to ‘close loopholes’, the Minerals Council of Australia has highlighted the risks the proposed changes present to the industry in reducing labour market efficiency and increasing the risks and costs associated with routine commercial arrangements.

BHP notes the proposed changes “will disincentivise the creation of permanent jobs by locking in workforce costs at highest common denominator rates set in peak market periods”, “fails to recognise the positive role of performance-based pay or incentive arrangements” and could cause “increased risk of industrial disputation”.

So, what does this all mean?

While there will naturally be a range of views on each of these government policies, and some may feel certain policies are necessary or justified, the more significant issue confronting the natural resources industry is the cumulative effect of these policies in increasing complexity and costs, reducing profitability, discouraging new investment, and eroding confidence in Australia as a competitive and stable jurisdiction for investment.

Within global financial markets, this issue is described as ‘country risk’. While some use the term ‘sovereign risk’ when describing these effects, this is not strictly correct. Sovereign risk is the measure of risk that a government becomes unable or unwilling to meet its loan obligations - not a relevant consideration here. More aptly, ‘country risk’ is a measure of the collective risks of investing within a country, arising from possible changes in the business environment, including government policies and regulations, that may diminish profits or asset values, especially after investments have already been made.

In extreme cases, country risk may manifest as resource nationalism, a term used to describe the actions of governments to assert increasing control over resource assets, or as expropriation (compulsory seizure) of natural resources projects.

There is emerging evidence that Australia’s reputation has been damaged. For the first time, the perception of rising country risk for mining sector investment in Australia is now factoring into boardroom and investment committee decisions around the world. Several examples illustrate this point.

BHP and the Minerals Council of Australia

Responding to the Federal government’s proposed workplace relations changes, BHP observed that the resulting unsustainable cost pressures “will further erode Australia’s competitiveness as an investment destination”. Speaking on the same subject at its annual dinner in Canberra in September 2023, Minerals Council of Australia Chief Executive Tania Constable noted, “At a time when Australia needs more investment to unlock this exciting next chapter, these changes added to other policies – environment safeguards and energy – will push much sought-after capital to other shores.”

Japan’s Ambassador to Australia

In a rare public excoriation during a speech at the University of Queensland in July 2022, Japan’s then Ambassador to Australia, Mr Shingo Yamagami, addressed the Queensland government’s coal royalty changes, stating, “Make no mistake, this is a huge shock for Japanese companies. The future of the successful partnership between Japanese businesses and Queensland, as a competitive investment destination could be at great risk. What concerns me is the damage that it could deal to this trust and goodwill that Japanese business has built up with Queensland over the years. Some Japanese companies are already questioning whether Queensland will continue to be the safe and predictable place to invest that they had known for decades. I fear that this may have widespread effects on Japanese investment beyond the coal industry.”

It is no exaggeration to say that Queensland would not have the coal industry it does today without the foresight, commitment and investment from Japanese companies over the past six decades. Japanese investment and commodity offtake agreements laid the foundation for the opening up of the Bowen Basin coalfields, as it did for iron ore from Western Australia’s Pilbara region and LNG from the North West Shelf. The concerns this key partner and friend of Australia expressed must not be brushed aside.

Fitch Ratings Agency

In assessing the implications from government intervention in the coal and gas market, global ratings agency Fitch noted in December 2022 that “the caps highlight that energy companies face mounting political risks that could influence investor perceptions of the sector and capex plans over the long term.” It went on to explain that “mounting political risk may influence investors’ perceptions of the sector, and therefore the terms on which companies are able to access finance. This could also have ramifications for M&A plans or long-term capex strategies.” It is quite extraordinary to see a global ratings agency refer to mounting political risk in Australia.

Fraser Institute Mining Survey

The Fraser Institute is an independent, non-partisan policy think-tank headquartered in Vancouver, Canada. Each year, it conducts a highly regarded ‘Annual Survey of Mining Companies’ to assess and rank the relative attractiveness of global jurisdictions for mining investment. In its latest 2022 survey, Australia still ranked very highly, with three states or territories – Western Australia, Northern Territory and South Australia – ranking in the top ten on the Investment Attractiveness Index.

A key component of this Index is an assessment of geologic attractiveness, for which Australia rates very highly. The other key component is the Policy Perception Index, a composite index that assesses the effects of government policies. On this measure, the latest survey reported an alarming decline for Queensland from an index score averaging 80 in the four years prior to 67.8 in 2022, placing the State in 28th place of the 62 jurisdictions surveyed. This compares to a score of 96 for South Australia and 87 for Western Australia, which is lower than seven key mining jurisdictions in Canada and all the jurisdictions surveyed in the United States other than California.

Over 30% of survey respondents stated that the taxation regime in Queensland (which includes royalties) would be a strong deterrent to investment (13%) or would prevent any investment (19%). This stands in stark contrast with Western Australia (10%), New South Wales (6%) and South Australia (0%). The next survey may well see further deterioration.

Where do we go from here?

It may be tempting –especially for governments – to believe these trends do not matter. This can be a view only held by those who do not understand the confluence of economic, geologic and political conditions and incentives that have given rise to the remarkable growth of Australia’s mining industry over the last 100 years, and those conditions required to sustain it well into the future.

Resource-related projects represent long-term capital investment decisions that need stable and predictable government policy and regulation.

While overall, Australia’s country risk assessment remains very low in comparison to most other global mining jurisdictions, the natural resources industries in Australia are highly capital-intensive and substantively dependent upon foreign direct investment – not only for the equity required for project development but increasingly for debt capital too as Australian banks withdraw support for the industry. Global capital is fluid. Investors have myriad options available globally for capital allocation, including into other industries such as infrastructure, renewables and technology.

As the natural resources industry in Australia continues to see strong demand for key commodities—iron ore, coal, LNG, gold, and base metals—and prepares for future demand for new commodities like lithium arising from the global energy transition, engagement with government has never been more important to ensure a return to stable and supportive policy frameworks in which capital providers may restore conviction.

Hand in hand with this is the perennial need to highlight more broadly to the voting community the critical role the industry plays in safeguarding Australia’s economic prosperity to the benefit of all.

For the first time, the perception of rising country risk for mining sector investment in Australia is now factoring into boardroom and investment committee decisions around the world.

For companies and project sponsors seeking capital, the headwinds created by government policies can be countered somewhat with closer stakeholder engagement with capital providers, broadening of capital sources, more robust economic modelling and structural protections, and increased lead times to secure capital, alongside efforts to encourage a return to stable and supportive long-term policy frameworks.

For the resources sector to flourish requires government policy settings that are genuinely supportive of the industry and conducive to the attraction of global capital. In Queensland, especially, there is clearly much work ahead to repair and restore its reputation.

It is not too late

The Hen which lays the golden eggs might yet be spared, and let's hope it is. Australia’s future economic prosperity, global energy security, and collective hopes of achieving energy transition all depend upon a thriving and well-supported natural resources industry in Australia.