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Opportunity at Risk

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Opportunity at risk

Regaining our competitive edge in minerals resources
report commissioned by and prepared for the Minerals Council of Australia

September 2012

port JackSon partnerS

Opportunity at risk

Regaining our competitive edge in minerals resources
report commissioned by and prepared for the Minerals Council of Australia

September 2012

port JackSon partnerS

Port Jackson Partners is a consulting firm providing advice to CEOs, boards and senior managers to help set corporate direction, define business strategies and develop their organisations. The firm was founded in 1991 by two former Directors of McKinsey & Company and has grown over the past two decades into one of Australia’s most respected strategy consulting firms. the Minerals council of australia is the peak national body representing Australia’s exploration, mining and minerals processing industry, nationally and internationally, in its contribution to sustainable economic and social development. The views expressed in this publication are those of the authors. This publication forms part of the overall program of the MCA, but does not necessarily reflect the position of the organisation. Photographs © Glenn Campbell 2012 (glenncampbellspictures.com) ISBN 978-0-9872897-1-1 MINErAlS COuNCIl Of AuSrAlIA level 3, 44 Sydney Ave, forrest ACT 2603 (PO Box 4497, Kingston ACT Australia 2604) P. + 61 2 6233 0600 | f. + 61 2 6233 0699 W. www.minerals.org.au | E. [email protected] Copyright © 2012 Minerals Council of Australia. All rights reserved. Apart from any use permitted under the Copyright Act 1968 and subsequent amendments, no part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of the publisher and copyright holders.

CONTENTS |

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Foreword executive summary 1. the opportunity: grow volume to capitalise on developing world transformation 2. the challenge: declining competitiveness as rivals multiply 2.1 We are losing the battle for market share 2.2 We are no longer cost competitive 2.3 rivals are emerging, aided by policy reform, new technologies and new investors 2.3.1 Improved policy settings are creating more attractive investment climates 2.3.2 New technologies are aiding development of new resources 2.3.3 New investment models are supporting new competitors 2.4 Across key sectors, many Australian projects are now under threat 2.4.1. Iron ore: only the Pilbara remains competitive 2.4.2 Coal: many thermal coal projects at risk 2.4.3 Aluminium and bauxite: missing a new export opportunity 2.4.4 Copper and nickel: future uncertain 3. Failure to respond places enormous benefits at risk 4. We need a co-ordinated approach to regain our competitive edge 4.1 Build recognition of the need for change 4.1.1 Shift the national dialogue towards the opportunity and benefits at risk to strengthen the appetite for reform 4.1.2 Match others in acknowledging a home-grown gap in competitiveness 4.2 Immediately address cost pressures on current operations and projects 4.2.1 Mobilise all available skilled labour to stop wage cost super-inflation 4.2.2 Ensure unfettered access to globally competitive suppliers 4.2.3 Ease exchange rate pressures 4.3 regain world leading competitiveness through a new program of structural reform 4.3.1 Grow ample skills by building university capacity and technical training completions 4.3.2 Maximise innovation dividends to enable productivity gains 4.3.3 reorient the workplace relations framework towards deals that reward more output with more pay 4.3.4 Align owner and user interests to optimise infrastructure investment 4.3.5 reform approvals and commit to stable resource taxation to lower government risk 5. conclusions appendix: modelling the economic impact of a lost opportunity A. The analytical framework A.1 BAEGEM A.2 BAEGEM database B. Scenario characteristics

7 9 17 23 23 25 28 28 29 30 31 31 33 35 36 41 49 49 49 51 52 52 57 58 58 60 62 64 65 68 75 77 77 77 78 80

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Foreword
Over recent years, the Minerals Council of Australia (MCA) has warned of the structural deficits in our economy that have been masked by historically high terms of trade. As the value drivers of the “mining boom” shift from price-led to volume-led growth, Australia is increasingly vulnerable to competition from resource-rich emerging economies. Our country’s attractiveness as a place to do business in a highly globalised industry is slipping due to a combination of rising costs, declining productivity and a deteriorating sovereign risk reputation. With commodity prices having fallen from peak levels, complacency and backsliding on economic reform pose a real threat to the minerals sector and to the wider economy. We commissioned this report from Port Jackson Partners to gauge the extent of the industry’s exposure, the opportunity cost of declining competitiveness and the policies needed to regain Australia’s position as a premier global supplier of minerals. The report is a wake-up call for those who think our mining and minerals processing sector is so resilient it will thrive regardless of the prevailing economic and policy climate. It is the most detailed panorama yet painted of the burgeoning cost environment in Australia, our deteriorating reputation as a place to do business and the threat this poses to our ability to capture market share and future investment. Within highly-competitive global markets for thermal and coking coal, copper and nickel, more than half of Australia’s mines now have costs above global averages. Even in iron ore, Australia has lost its operating cost advantage for all but established Pilbara projects. The report demonstrates that Australia is losing global market share to rapidly emerging resourcerich economies. Added to that, a policy focus on the redistributive rather than the productive side of the economy has been pivotal to undermining our competitiveness and attractiveness to investment. But there is an antidote. As is our signature card, we asked Port Jackson Partners to not only identify the problem, but also the policy solutions in order to test alignment with the MCA’s own policy advocacy. The report clearly sets out the road map for reform which, it is argued, must begin with the recognition of our eroding structural competitiveness – what the report describes as our ‘burning platform’. The prize for getting the framework for minerals resource development right is immense, but it will take hard work from both industry and government to secure the economic opportunity that is currently at risk. mitchell H. Hooke chief executive officer, minerals council of australia September 2012

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Executive summary
The developing world’s economic transformation continues to offer sustained demand growth for Australia’s commodity exports.
The fundamental drivers of minerals demand growth, urbanisation and industrialisation, will exist for the next 20 years or more. Neither weaknesses in developed world economies nor a temporary deceleration in China will dampen these long-term trends. for Australia, maintaining our current minerals market shares would add $121 billion per annum to resource sector revenues by 2031. This is a 65% increase for a sector already twice the size it was in 2006. The benefits of this growth would be large and widespread. Since the onset of China-led developing world growth, demand and price have grown simultaneously. Between 2003 and 2011, iron ore exports more than doubled, as did the price we received. This will not last; a significant supply side response already underway will lead to price stabilisation or declines in coming years. As a result, Australia cannot bank on continued commodity price increases. In the future, growth in export revenues will come from bringing new low cost brownfields and greenfields projects on stream. Does this mean the mining boom is over? No; but its dynamics have changed and its policy demands are greater and more urgent. Before, higher prices underwrote higher revenues. Now, Australia must do the hard yards of volume growth in order to grow (or even maintain) market share and capture our share of future investment and revenue potential. low cost volume growth has been our strength, but a repeat of our past success cannot be assumed. large market share gains over earlier decades have been replaced by stagnation or share losses – we have lost our competitive edge. Crucially, this has happened at a time when Australia’s competitors are increasing in number and quality.

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This trend reflects basic industry fundamentals. At our existing operations, Australia’s cost position is declining. Within highly competitive markets for thermal coal, coking coal, copper and nickel, more than half of Australia’s mines have costs above global averages. Even in iron ore, we have lost our operating cost advantage for all but established Pilbara projects. Increased labour, energy and transport costs have all played a part. labour costs, the primary driver of minerals industry cost structures, are growing much more quickly than the national average. They are now amongst the highest in the world. An unnecessarily high exchange rate due to a failure to run sustained budget surpluses is also part of the story. rising capital costs mean our new projects are also less competitive. for example, only five years ago we could build coal and iron ore projects as cheaply as our competitors. Capital costs, however, are rising more rapidly here than in the rest of the world. Now, Australian iron ore projects are 30% more expensive than the global average. for thermal coal, the figure is 66%. This structural cost competitiveness problem – what we characterise in this report as our ‘burning platform’ – is playing out in different ways in each commodity sector. Even in sectors where we have traditionally been strong, the picture is worrying. • In thermal coal, the majority of the project pipeline is at risk. ranked by price needed for investment, the most attractive projects are overwhelmingly in other countries. The proportion of Australia’s production in the lower half of the cost curve has fallen from 63% to 28% since 2006 and only 15% of potential capacity falls into this category. Poor economics are exacerbated by project delays which have been increasing over the past decade. Each year, the completion date of the average Australian thermal coal project is delayed by a further 3-4 months. • In aluminium, there are few prospects for growth. We cannot compete in processing

given estimated capital cost advantages (between 60% and 80%) enjoyed by Chinese and Indian producers. While capital costs in the Middle East are only 25% cheaper than in economies such as Australia and Canada, projects there are underpinned by cheap energy. We are also failing to capture the inevitable implication of this trend in processing: rapidly growing bauxite exports to China. This opportunity is being captured by Indonesia. • Even in iron ore, we have lost our operating cost advantage for all but the established Pilbara projects, with new projects facing rapidly escalating capital costs. By 2020, Australian projects beyond the Pilbara are forecast to have higher delivered costs than benchmark Brazilian producers, and will cost up to 75% more to build than projects in West Africa. • copper and nickel projects are also under great pressure based on deteriorating cost profiles. In both metals, nearly half of Australia’s production is now in the most expensive 25% of mines globally. As an example, the flagship Olympic Dam project has been deferred, at this stage indefinitely, while BHP Billiton attempts to address capital cost pressures. Australia’s projects have become less attractive just as new, strong rivals have begun emerging. Previously untapped resources in the developing world are rapidly coming on stream. These new competitors are strengthened by improved policy settings, new technologies and new sources of capital. like Chile and Peru before them, new competitors including the Democratic republic of the Congo (DrC), Mongolia and Mozambique are developing (and in some cases reviving) minerals industries by improving their institutions. In uranium, new technologies and new investors have transformed Kazakhstan into a strong challenger to Australia’s previously dominant position. The lesson is clear: Australia needs to compete with more diverse and increasingly sophisticated

ExECuTIvE SuMMAry |

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rivals, often with highly competitive cost structures. The easy assumption that we will inevitably be a competitive minerals supplier and the location of choice for new investment because of our natural endowment can no longer be sustained. To understand both the scale of the economic opportunity at risk and the potential for policy settings to have a negative impact on Australia’s competitiveness as a supplier of mineral resources, BAEconomics was asked to model two economic scenarios: • Competitive Edge (the Competitive scenario) and • Headwinds to Growth (the Headwinds scenario). The opportunity lost under the Headwinds scenario is very large. Policy decisions made now can create or destroy an economic opportunity equal to more than 5% of the Australian economy in 30 years, with lower minerals industry growth quickly translating into poorer economic performance. The modelling suggests that, without improvements in our competitiveness, real GDP in 2040 is 5.3% lower than it would be under the Competitive scenario. That equates to a reduction in income relative to that scenario of more than $5,000 per person in today’s dollars. Compared with the Competitive scenario, real wages are lower by 6.3% under the Headwinds scenario. The modelling confirms this report’s sector-bysector risk assessment: • coal is particularly affected under the Headwinds scenario. Growth in coal export volumes slows and almost stops. By 2040, coal exports are down 37% relative to the Competitive scenario. • iron ore growth persists, consistent with the view of this report, but by 2040 exports under the Headwinds scenario are 21% lower than they would have been under the Competitive scenario. regaining our competitive edge will require an immediate and coordinated effort to overcome complacency and address what is a structural (and

The easy assumption that we will inevitably be a competitive minerals supplier and the location of choice for new investment because of our natural endowment can no longer be sustained.

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not merely cyclical) competitiveness problem. This report recommends a series of initiatives under three broad headings. first, the need for change in the minerals sector must be recognised. In order to build this recognition we should: • shift the national dialogue on mining towards the opportunity and benefits at risk in order to strengthen the appetite for reform. At present, the national dialogue on the mining industry focuses primarily on how to distribute the earnings of the minerals sector, not on actions needed to ensure those benefits continue. for example, we need a more open discussion of the magnitude of the risks to the current investment pipeline. In reality, 75% of all projects included in the Bureau of resources and Energy Economics (BrEE) major projects list remain uncommitted. • Match competitors in acknowledging a home-grown competitiveness problem. Other established minerals producers have acknowledged the importance of minerals sector competitiveness and are taking the need for long-term reform seriously. Canada has announced plans for a ‘one project, one review’ approvals process; Chile is driving innovation in state-of-the-art mining techniques; and Brazil has announced plans to modernise its regulatory framework to encourage investment. second, we should immediately address the cost pressures on current operations and projects. This will require us to: • Mobilise all available skilled labour, including importing critical skills, to stop labour cost super-inflation. A large and persistent shortage of skilled labour has resulted in rapid growth in minerals sector wage costs. Construction wages, for example, grew at 9% per annum between 2001 and 2011. Policy settings must ensure every step is taken to attract suitably skilled labour into minerals employment with skilled immigration in particular being a necessary element.

• ensure unfettered access to globally competitive suppliers. To remain competitive, Australian projects must have access to the most competitive supplies of inputs, including fuel, materials, equipment and consumables. To take one example, diesel contributes up to one quarter of mine operating costs and any move to scrap the diesel fuel tax offset would impose cost increases of 4-7% on typical minerals projects. • increase national savings to ease exchange rate pressures. While Australia’s higher terms of trade is in part responsible for the strong dollar, structural budget surpluses would reduce upward pressure on inflation, interest rates and the Australian dollar. finally, we should set about regaining worldleading competitiveness through a new program of long-term structural reform. To accomplish this we will need to: • Grow ample skills by building university capacity and lifting technical training completions. This requires increasing enrolments in minerals-related higher education and improving course quality, providing additional support to boost completion rates in key trades and better matching school leavers to trade apprenticeships that align with their aptitudes. • Maximise innovation dividends to enable productivity gains. Australia tends to get fewer rewards from innovation effort compared with other economies. With competitors stepping up their efforts to attract investment in innovation, more needs to be done to boost returns from our minerals innovation spend. • reorient the workplace relations framework towards ‘win-win’ deals that reward more output with more pay. The fair Work Act needs to be reworked to encourage direct, collaborative relationships between the employee and the employer. • align owner and user interests to optimise infrastructure investment and operation. reforms are needed in the area of multi-user

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infrastructure chains to maximise throughput, particularly as existing infrastructure comes under pressure from increased volumes. • reform approvals processes to reduce delays and lower costs. Project delays inhibit our ability to compete for new market opportunities and rapidly erode incentives to invest. In thermal coal, for example, the average Australian project experiences an additional 1.3 years of delay relative to those elsewhere. Clear and predictable rules and timeframes for approvals are essential. • lock in stable and internationally competitive tax and royalty arrangements. The resource Super Profits Tax (rSPT) debate damaged Australia’s reputation on tax. To restore investor confidence to previous levels, governments in Australia should commit to stable and competitive tax and royalty regimes. regaining our competitive edge in minerals resources will require immediate and coordinated action, as well as a new program of structural reform and renovation for the long term. We must first acknowledge the burning platform outlined in this report and, in the process, recognise the opportunity for growth and higher national living standards which is at risk. It is important to remember that many of Australia’s minerals resources are of high quality and well located to serve this century’s growth markets. If we get their development right they will deliver enormous benefits to Australia. Getting it right means delivering new volume from projects that are more attractive to investors than those of our rapidly proliferating competitors. right now, we are not well positioned to grow market share or to attract the next wave of investment. Without action to restore Australia’s competitiveness, a huge opportunity will be lost. ■

Without action to restore competitiveness, a huge opportunity will be lost.

tHe opportunity: groW volume to capitaliSe on developing World tranSFormation

1

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THE OPPOrTuNITy: GrOW vOluME TO CAPITAlISE ON DEvElOPING WOrlD TrANSfOrMATION |

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SECTION 1

The opportunity: grow volume to capitalise on developing world transformation
The continued urbanisation and industrialisation of the developing world will drive future minerals demand growth for decades. Over the next 20 years, demand for key minerals will increase by between 50% and 200%. Minerals demand growth is an inevitable consequence of economic development. Historical patterns suggest that demand for minerals and metals grows together with income growth from about $2,000 per capita to $10,000-$15,000 per capita, as witnessed by phenomenal growth in China’s demand for iron ore over the last decade. Although China’s urbanisation must slow, other nations and other commodities will increasingly contribute to demand growth. India, for example, is moving into the most resource intensive phase of its development. In time, parts of South East Asia, South America and Africa will play an increasing role. And while growth in iron ore demand slows as basic infrastructure is developed, there is likely to be new growth in demand for products such as copper, aluminium and other minerals and metals as consumers demand more sophisticated products.

Minerals Resource Demand Growth
demand elasticity for iron ore
Change in consumption/change in GDP per capita 3.0
2010

australia’s revenue potential
2010 A$ Billions per annum*

china 2030 india 2030

$119b

309

2.5 2.0

2010

278
$1b

244 190

188 1.5 1.0 0.5 0
$93b

95

0

10

20

30

40

50

2006

2011f

2016f

2021f

2026f

2031f

* Includes: iron ore, metallurgical coal, thermal coal, alumina, aluminium, nickel, copper, gold, uranium and other hard commodities Source: ANZ Insight, Issue 1; PJPL analysis

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Demand Elasticity for Key Hard Commodities
Change in consumption/change in GDP per capita 3.0

2.5

2.0

1.5

1.0

iron ore aluminium copper nickel electricity (proxy for coal and gas)*

0.5

0.0 0 5 10 15 20 25 30 35 40 45 50 gross domestic product per capita 2010 uS$ Thousands at PPP rates

* recognising that overall demand is driven by total energy demand Source: ANZ Insight, Issue 1; PJPL analysis

Continued growth of Australia’s minerals sector depends on bringing new low cost brownfield and greenfield expansions into production.

Growing global demand could underpin Australia’s minerals sector for many years. If Australia can maintain market share through the next two decades, the country’s minerals revenue could increase by $121 billion per annum by 2031 – a 65% increase for a sector already twice the size it was in 2006. Capturing this potential depends on out-competing our rivals for new projects. Between 2006 and 2011, price increases contributed $44 billion of Australia’s $93 billion in minerals

revenue growth. In coking coal, for example, prices increased 80% between 2006 and 2011. Even without any additional volume, annual coking coal revenues would have increased by $14 billion per annum. volume growth contributed an additional $10 billion per annum in revenues. However, current high prices have created the impetus for a significant supply response from both existing and new producers. Over time, prices will fall as supply catches up with demand. In the long run, prices around

THE OPPOrTuNITy: GrOW vOluME TO CAPITAlISE ON DEvElOPING WOrlD TrANSfOrMATION |

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Drivers of Revenue Change – 2006 to 2030
2010 A$ Billions; bubbles indicate total revenue change

2006–2011

2011–2016

2016–2031

$93b

$1b

$119b
109

44

49
revenue decline through lower prices assuming no volume growth

53

10
Extra revenue through volume growth revenue benefit Extra revenue of increased through volume price assuming growth no volume growth

revenue benefit Extra revenue of increased price through volume assuming no growth** volume growth*

(52)
* Calculated by multiplying 2006 volumes by the change in prices between 2006 and 2011 ** Difference of total revenue increase between 2006-2011 ($93b) and revenue benefit of increased prices assuming no volume growth ($44b) Source: PJPL analysis

the costs of the most expensive suppliers can be expected. In most commodities, this is much lower than current prices. under these circumstances, continued growth of Australia’s minerals sector depends on bringing new low cost brownfield and greenfield expansions into production. ■

Competition for new minerals investment worldwide is intense.

tHe cHallenge: declining competitiveneSS aS rivalS multiply

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THE CHAllENGE: DEClINING COMPETITIvENESS AS rIvAlS MulTIPly |

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SECTION 2

The challenge: declining competitiveness as rivals multiply
Competition for new minerals investment is intense. Australia’s resource endowment alone will not guarantee market share or ongoing investment. We must also remain cost competitive to secure our share of new projects. unfortunately, Australia’s competitiveness is declining, just as the number of our rivals is increasing.

2.1 We are losing the battle for market share
from the 1960s to around 2000, Australia was a highly successful competitor for mineral sector investment. In iron ore, for example, Australia captured 35% of global demand growth between 1965 and 2000. In the smaller but still significant bauxite market, Australian assets contributed nearly 50% of all production growth between 1960 and 2000. Over the same period,

Australia also gained substantial market share in uranium, nickel, gold, coal and copper. At the present time, however, Australia is losing the battle for market share. While volumes have grown in important commodities, our market shares are at best stagnant, and in some cases declining. In bauxite, for example, Australia’s production has grown at only half the rate required to hold share. Iron ore is the only major mineral in which

Australia’s Market Share of Global Production
Change in market share, percent of world production

1960 to 2000 – substantial share gains
Bauxite uranium Iron ore Nickel Gold Coal* Copper 5% 4% 8% 15% 15% 13% 38%

2000 to 2010 – share loss or stagnation
(7%) (8%) 1% (3%) (1%) (1%) (1%)

* Includes bituminous and anthracite, lignite and brown coal Source: US Geological Survey Minerals Yearbook; British Geological Survey World Minerals Statistics; BP Statistical Review of World Energy; ABARE

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Australia increased its market share over the last decade, and did so by only 1 percentage point. Two important indicators of our competitive strength and the mining investment environment are also in decline.

Since 2003, overall productivity in the minerals sector has fallen by 30%.

first, mining industry productivity has fallen markedly and is now well down from historical highs. Australia’s minerals sector last delivered a productivity increase in 2003. Since that time, overall productivity in the minerals sector has fallen by 30%. New capacity currently under construction is about to come on stream. When this occurs, measured productivity will likely improve. yet others have delivered growth without sacrificing productivity to

anything like the same degree. Canada has mature resources and its minerals industry is in the midst of a massive investment boom – mining investment has risen from just C$2.5 billion in 2002 to almost C$16 billion in 2012.1 Despite this boom, productivity levels in Canada’s mining industry have held up comparatively well, with labour productivity declining by 17% and multifactor productivity by only 9% between 2001 and 2007. Second, Australia’s share of global exploration expenditure is falling. Throughout the 1990s, Australia consistently attracted close to 20% of global nonferrous metals exploration expenditure. This measure excludes the exploration activity needed to support ongoing iron ore operations.

Australia’s Mining Productivity
productivity growth
Percent, rolling five year CAGr 8% 6% 4% 2% 0% (2%) (4%) (6%) (8%) 2000 2002 2004 2006 2008 2010
Source: ABS; CSLS

multifactor productivity index
Index, 1997 = 100 140 130 120 110 100 90 80 70
labour Multifactor australia canada

60

0 1997 1999 2001 2003 2005 2007 2009 2011

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Australian and Global Non-Ferrous Exploration Expenditure
australia’s share of exploration (Percent) 25 exploration spend (uS$ Billions) 20 18 20 16 14 15
australia’s share of exploration expenditure (lHS) World exploration expenditure (rHS) australian exploration expenditure (rHS)

12 10 8 6

10

5

4 2

0

0



Source: Metals Economics Group, 1991-2009 data sourced from AusGeo News, March 2009

Since 2000, however, Australia’s share of exploration has fallen to around 13%. At a time when global exploration activity has grown strongly, this loss of share represents a considerable missed opportunity. It speaks directly to the relative weakness of Australia’s competitive position outside iron ore.

future prices and margins are uncertain, as they are today, cost competitiveness is crucial to attract investment. The evidence is, however, that Australia’s mining operations and projects are no longer as cost competitive as they once were. Our existing resource operations have become high cost. ranked against competing producers in the thermal coal, coking coal, copper and nickel markets, more than half of Australia’s mines have costs above global averages. for example, only six years ago, 63% of Australia’s thermal coal production fell within the first two quartiles of the global cost

20

2.2 We are no longer cost competitive
low cost operations have been the foundation of Australia’s competitive position. lower costs deliver higher returns under any conditions. But when

01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11

91

92

93

98

99 19

19

00

94

95

96

97

20

19

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19

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curve. In 2012, this has fallen to 28%. The picture is similar in coking coal. In copper and nickel, an already weak cost position shows no sign of improvement. In both metals, nearly half of Australia’s production is now in the most expensive 25% of mines globally. Even in iron ore, we have lost our operating cost advantage for all but established Pilbara operations. rising capital costs mean our new projects are also becoming less attractive. Globally, industry costs are rising for key inputs like labour, equipment, contracting services and raw materials. yet capital costs for projects in

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Competitiveness of Australian Mines – Cash Operating Costs
Percent of production by cost curve quartile, Mt of production; coal delivered to China; metals costs net of by-product revenue

thermal coal
152
3% 34% 66%

Hard coking coal
Quartile 1 Quartile 2

copper
Quartile 3 Quartile 4

nickel
0.47
31%

206
6%

89
25%

120
20%

1.76

2.14

0.48

37% 31%

48%

42%

45% 58% 29% 23% 47% 21% 6% 28% 25% 11% 6% 25%

32% 39%

38% 19%

2006

5%

2012

2006

2012

2005

2012

2008

2012

* Q1, Q2, Q3 and Q4 represent the percentage of total Australian production within the first, second, third and fourth quartiles of the global cost curve. Copper and nickel costs based on C1 cost ranking. Source: AME; Brook Hunt

Capital Spend to Build a Tonne of New Capacity
2011 uS$ per tonne of capacity

thermal coal 2011/2012
176

iron ore 2011/2012
195

150

2007 2007
73 106 96 100

61

rOW


Australia

rOW

Australia

rOW

Australia

rOW

Australia

Source: Bank of America Merrill Lynch; JP Morgan; company announcements; press reports

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Australia are rising faster than elsewhere. Only five years ago, the costs of Australian iron ore and coal projects were on par with our competitors. Australian projects are now at a distinct capital cost disadvantage relative to peers. Australian iron ore projects, for example, are currently 30% more expensive than the global average. The situation in thermal coal is worse; project capital costs are 66% above the global average. Australian projects are also more prone to delays which contribute to cost escalation, as well as increasing perceptions

of investment risk. These delays also inhibit our ability to compete for new market opportunities, an important factor in some commodities. In thermal coal, for example, the average Australian project experiences an additional 1.3 years of delay relative to those elsewhere (3.1 years compared with 1.8 for the rest of the world). Project delays in Australia have been increasing over the past decade, and the gap relative to other countries is likely to be higher now than it has been for some time.

Capital costs for projects in Australia are rising faster than elsewhere ...iron ore projects, for example, are currently 30% more expensive than the global average.

Project Delays – Thermal Coal Case Study
delays to australian thermal coal projects
Additional years of delay incurred per annum

total historic delays by geography – 2002 to 2011
Total delay from studies to completion, years

0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1

gFc effect – one off increase in delays of ~6 months project delays have been increasing over the past decade

3.1

1.8

0.0 2002 2003 2004 2005 2006 2007 2008 2009 2010

Australia

rest of world

* Average new delays in each year based on ABArE announced date – may differ from actual delays incurred/announced by operator Source: ABARE; Wood Mackenzie; PJPL analysis

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2.3 Rivals are emerging, aided by policy reform, new technologies and new investors
The discovery of new, high quality minerals provinces is inevitable. Many developing countries have been chronically underexplored, so it is not surprising that mining industry exploration expenditure is increasingly focussed on these nations. Although this broad dynamic is well known within the minerals industry, the speed and methods by which new rivals are emerging, and their quality when they do emerge, is not as widely appreciated. Three new factors are responsible.

Mongolia, for example, the World Bank actively influenced the development of the investment agreement for Oyu Tolgoi. Progressive elements of the investment agreement, including an interest bearing carried government equity stake repaid through project dividends, will see the Government of Mongolia and the project developer share the benefit of periods of high prices. There has also been an increasing research focus on the role of resources in the development of low income countries. Moreover, the lessons from decades of minerals sector reform are increasingly clear. Chile and Peru, for example, were able to revive their dormant copper industries through important investment reforms. The impact of the privatisation of Peru’s Antamina is telling. under government management, studies began at Antamina in 1973. fifteen years later, only 12km of diamond drilling had been completed, and estimated reserves were at 120 million tonnes. Eleven months after its privatisation in 1996, 118km of drilling had been completed and reserves were estimated at 500 million tonnes. The mine was operational by 2001, and is now the world’s third largest zinc and eighth largest copper mine.2 These improved policy settings are now catalysing the development of new resource

industries. The Democratic republic of the Congo, for example, is following in the footsteps of Peru and Chile. In 2002, the DrC implemented a new minerals code with the support of the World Bank. The code was based on best practice examples from other mineralsrich countries, including Chile, and provides a transparent framework for the exploration, development and mining of mineral resources.3 Political stability has improved, with the first multi-party democratic elections held in 2006. Copper production, which collapsed by more than 90% through periods of nationalisation and war, is quickly recovering. Similarly, after opening to investment during the 2000s, Mongolia and Mozambique are emerging as major new producers of coking coal. Guinea and other West African countries previously regarded as ‘off limits’ are working to bring projects capable of producing 400 million tonnes per annum of high quality iron ore on line over the next 15 years. Whilst operating in developing nations remains risky – there will be ‘bumps in the road’ for investors – it is now clear that these countries have steep growth trajectories.

2.3.1 Improved policy settings are creating more attractive investment climates
The broad ingredients needed to attract minerals sector investment are increasingly known and widely disseminated, facilitating the funding of new projects. Institutions such as the World Bank and the International Monetary fund routinely advise governments on the ingredients for competitive investment agreements. The World Bank’s model tax regime is responsive to periods of high and low prices, ensuring governments receive a fair share of price upside whilst still promoting new investment.  In

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Impact of Policy Reform on Copper Production
Production index, 1960 = 100 1200 1000 800
Peru Beginning of key reforms chile 1983 mining law reform delivered more competitive investment agreements

600 400 200
Zaire/drc

from 1991, privatisation and fDI reforms reinvigorated a dormant sector

World

0

2002 revision of mining code reversed 20 years of production declines

1960

1975

1990

2005

* DrC revised their mining code in 2002; Chile reformed mining laws in 1983; Peru privatised the copper industry and lifted fDI restrictions from 1991

The speed and methods by which new rivals are emerging, and their quality when they do emerge, is not widely appreciated.

2.3.2 New technologies are aiding development of new resources
New technologies are aiding the discovery of new resources and, in some resource sectors, lowering the production costs of large, low-grade ore bodies. A good example of this is in the uranium industry. New in situ leaching techniques have transformed the economics of new supply. The technique has made high carbonate Kazakh ores cheaper and quicker to bring on stream. Kazakhstan’s share of global uranium production has increased from 6% in 2000 to 30% today. A second example, albeit in a related sector, is the emergence

of horizontal drilling and fracking technologies. These technologies have revolutionised the uS gas market. As recently as 2003, it was widely assumed that America’s natural gas production was in decline and that it would have to begin importing lNG.4 Shale gas has since proven to be ubiquitous and cheap, and today accounts for 23% of uS natural gas production and 22% of uS proved reserves.5 At the current rate of consumption, uS gas resources are sufficient to supply 90 years of use. Consequently, lNG prices have been very volatile and at times very low. Some uS gas import terminals have been mothballed.

30 | Minerals CounCil of australia

Proliferation of Competitors Driven by New Technologies
Share of global uranium production
In situ leaching 35% 30% 25% 20% 15 15% 10% 5% 0% 1990


uS natural gas production
Trillion cubic feet per annum 30
kazakhstan

Jvs with russia, China and Japan

25 20
shale gas

australia

10 5

tight gas coalbed methane conventional

0 1995 2000 2005 2010 1990 2005 2020 2035

Source: World Minerals Statistics; Press search; Kazatomprom; EIA Annual Energy Outlook 2012

The Mongolian mining sector is another example of how new, more potent, competitors are emerging to challenge Australia. Advances in geographical information systems, satellite imaging and 3-dimensional visualisation programs have facilitated the exploration of previously inaccessible areas of Mongolia. The majority of exploration undertaken since the market was opened to investment in the early 2000s has relied on these techniques. The exploration of Oyu Tolgoi, one of the world’s largest copper deposits, was conducted primarily using remote sensing and geophysical methods. unmanned drones and robotic systems are expected to further improve exploration

effectiveness. 3D Mine Surveying International has introduced a remote surveying vehicle that conducts 3D surveys at a far greater rate than conventional methods and can operate in remote and dangerous environments.6

suited to bringing new minerals provinces into production. In many cases, investments are made through sovereign wealth funds which have long-term investment objectives well matched to minerals project timelines. Many such funds, particularly those from the Middle East, are vastly experienced in resource sector investment. Others, Chinese investors in particular, benefit from a model of investment that is at present uniquely effective in emerging resource provinces. finally, national governments with ambitions to develop their minerals sectors are becoming more active direct investors in new projects. At present, this

2.3.3 New investment models are supporting new competitors
Western capital markets have long been the predominant provider of capital to the minerals sector. This is unlikely to be the case in the future – Asian and Middle Eastern investors are set to become increasingly important sources of capital. Importantly, these investors have characteristics particularly

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occurs through equity interests purchased through deferred dividend streams. As the industries of these countries increase in size, however, this type of ‘bootstrapping’ will not be needed, and more conventional equity investment at higher ownership shares will occur. The oil industry is perhaps an indication of the logical end point for this evolution. National oil companies dominate reserves and production, and exert a high degree of control over the pace and timing of reserve development. These national companies have also benefited from new technologies. This has been enabled by oil industry service specialists, who typically develop and facilitate the application of new prospecting and drilling techniques. The lesson for Australia is clear: we need to compete with more diverse and increasingly sophisticated rivals, often with highly competitive cost structures.

2.4.1. Iron ore: only the Pilbara remains competitive
In iron ore, Australia has lost its competitive advantage in all but the best Pilbara developments. Australia’s iron ore industry is best considered in three groups: ‘Established Pilbara’, which includes the existing and future operations of miners with decades of experience in the Pilbara; ‘Emerging Pilbara’, which includes the post-2008 commercially producing operations of miners with less experience in the Pilbara; and ‘Non-Pilbara’ operations outside the northwest. If we are to hold and potentially grow share, projects from all three groups will be needed. Approximately 60% of projected growth in Australia’s iron ore production to 2020 will come from projects outside Established Pilbara. These three groups have starkly different operating cost positions. Measured by delivered cost into China, Established Pilbara operations, aided by low cost infrastructure and high quality resources, remain highly competitive. Most Established Pilbara operations are in the cheapest quartile of the global iron ore cost curve. Other projects are less well positioned. Based on current estimates, Emerging Pilbara and NonPilbara operations will be in the less attractive half of global projects. Non-Pilbara projects will almost exclusively be in the most expensive 25%.

We need to compete with more diverse and increasingly sophisticated rivals, often with highly competitive cost structures.

2.4 Across key sectors, many Australian projects are now under threat
The broad trends described above are playing out in distinct ways across Australia’s minerals industry. In some sectors, our highest quality projects remain likely to proceed and succeed. In others, comprehensive improvement is required to ensure successful development and operations.

32 | Minerals CounCil of australia

Competitiveness of Australian Iron Ore Mines – Delivered Cost into China
Percent of production by cost curve quartile, totals in Mt of production

established pilbara
Quartile 1

emerging pilbara
Quartile 2 Quartile 3 Quartile 4

non-pilbara

190mt 254
10%

152mt 600
9%

122mt 226 15
24% 62% 52% 74%

2%

410
8%

74
12%

44

167

89%

92%

91%

88% 11%

76% 48%

N/A 2006
Source: CRU

26%

23% 2%

2012

2020

2006

2012

2020

2006

2012

2020

rapidly escalating capital costs also threaten the attractiveness of some of our iron ore projects. At an average capital intensity of uS$235 per tonne, projects outside the Pilbara are 75% more expensive to build than West African alternatives. Even expansions within the Pilbara are at a 20% cost disadvantage. This is a new development. As recently as 2007, Australia’s iron ore project capital intensity was comparable with global peers. Comparisons with direct competitors illustrate this broader issue. These two effects combine to make many of Australia’s iron ore projects uncompetitive. In 2020, Brazilian iron ore will be

cheaper to deliver to China in operating cost terms than ore from all but the Established Pilbara projects. Emerging Pilbara operations will be at best competitive, while those outside the Pilbara will be substantially higher cost. Australian projects will also have uncompetitive capital costs relative to the most important source of new iron ore developments, West Africa. New resource sector investors are responding to Australia’s lack of competitiveness in iron ore. China’s changing investment patterns in iron ore are noteworthy. Between 2006 and 2009, Chinese state owned enterprises (SOEs) invested a total of $7 billion in a range

of Australian iron ore projects. These projects, however, have experienced lengthy delays and major increases in capital costs. for example, capital costs have escalated 205% at Sino Iron, 150% at Midwest and 160% at Gindalbie.7 China’s SOEs now view Africa as the preferred destination for iron ore investment. West Africa has reserves of high-quality iron ore that are estimated to match those in Australia, while offering much lower capital costs. China’s SOEs are now making substantial investments in African iron ore projects. Examples of major Chinese investments since 2010 include Chinalco’s $1.4 billion investment

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Competitive Position of Australian Iron Ore Projects
delivered cost advantage vs brazil by 2020*
2020 uS cents per dmtu, CIf to China

regional average capital spend for one tonne of iron ore capacity
uS$ per tonne of capacity 67% 235

20
Emerging Pilbara Established Pilbara

Non-Pilbara

26% 141

177

(5)

(48)

West African projects

Pilbara expansions**

Non-Pilbara Australia

* Growth volume only. for expansions at existing operations, growth volume is assumed to have the same cost structure as existing volume. fMG operating costs adjusted to exclude charges for off-balance sheet capital expenditure of $10/t of capacity. ** fMG estimated at $110/t. Based on announced capex of $84/t, broker estimates of equipment costs of $16/t, and finance and operating leases of $10/t as per initial 55Mtpa investment. Source: CRU; JP Morgan; FMG annual reports, company announcements

in Guinea’s Simandou project; CrM and SISG’s $1.8 billion investment in Sierra leone’s Tonkolili project and Hanlong’s $1.8 billion investment in the DrC’s Mbalam project.8 In all cases, Western mining companies are willing partners. Australia’s premier iron ore assets will remain competitive. for our other assets, which will be critical in maintaining market share, the future is much less certain.

intense competition from a range of competing producers. Many of these competitors share our proximity to growth markets in China and India, as well as to traditional markets like Japan, Korea and Taiwan. These rivals currently offer more attractive investment opportunities. Measured by the ‘incentive price’ needed for these projects to deliver an attractive return, our competitors dominate the most attractive 50% of the global project pipeline.9 Only 15% of Australia’s projects are in the most attractive half of the global pipeline. rising capital and operating costs have both contributed to

this problem. In 2007, project capital intensity in Australia was comparable to the global average. In the five years to 2012, however, it has risen to two thirds higher than the global average. In addition, Australia’s proportion of thermal coal production in the lower half of the global operating cost curve has more than halved since 2006, falling from 63% to 28% of production. Our rivals are already making substantial inroads in boosting their market share. Extensive thermal coal exploration has led to the discovery of large, high-quality resources in many locations. Indonesia, for example,

2.4.2 Coal: many thermal coal projects at risk
Much of Australia’s thermal coal project pipeline is at risk. There are many thermal coal resource provinces, and Australia faces

34 | Minerals CounCil of australia

Emerging Competitors – Mongolia and Mozambique
Hard coking coal exports
Millions of tonnes per annum 30 25 20 15 10 5 0 2000 2005 2010


forecast

Mongolia

• Substanial reserves of coking coal have been discovered since Mongolia opened to foreign investment in the early 2000s • New technologies, including advances in GIS, satellite imaging and 3D visualisation have facilitated exploration in remote regions with harsh climates

Mozambique

• Mozambique revised its mining laws in 2002 and 2006, introducing attractive investment agreements and incentives to attract investment • Exploration and investment rapidly increased, leading to the discovery of substantial coking coal reserves - Mining licences increased from 350 in 2002 to nearly 1000 by 2005 - Exploration expenditure grew from uS$33m in 2004 to $220m by 2007 • Chinese investors, including SOE Wuhan Iron and Steel, are facilitating the development of the mining sector and supporting local infrastructure

2015 2020 2025

Source: AME; Barlow Jonker; press search

has experienced a sixfold expansion in its production over the past 15 years. Its projects are also highly competitive when compared to Australia’s. The incentive price of the average Australian project is almost 50% higher than the average Indonesian project (after accounting for the impact of coal quality on market price received). Colombia, too, is now positioning itself as an attractive destination for new thermal coal investment. foreign direct investment in the Colombian mining sector increased from uS$1.1 billion in 2004 to over uS$4 billion in 2011.10 rising costs and risks, combined with the emergence of low cost producers, will have significant

implications for the future growth of Australian thermal coal production. The scarcity of coking coal resources means our worsening cost position is less directly damaging than in thermal coal. Australia is, however, losing share through failure to respond to an obvious supplydemand gap. New coking coal competitors are proliferating and successfully gaining share. Mongolia, for example, has massive reserves of coking coal which are undergoing rapid development. Production is expected to reach 54 million tonnes per annum by 2020, more than four times larger than in 2010. The flagship Tavan Tolgoi project has the potential

to produce 12 million tonnes per annum, on par with Australia’s largest mines. Whilst Mongolian coals trade at a discount to the seaborne market, very low operating and capital costs make Mongolia’s projects highly competitive. Similarly, Mozambique’s metallurgical coal industry has developed rapidly since large resources of hard coking coal were discovered in the mid2000s. The country exported its first metallurgical coal in 2011 and is expected to be the world’s fourth largest seaborne exporter by 2020. Operating costs are expected to be competitive. Given a generally firm price outlook, infrastructure constraints in combination with

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protracted approvals processes are the greatest threat to Australia’s coking coal projects. We are already beginning to lose share. Between 2005 and 2010, Australian production increased by 4.5%, well below the global increase of 6.1%. unless Australia rapidly improves its ability to bring growth projects to production, new competitors will capture a growing share of industry growth.

2.4.3 Aluminium and bauxite: missing a new export opportunity
Australia is losing the chance to capture a new opportunity to export bauxite. Australian aluminium smelting is uncompetitive on both capital

and operating costs. Chinese smelters have a clear capital cost advantage.11 Middle Eastern smelters, although higher in capital costs, benefit from low cost power generated from cheap natural gas. Combined, these low cost producers captured 89% of global growth between 2000 and 2011. Indian producers with access to competitively priced power, low labour costs, abundant raw materials and close proximity to a growing local market are also emerging as strong competitors. Given these competitors’ strengths, it is not surprising that no Australian smelter expansions are currently planned. Australia’s competitive position in alumina processing is similarly weak. The recent Worsley

expansion, for example, is expected to be the most capital intensive refinery in history. This is due in large part to a 58% cost overrun and a nine month delay.12 Although our competitive position in processing is poor, Australia is well positioned to supply the emerging bauxite export market into China. Australia has abundant high-quality bauxite reserves and a freight advantage over African and South American competitors, but competition to secure the opportunity will be intense. A swift response has seen Indonesian production increase tenfold since 2005. By 2011, Indonesia had captured 80% of Chinese import demand and was one of the top four producers globally.

Aluminium and Bauxite Opportunities
aluminium production growth and capital intensity
Capital spend for one tonne of new capacity uS$/t of capacity
China 1700

Supply of chinese bauxite imports
Million tonnes per annum
indonesian supply other suppliers 18% 30 45

2000-2010 production growth CAGr, percent p.a.

Middle East

5800

11% 23

27 20

India

3100

9%

Canada

7800

2% 2 2 2004 3

8 1 2000 1 1 2002

Australia*

7000-9000

1%

2006

2008

2010

* PJPl estimates; no expansions are currently planned for Australasia. Efficiency gains at existing facilities are expected to deliver small production increases over the next 10 years Source: World Mineral Statistics; CRU; PJPL analysis

36 | Minerals CounCil of australia

Copper Project Capital Intensities
Thousands of dollars per tonne
capital per tonne of copper equivalent* production capital per tonne of copper production 35.2

20.6 13.8 15.7 13.3 16.3

19.4

10.4

11.1

10.9

12.2

11.6

12.5

12.1

Tintaya – Antapaccay

El Pachon

las Bambas

Oyu Tolgoi

Tampakan

freida river

Olympic Dam

* Includes the value of silver, gold , uranium and other byproducts, converted into copper at long run prices Source: Deutsche Bank; Brook Hunt; Bank of America Merrill Lynch; press search; PJPL analysis

The possibility of an Indonesian ban on exports from 2014 provides an opportunity for Australia to replace Indonesia as the dominant supplier of Chinese demand.13 This opportunity, however, will also be apparent to others. Guinea, for example, is a well-established producer and holds over 30% of global bauxite reserves.14 Brazil has steadily grown market share over the past 10 years. China is also exploring vietnam’s potential as an alternative bauxite producer.15 If this attractive opportunity is to be secured, Australia must take steps to preserve its ongoing cost competitiveness and minimise delays to infrastructure and mine site development.

2.4.4 Copper and nickel: future uncertain
The future of Australia’s copper industry is much less assured following the decision to postpone further development of Olympic Dam. Olympic Dam is among the world’s largest copper and uranium deposits. until recently, planned expansions beyond its current underground operation would have seen it become among the world’s largest copper mines. ultimately, high capital costs undermined the project’s attractiveness. Independent estimates put Olympic Dam’s prospective capital costs

well above other greenfield copper developments. Analysts estimated that the expansion would have resulted in a capital intensity of uS$19,400 per tonne of copper equivalent production, well above the average of other major projects.16 An unusually lengthy construction period prior to first production also reduced returns and increased risk. Beyond Olympic Dam, Australia’s copper project pipeline is characterised by small, uncompetitive projects. ranked by price needed for investment, none are in the more attractive half of copper growth projects globally.17 Australia has a weak and

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Australia’s nickel production remains at 2005 levels; world production has increased 37% since that time.

worsening cost position in nickel. In 2012, 81% of Australia’s nickel production had costs above the global average, up from 63% in 2006. Consequently, Australian production volumes are stagnant. Australia’s nickel production remains at 2005 levels; world production has increased 37% since that time.18 Australia’s nickel industry has, perhaps more than other sectors, experienced the impact of new rivals through technological innovation. Widespread use of nickel pig iron (NPI) technology has allowed extraction of previously uneconomic resources. Current NPI plants can produce nickel for around

uS$7.35 per pound, cheaper than 80% of Australia’s nickel mines.19 Chinese stainless steel producers view NPI plants as highly attractive, with NPI now accounting for more than 30% of China’s nickel consumption.20 ■

Policy decisions made now will create or destroy an opportunity.

Failure to reSpond placeS enormouS beneFitS at riSk

3

40 | Minerals CounCil of australia

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41

SECTION 3

Failure to respond places enormous benefits at risk
To understand both the scale of the economic opportunity at risk and the potential for policy settings to have a negative impact on Australia’s competitiveness as a supplier of mineral resources, BAEconomics was asked to model two economic scenarios: • Competitive Edge (the Competitive scenario) and • Headwinds to Growth (the Headwinds scenario). The Competitive scenario (the reference case in the modelling) envisages policy settings that prioritise mineral resources development and competitiveness. Improved approvals processes reduce project delays. Along with reform to workplace relations settings and renewed investment in education and innovation, this sees productivity growth at rates closer to those of earlier periods of strong competitiveness. The Minerals resource rent Tax (MrrT) and Carbon Tax are not levied in this scenario and State royalties are stable. The alternative, Headwinds scenario lies at the other end of the policy spectrum with a less benign mining investment environment compared with the Competitive scenario. Policy uncertainty and heightened sovereign risk result in a risk premium being placed on Australian projects at levels similar to Brazil or Chile, discouraging investment. Current workplace relations settings, continued project approval delays and a failure to invest in skills and innovation result in multifactor productivity in the minerals industry growing by 1 percentage point less than under the Competitive scenario. The Headwinds scenario assumes higher taxes on the industry (the MrrT, the Carbon Tax and the Emissions Trading Scheme as modelled by Treasury) in line with existing policies. The opportunity lost under the Headwinds to Growth scenario is very large. Policy decisions made now can create or destroy an economic opportunity equal to more than 5% of the Australian economy in 30 years, with lower minerals industry growth quickly translating into poorer economic performance.

The opportunity lost under the Headwinds to Growth scenario is very large.

42 | Minerals CounCil of australia

gdp per capita
2012 A$ Thousands
110 100 90 80 70 60

real gdp deviation from competitive case
Headwinds case $5,400 deficit by 2040

% 0
competitive headwinds
-1 -2 -3 -4 -5 -6

2010


2020

2030

2040


2010

2020

2030

2040

Source: BAEconomics

Source: BAEGEM projections

The modelling suggests that, without improvements in our competitiveness, real GDP in 2040 is 5.3% lower than it would be under the Competitive scenario. That equates to a reduction in income relative to that scenario of more than $5,000 per person in today’s dollars. Compared

with the Competitive scenario, real wages are lower by 6.3% under the Headwinds scenario. In the decade between 2010 and 2020, real GDP under the Headwinds scenario is projected to decrease by 0.16 percentage points a year in comparison with the Competitive scenario. This

gap increases to around 0.21 percentage points in the 2020s and 0.19 percentage points in the 2030s. As a result, real GDP per person is projected to grow more slowly under the Headwinds scenario. By 2020, the gap between the Competitive scenario and the

real gdp per person in australia 2010 2020 2012 $a Competitive case Headwinds case Difference
Source: BAEGEM projections

2030

2040

63,617 63,617 0

73,833 72,689 1,144

87,168 84,094 3,074

102,511 97,113 5,398

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export volumes under Headwinds scenario (deviation from competitive scenario)
% 0
-5 -10 -15 -20 -25 -30 -35 -40 2010


coal

iron ore

2015

2020

2025

2030

2035

2040

Source: BAEGEM projections

Headwinds scenario is $1,144 in 2012 dollars. This gap widens to $3,074 by 2030 and $5,398 by 2040. The modelling confirms the analysis in this report that Australia’s status as a world-class supplier of mineral resources is at risk without improvements to competitiveness. relative to the Competitive scenario, minerals production and exports are lower under the Headwinds scenario across all commodities. Coal is particularly affected under the Headwinds scenario. Growth in coal export volumes slows and almost stops. By 2040, coal exports are down 37% relative to the Competitive scenario. In the decade from 2010, the annual growth rate in coal

production is projected to decrease by around 1 percentage point in comparison with the Competitive scenario. This gap increases to around 1.2 percentage points in the 2020s and 2.4 percentage points in the 2030s. Iron ore growth persists, consistent with the view in this report, but by 2040 exports under the Headwinds scenario are 21% lower than they would have been under the Competitive scenario. under the Headwinds scenario, the annual growth rate in iron ore production is projected to decrease by around 0.5 percentage points in comparison with the Competitive scenario. This gap increases to around 0.6 percentage points in the 2030s.

Australia’s status as a world-class supplier of mineral resources is at risk without improvements to competitiveness.

44 | Minerals CounCil of australia

Policy decisions made now can create or destroy an economic opportunity equal to around 5% of the Australian economy in 30 years.

The larger negative impact on the coal sector relative to iron ore under the Headwinds scenario is driven both by the relative importance of coal in domestic demand and by the greenhouse gas intensity of coal production in Australia compared with iron ore. This modelling reinforces the importance of rebuilding the competitiveness of the minerals sector. Much of the impact uncovered by the modelling is associated with the productivity lag in the Headwinds to Growth scenario. Although predicting productivity trends with any precision is necessarily difficult, there are a number of reasons why the modelled productivity

lag is a reasonable assumption of policy impacts and the associated benefits at risk: • Productivity changes of this magnitude are well within the bounds of policy reform to deliver. The Productivity Commission has found that Australia’s multifactor productivity growth has varied from 0% per annum to 2.5% per annum over the most recent seven ‘productivity cycles’, with the 1990s productivity surge being the result of the dividend from economic reforms begun in the 1980s.21 • Since 2001, mining industry multifactor productivity experienced an average

annual decline of 5% at a time when productivity growth in the wider economy was flat.22 • Even after adjusting for mining-sector specific factors, including resource depletion and capital investment effects, mining productivity growth between 2001 and 2007 was only 1.2%, much lower than the long-run average of 2.3% between 1975 and 2007.23 In summary, policy decisions made now can create or destroy an economic opportunity equal to around 5% of the Australian economy in 30 years. further details of the modelling approach are provided in the Appendix to this report. ■

fAIlurE TO rESPOND PlACES ENOrMOuS BENEfITS AT rISK | 45

Regaining our competitive edge will require immediate and co-ordinated effort.

We need a co-ordinated approacH to regain our competitive edge

4

48 | Minerals CounCil of australia

Policy imperatives
1
Build recognition of the need for change
1a. Shift the national dialogue towards benefits at risk in order to strengthen the appetite for reform 1b. match competitors in acknowledging a home-grown competitiveness problem

2
Immediately address cost pressures on current operations and projects
2a. mobilise all available skilled labour, including importing critical skills, to stop labour cost super-inflation 2b. ensure unfettered access to globally competitive suppliers 2c. increase national savings to ease exchange rate pressures

3
Regain world-leading competitiveness through a new program of structural reforms

3a. grow ample skills by building university capacity and lifting technical training completions 3b. maximise innovation dividends to enable productivity gains 3c. reorient the workplace relations framework towards ‘win-win’ deals that reward more output with more pay 3d. align owner and user interests to optimise infrastructure investment 3e. reform approvals processes to reduce delays and lower costs 3f. lock in stable and internationally competitive tax and royalty arrangements

WE NEED A CO-OrDINATED APPrOACH TO rEGAIN Our COMPETITIvE EDGE | 49

SECTION 4

We need a co-ordinated approach to regain our competitive edge
regaining our competitive edge will require immediate and coordinated effort to overcome complacency and address what is a structural (and not merely cyclical) competitiveness problem. first, we should build recognition of the need for change by acknowledging this structural cost competitiveness problem – what this report terms our ‘burning platform’. To strengthen the appetite for reform, we must shift the national dialogue on mining towards the opportunity and benefits at risk. like other established minerals producing countries, we must take the need for long-term reform seriously. Second, we should immediately address the cost pressures on current operations and projects. This means mobilising skilled labour to stop labour cost super-inflation, ensuring unfettered access to globally competitive suppliers and pursuing fiscal discipline to ease exchange rate pressures. finally, we should set about removing the structural barriers to higher productivity and reducing government risk. Correctly executed, these policies have the potential to see Australia regain world-leading competitiveness in the mineral sector over the medium to long term. These three broad actions are described in more detail in the following sections. minerals sector, not on actions needed to ensure those benefits continue. There are calls for higher taxes on minerals producers, tighter restrictions on temporary migration to ensure jobs are filled by Australians, and new measures to force resource developers to source inputs from domestic manufacturers. Some have even called for government intervention to ‘ration’ or ‘cap’ the rate of minerals development in the name of the national interest.24 Although still minority policy positions, these claims have gained increased prominence in recent times. There are at least three reasons for this. first, the magnitude and benefits of the mining boom are poorly understood. Whilst 85% of Australians acknowledge that the mining boom has been good for Australia, only 21% feel that ‘average Australians’ have benefited from the boom.25 On a personal level, 52% feel they have not benefited at all and only 12% feel they have benefited a lot.

4.1 Build recognition of the need for change
Community discussion of the mining boom frequently assumes either that resource development is certain to proceed, or that it provides little benefit to ordinary Australians. Both these misconceptions must be addressed before Australia accepts the magnitude of the challenge ahead.

4.1.1 Shift the national dialogue towards the opportunity and benefits at risk to strengthen the appetite for reform
At present, the national dialogue on Australia’s mining industry focuses primarily on how to distribute the earnings of the

50 | Minerals CounCil of australia

public perceptions of the mining boom
Has the mining boom been good for Australia? Have you personally benefited from the boom?

not sure Bad for australia

100% 8% 7%

100% not sure

52%

not at all

Good for australia

85% 33% 12%
nielsen, march 2012 nielsen, march 2012

a little a lot

A comparison of attitudes to Australia’s coal seam gas industry with Canada’s oil sands industry is telling. fifty-seven per cent of Canadians believe oil sands development is good overall, with only 29% disagreeing.26 Sixty-five per cent believe that it is possible to increase production whilst protecting the environment. By contrast, only 33% of Queenslanders are in favour of coal seam gas development, with 40% not in favour and 27% undecided.27 These negative perceptions have little grounding in facts or analysis. Australia’s policy makers and economists have sought to explain the various ways in which the benefits of the mining boom have been spread widely – for example, by reducing the extent and spread of unemployment, raising incomes, increasing the buying power of consumers and businesses, and insulating Australia from weaknesses in global markets.28 Second, it is widely assumed that the bulk of the mining investment pipeline is effectively committed, and that project attractiveness is assured. In reality, 75% of all projects included in the BrEE major projects list remain uncommitted. finally, Australia has been slow to acknowledge that our competition is increasing, perhaps due to a perception

Benefits captured by others

Queensland cSg versus canadian oil sands
Are you in favour of coal seam gas development in Queensland? Overall the benefits of development of oil sands in Canada outweigh the negatives

100% undecided
27%

100%
14% 12% 17%

other strongly disagree disagree agree strongly agree

not in favour

40% 36%

in favour strongly in favour

22% 11%
newspoll 2012

21%
ipsos reid, 2012

unlike elsewhere, majority against or undecided about specific developments
Source: The Australian; Newswire

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51

that the risk of operating in emerging markets is simply too great. However, this is no longer the case, with Australian miners themselves leading the charge into emerging mining regions. for example, more than 160 listed Australian mining companies were pursuing African mining projects in 2010, up from 54 in 2003.29 Shifting the national dialogue towards constructive debate requires a more open discussion of the magnitude of the risks to the current pipeline. There are signs that this is starting to happen. recent announcements from rio Tinto and BHP Billiton, including the Olympic Dam deferral, have highlighted the growing risks of project delays or cancellations.30 Industry and government should increase efforts to communicate more precisely the benefits of minerals industry growth to the community, and the consequences of a shrinking project pipeline. As these risks become more widely recognised, it will be important for policy makers to send clear signals that a new program of reform has the potential to restore our competitiveness. A sustained period of high commodity prices and economic growth has seen Australia lose its focus on reform. We must overcome this inertia and build community confidence that reforms aimed at improving competitiveness in both the

A sustained period of high commodity prices and economic growth has seen Australia lose its focus on reform.

minerals sector and the wider economy will bring worthwhile benefits. The successes of the 1980s and 1990s demonstrate this is possible, but renewed momentum will require leadership and a bold reform agenda.

4.1.2 Match others in acknowledging a home-grown gap in competitiveness
Australia is not alone in facing these challenges. The difference is that other established minerals producers have acknowledged the importance of minerals sector competitiveness and are taking the need for long-term reform seriously. In particular, policy makers in those countries are more actively pursuing improved competitiveness. Canada, for example, announced plans for a ‘one-project, one review’ approvals process in April 2012. This was in recognition that its lengthy investment process, including approvals, was much less

attractive than that of competitors. In the words of the Canadian Minister for Natural resources: “We have to compete with other resource rich countries for fast growing markets and scarce capital. … Streamlining the investment process for major economic projects will attract significant investment dollars and give every region of our country a tremendous economic boost.”31 Canada’s system will establish legally binding timelines for key processes and is expected to dramatically reduce delays. To eliminate duplication, most projects will be approved at a provincial level and responsibility for environmental assessments will rest with a single agency. Chile, conscious of the threats posed by declining copper grades and water shortages, is actively driving innovation by incentivising technologyintensive foreign investment in state-of-the-art mining techniques. In its institutional vision, the Chilean Ministry of

52 | Minerals CounCil of australia

Australia should immediately take steps to rapidly reduce cost pressures on current operations and projects under development.

Mines recognises innovation as “key to improving the technology and processes that make [Chile] more competitive”.32 Brazil recognised that its regulatory regime was much more complex than its peers, deterring foreign investment. The Brazilian Minister of Mines and Energy has announced plans to “modernise the regulatory framework [as] an effective way to attract further investment and support the development of the mining industry”.33 Application and licencing processes will be simplified under the new regime, and the Ministry of Mines and Energy will create a 20 year strategic plan to aid long-term planning within the mining industry.

Australia should match others in acknowledging a home-grown competitiveness problem and the growing gap in competitiveness between the world’s established and emerging minerals producers. Only by doing so will we generate momentum on key reforms.

the minerals sector in the next five years.34 Decisions regarding these projects – from investment in studies to final investment decisions – are being made now. In the short term, labour and globally traded inputs drive project economics. Project proponents are of course under their own pressure to improve project economics. But in three areas meaningful improvements will be impossible without policy reform.

4.2 Immediately address cost pressures on current operations and projects
Australia should immediately take steps to rapidly reduce the cost pressures faced by current operations and projects under development. Maintaining market share requires securing $400 billion in investment across

4.2.1 Mobilise all available skilled labour to stop wage cost super-inflation
labour is the primary driver of minerals project cost structures. labour’s cost contribution to the construction of a typical

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Resource and Energy Sector Project Construction Wages*
resource sector vs national average
Australian dollar index, Mar 2001 = 100 300 250 200 150 100 40 50 0 2001 20 0 2001
6.0% south africa 10.0% Brazil 3.7% national average
2001-12 caGr

australia vs competitors
Nominal US$ per hour 140 120 100 80 60
2001-12 caGr

9.2% construction

16.6% australia

8.6% canada 5.6% us

2003

2005

2007

2009

2011

2003

2005

2007

2009

2011

* Australian and competitor wages are all-in hourly rates. Australian all sector national average is the total hourly rate of pay national labour index Source: IPA; ABS

base metal mine, for example, is approximately 35-50% of total construction costs.35 for bulk commodities, including iron ore and coal, the figure is approximately 50%.36 As well as growing much more quickly than the national average, Australian minerals sector wage costs are outpacing those in competitor countries. Construction wages, for example, grew at 9% per annum between 2001 and 2011 and are now more than double pre-boom levels. In uS dollar terms, Australian construction wages are now amongst the highest in the world, and engineering wages are 60% above the global average.37

These wage increases reflect a large and persistent shortage of skilled labour. The current project pipeline requires the permanent mining labour force to grow by 90,000 between 2010 and 2016.38 In addition, there may be as many as 90,000 workers employed on project construction.39 Capital expenditure, and thus the requirement for project construction labour, is expected to peak in 2014, but will be maintained at 2011 levels or higher until 2019.40 The National resources Sector Employment Taskforce (NrSET) report of June 2010 identified that resources sector employment (including oil and

gas) would grow to 216,000 by 2015. That number was exceeded last year. In May 2011, Skills Australia revised the NrSET projections and forecast that the resources sector would grow to 270,600 by 2016. That number has now also been surpassed. The occupational profile of the mining industry shows that, in terms of highly skilled occupations, the sector requires relatively large numbers of engineers, mining professionals and accountants, as well as engineering, automotive and electrotechnology trades workers. Construction trades are also key to the resources sector, as are less skilled jobs such as drillers, truck drivers and plant operators.

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Meeting this challenge means in part redirecting labour from manufacturing into minerals jobs. Whilst the overall labour market is tight, regions dominated by manufacturing have unemployment rates of 7%, nearly twice as high as in mining dominated regions.41 Many new mining jobs are open to people without mining-specific trade or professional qualifications. Machinery operators and drivers and labourers, for example, will comprise 40% of new mining jobs.42 Nevertheless, relocation to mining regions is not occurring at the required pace. To date, strong wages growth and low unemployment have not encouraged sufficient labour migration into mining regions, particularly East to West. In 2009-10, for example, net internal migration from the Eastern states into Western Australia was only 2,000. Since 2005, net internal migration into Western Australia has been only 29,000.43

Employment, Wages and Migration by State total employment growth
Percent pa, 2005-2011 CAGR

average wage cagr
Percent pa, 2005-2011 CAGR

Wa

2.8%

Wa

7.4%

Qld

2.5%

Qld

5.1%

vic

2.4%

Sa

4.4%

nSW

1.7%

vic

3.9%

Sa

1.5%

nSW

3.5%

net interstate migration – 2009/2010
Thousands

2

3

26 West to all east*
net Gain 2

28 all east to West*

2 2 5 5 6 7 20 23 42

35

movements with net flow movements against net flow

* East to WA: 8 from NSW, 8 from victoria, 9 from Queensland, 1 from Tasmania, 1 from ACT. WA to East: 8 to NSW, 8 to victoria, 8 to Queensland, 2 to Tasmania, 1 to ACT Source: ABS

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To date, government relocation programs that aim to increase mobility have been largely ineffective. The ‘Connecting People with Jobs’ scheme, for example, offered relocation assistance to up to 4,000 unemployed people. Only 452 grants were taken up in the first 18 months of the two year scheme, with only 37 recipients relocating to Western Australia, and only 27 taking up work in the minerals industry.44 More targeted strategies integrated to the needs of the industry have proved to be more successful. for example, fly-in, fly-out has been an effective method of transferring workers who wish to retain a home base, often for family reasons. In addition, Advanced Entry

Adult Apprenticeships through the National Apprenticeships Program (NAP) offer opportunities for Australians with extensive trade skills and experience, but not necessarily a formal qualification, to complete minerals trade training (potentially within 18 months) so as to fill some of the skills gaps in the sector. A certain number of critical positions will demand miningspecific skills which cannot presently be found within Australia’s labour force. On current trends, Australia will not be able to supply sufficient technicians, geologists, mining engineers or other related skills to meet immediate project needs. New graduates in geoscience between 2010

and 2015 are forecast to meet less than 20% of new and replacement demand. In mining engineering, the figure is 40%.45 These fields already rely on immigration to meet demand. In mining engineering, temporary migration visas outstripped university graduations by more than 2 to 1 between 2006 and 2010. In geosciences the ratio was more than 4 to 1. Over 50% of the skilled engineering labour force is estimated to be overseas migrants.46 Shortages are also acute in key trades. Between 2005 and 2010, for example, supply of newly qualified electrical and telecommunications tradespeople was only 55% of new job growth before replacement.47

Supply of Minerals Sector Specific Skills mining engineers
graduates temporary skilled migration

minerals geoscientists
Forecast
857 799

Forecast

demand for new minerals scientists

574 487 395
360 290 450 360

demand for new mining engineers
505 445
230

527

implied annual supply gap = 357

455 365

730

660

implied annual supply gap = 590

380 360 270

105

127

124

145

215

252

227

189

212

235 95 95 127 139 147

173

171

188

184

184

06

07

08

09

10

11

12

13

14

15

06

07

08

09

10

11

12

13

14

15

Source: NRSET; MTEC

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for all types of positions, attracting labour is made needlessly difficult by current workplace relations policies. for example: • The scope of collective agreements has been dramatically expanded, and this has encouraged their use to restrict access to contractors and other labour sources. In the Bowen Basin, for example, collective agreements were used to attempt to limit the way employers could use supplementary sources of labour.48 • Individual flexibility Agreements (IfAs), intended to encourage workforce diversity and participation, have proven unworkable in practice.49 unions routinely insist on limiting flexibility terms to a narrow list of subjects that deliver little additional flexibility.50 uptake of IfAs has been less than 5% in the resource industry. By contrast, in 2008 two thirds of the resources workforce was employed on Australian Workplace Agreements (AWAs), the previous equivalent agreement.51 • low thresholds for access to protected industrial action encourage unions to take premature industrial action during bargaining.52 for example, there is no requirement for good faith bargaining to occur prior to gaining access to protected action. 53

Our policy settings must therefore reflect two inescapable realities: that we must take every step possible to attract suitably skilled domestic labour into minerals employment, and that immigration, and in particular skilled immigration, will be needed. This means: • Encouraging mobility of labour and skills by: o reforming occupational licencing and expanding transitional programs, to make existing skills more transferable to minerals o Investing ‘ahead of the game’ in key minerals communities to deliver levels of community amenity commensurate with larger, more permanent and diverse communities o Comprehensively rethinking government relocation programs. • Appropriately developing alternative training channels. for example, under a Minerals Council of Australia program to develop para-professional roles and alleviate reliance on four-year trained professionals, holders of national associate degrees in mining and geoscience perform discipline-specific roles under the supervision and mentorship of a four-year trained professional. In time, this will create a new pipeline of skilled labour, though it will not negate the chronic need

for four-year trained mining engineers and minerals geoscientists. • Ensuring the temporary skilled migration scheme remains uncapped and that employers remain free to use these arrangements to rapidly respond to economic conditions. • loosening some of the restrictive rules around Enterprise Migration Agreements and labour agreements. • reworking workplace relations arrangements to allow ready access to tailored employment offers without the risk of industrial action by: o Ensuring that collective agreements do not restrict access to alternative labour o reworking IfAs to provide choice and flexibility in employment instruments o raising the threshold for protected industrial action to circumstances where a genuine impasse has been reached between parties negotiating in good faith.

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4.2.2 Ensure unfettered access to globally competitive suppliers
labour aside, the bulk of other inputs to minerals projects and operations are globally traded, including fuel. To remain competitive, Australian projects must have access to the most competitive global suppliers of these inputs.

We should resist renewed calls for protectionist measures that aim to undo three decades of tarriff reduction and other trade reforms.

Diesel, for example, contributes up to one quarter of operating costs. rivals, including Canada, the united States, Argentina and Indonesia, have recognised that the minerals sector needs access to competitive diesel supplies, and supply diesel tax free. There have been calls for Australia to completely remove the diesel fuel tax offset. This would result in a substantial lessening of our competitiveness, by imposing operating cost increases of approximately 4-7% on typical minerals projects. Other inputs, including materials, equipment and consumables, also have deep globally traded markets. Ongoing competitiveness means resisting calls for local sourcing policies which ultimately seek to protect manufacturing from inevitable structural adjustment. The Australian Steel Institute, for example, has argued for ‘fully transparent’ Australian Industry Participation (AIP) plans for all major projects and tax incentives for increased use of ‘contestable’ Australian content.54 The requirement for project proponents to report more

frequently on AIP plans will increase the costs of reporting by up to 200%, according to one MCA member company. The Australian Workers union (AWu) and the Australian Manufacturing Workers union (AMWu) have called for audits of major resource projects to determine their ‘real’ level of local content.55 In reality, the bulk of imported components cannot be produced locally in a timely and cost effective manner. Imposing local sourcing requirements has the potential to impose significant additional costs and delays on projects already under pressure. More generally, we should resist renewed calls for protectionist measures that aim to undo three decades of tariff reduction and other trade reforms. These hard won reforms contributed to a substantial improvement in our overall competitiveness. In the 1990s, Australia’s multifactor productivity growth was amongst the highest in the OECD. GDP per capita rose from 16th in the OECD in 1990 to 8th by 2002. On Productivity Commission estimates, Australian households are $7,000 per annum better off today as a result of these productivity gains. The evidence is that protecting local suppliers that are not globally competitive is of little lasting value. The Productivity Commission reports that: • Australia’s manufacturing sector has been in decline

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since the early 1970s, a trend that is common to all advanced economies. In the uSA, for example, manufacturing’s share of employment has fallen from more than 20% in 1970 to less than 10% today. • The mining boom has brought forward this decline in the manufacturing sector by at most two years. • Assistance delivered to industry sectors is associated with ongoing lack of competitiveness – in other words, it is wasted effort. Ensuring minerals producers have unfettered access to globally competitive suppliers means: • Continuing the path of tariff reductions • Stopping moves towards local sourcing requirements • Maintaining diesel tax offset arrangements.

it has also had an adverse impact on the competitiveness of trade-exposed Australian industries, including the minerals sector. Other examples of industries under pressure due to the high exchange rate include agriculture, education, manufacturing and tourism. An upward shift in Australia’s average terms of trade is in part responsible for the strong dollar. Because commodities make up a large proportion of Australian exports, there is a strong relationship between our terms of trade and commodity prices. Consequently, the Australian dollar has risen with commodity prices. falling import prices, particularly in manufactured goods, have also contributed to Australia’s increased terms of trade. The stance and mix of macroeconomic policy also has implications for the exchange rate in an open economy. The Australian dollar has stayed higher than it should be in recent years by virtue of fact that monetary policy has remained too tight and fiscal policy too loose. As Professor Max Corden, one of Australia’s most eminent economists, has stated “the only way in which governments and central banks can significantly depreciate the exchange rate is through monetary policy – reducing interest rates – and if inflation is to be avoided, reduced interest rates need normally be associated with appropriately contractionary fiscal policy”.56

This has not been the case. Since 2008-09, Australian governments have run substantial fiscal deficits. With Australia’s growth at around trend, relatively low unemployment and the terms of trade above long-run historical averages (albeit down from peak levels) the Commonwealth Budget should be in structural budget surplus to achieve a lower exchange rate without inflation.

4.3 Regain world leading competitiveness through a new program of structural reform
Actions to immediately address cost pressures should be complemented by long-term structural policies that will help the minerals industry regain world-leading competitiveness. These policies should target two important long-run determinants of investment attractiveness: productivity and government risk. Although critical to competitiveness in any industry, productivity and government risk are particularly relevant to the current situation of Australia’s minerals industry. Competitors entering the resources sector today are unencumbered in their potential to employ the latest technologies. New projects frequently take advantage of new construction approaches during development and have the opportunity to deploy technologies that enable higher levels of productivity.

4.2.3 Ease exchange rate pressures
The strength of the Australian dollar in recent years is primarily a result of structural changes in the global economy. While policy cannot entirely offset shifts in the exchange rate that are the result of such structural changes, current policy settings have the Australian dollar trading at a level higher than it needs to be. The strong dollar reflects relative strength in the Australian economy and has benefited consumers through cheaper imports, but

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In recent years, policy uncertainty in Australia has increased markedly, most notably in relation to tax policy settings.

In addition, as highlighted above, our new competitors are designing approvals processes and other regulations to maximise the rate and value of minerals development. Conscious of their poor reputations in the past, they are offering investment agreements on attractive terms, strengthening institutions and fast tracking development applications. Australia has previously been a leader in these areas. from the reforms of the 1980s and 1990s, Australian productivity improved – overall as well as in the mining sector. from 1986 to 2003, mining labour productivity

grew at 5% per annum and capital productivity was steady. Since then, labour productivity has declined by 8% per annum and capital productivity by 6% per annum. Even after adjusting for declining ore grades and lags between capital investment and new productive capacity, minerals sector multifactor productivity has been 3% per annum lower in the 2000s than in the 1990s. 57 Minerals sector productivity will no doubt begin to improve as new capacity comes online, but there is still a need for coordinated effort to maximise gains. In addition, for decades government risk in Australia

was clearly very low, typified by a stable tax and royalty environment. This stability contributed to constant growth in investment and expanded market share for Australia’s minerals sector. yet in recent years, policy uncertainty in Australia has increased markedly, most notably in relation to tax policy settings. Just as in the 1980s and 1990s, the challenge now is to identify and remove the structural barriers to ongoing productivity gains and to reduce government risk. The long-term reforms needed to regain worldleading edge competitiveness are discussed in detail below.

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4.3.1 Grow ample skills by building university capacity and technical training completions
Greater investment in higher education and trade qualifications is needed to secure the future skills base required to support ongoing productivity gains. Australia’s education and training systems are failing to keep up with higher minerals sector demand for specialist skills. Stalled growth in mining engineering enrolments, for example, is projected to result in a substantial shortfall of mining engineers.

In terms of technical skills, data from the National Centre for vocational Education research (NCvEr) show a lift in the number of trainees and apprentices in the minerals sector with the total number in training up 31% in the December quarter 2011 compared with 12 months earlier, while commencements rose by 62%.58 unfortunately, declining completion rates for traditional trade apprentices have eroded the benefit of growing commencements. In trades highly relevant to the minerals sector, completion rates are 20% to 30% below their

peaks. As a result, key trades (including electricians and diesel fitters) have been in shortage for many years. More than 30% of trade apprentices abandon their courses in the first 12 months alone. Only a fraction of these re-enrol in an alternative apprenticeship and go on to receive a qualification. Common reasons for exiting apprenticeships include a lack of support, low wages, problems with the workplace or employer and a lack of engagement with the work. With global demand for these skills likely to grow strongly, we cannot rely on immigration over

Education and Shortage of Mining Engineers
mining engineering graduates, 1969 to 2015
600
eight minerals programs closed between 1998 and 2004 – just as the china growth boom began
Forecast*

projected shortfall of graduate mining engineers
Annual average, 2011 to 2014

580
85% are from minerals tertiary education council sponsored schools**

500

400

300

200

lagged supply response to industry booms and busts

220

100

0 Cy69 74 79 84 89 94 99 04 09 14

mining engineering graduates

demand for mining engineers

* MTEC forecasts based on historic enrolments. Enrolments in mining engineering are a proxy for completion as attrition and transfers are approximately equal ** MTEC is a minerals industry sponsored council that coordinates mining education curricula; supports university programs and research; and fosters partnerships between industry and academia Source: MTEC; NRSET; DEEWR

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Vocational Education and Training
commencements in selected courses relevant to the mineral sector
Thousands per annum

completion rates
Percent, completions over commencements four years prior

30

100% 90%

25
Construction Metal and vehicle

80% 70% 60% 50%
Electrical* Electrical* Metal and vehicle Construction

20

15

40% 30% 20% 10%

10

5

0 1980 1985 1990 1995 2000 2005 2010
* Includes telecommunications Source: NCVER; Historical time series of apprenticeships and traineeships in Australia

0% 1980 1985 1990 1995 2000 2005 2010

the long term. Instead, we must increase supply. This means: • Increasing enrolments in minerals-related higher education and improving course quality. We should set a goal of at least doubling enrolments in mining engineering and quadrupling enrolments in minerals geoscience over the next five years. To ensure their ongoing viability and improve the quality of teaching, Commonwealth Grant Scheme funding for mineralsrelated programs should be increased to levels reflective of their true cost.

• Providing additional support to boost completion rates in key trades. research demonstrates that apprentices engaged under arrangements that include pastoral care and more personalised selection have higher completion rates. Accessible support should be extended to all apprentices, particularly in the first six months of the employment arrangement when the apprentice is most at risk of dropping out.59 • Better matching school leavers to trade apprenticeships that align with their aptitudes. School leavers should be provided

with better information about what apprenticeship entails and guided to trades that match their aptitudes. Involvement in pre-vocational and pre-apprenticeship programs should be encouraged. Careers advisers should be encouraged to promote apprenticeships as a rewarding alternative to university study. In many cases, these initiatives will require the cooperation of industry and the public sector. The urgent challenge is to define how these partnerships will work, their specific targets, and ensure they do not simply get the industry to the next crisis point.

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History of Key Technical Innovations in Copper Production
Average operating costs for mines in Western World, 2009 US$ per tonne of ore
160 140 120 100 80 60 40 20 0 1900

Improved transportation Froth flotation Bulk mining at Bingham Canyon & Chuquicamata... ...which opened up the “Age of the Giant Porphyries” Improved recoveries 65% to 85% Better smelting and refining

estimate

actual

Airborne geophysics port–WW2 led to raft of new discoveries

Development of a good geological model for Porphyries SXEW Better work practices

Computer controls, modelling and scheduling

Low cost mines in new countries

expanding demand led to economies of scale
1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

1910

Source: BAEconomics; MinEx Consulting, 2010 MEMS Conference

4.3.2 Maximise innovation dividends to enable productivity gains
Continuous improvement is needed to maintain minerals sector competitiveness. Innovations in copper mining, for example, have seen the average operating cost per tonne of copper ore decline for over a century. Australia’s mining sector has increased research and development (r&D) intensity since the mining boom began. According to the Australian Bureau of Statistics, the mining industry spends around $4 billion per annum on r&D, with r&D intensity around 4% of industry gross value added. While policy prescriptions in a number of areas may involve

increased expenditure, Australia has a particular challenge to increase the productivity of r&D efforts already being made. While Australia’s investment in innovation is relatively high, our innovation efficiency is poor. In the 2011 economy-wide INSEAD Innovation rankings, Australia ranked last amongst OECD countries in innovation efficiency. Put simply, we get fewer rewards from innovation effort than our peers. This problem seems to characterise the minerals sector as well. Although a leading minerals producer, Australia is rarely the first to benefit from minerals sector innovation. Key minerals innovations are frequently developed and first

applied elsewhere, and can be surprisingly slow to reach Australia. Automated trucks, for example, were first tested in finland in 2003, and spread to Chile, South Africa and Canada by 2007.60 rio Tinto began the first trials of autonomous haulage in Australia at West Angeles in 2008, and a full roll out of a driverless fleet began in 2012. Competing countries have stepped up their mining innovation programs and will be strong competition in attracting investment and talent. Chile and Brazil, for example, have increased incentives for mining r&D and innovation.61 India continues to promote itself as an attractive, low cost and highly skilled destination for IT focussed r&D.62

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Australian Mining Sector R&D
2010 A$ Billions 5 4 3 2 r&d (lHS) 1 0
94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 19 19 93

5% 4% 3% 2% 1% 0%

r&d intensity (rHS)

* Mining r&D expenditure as a percent of minerals GvA Source: ABS

INSEAD Innovation Rankings
2011 rankings input index
Hungary Switzerland ireland Sweden Finland denmark canada luxembourg uk uSa australia iceland norway new Zealand netherlands korea Japan austria israel germany belgium France estonia czech republic Spain Slovenia portugal Slovakia chile italy poland greece turkey mexico
70 66 66 65 65 65 64 64 64 63 63 62 61 61 60 59 59 59 59 59 58 56 55 53 52 51 50 48 48 48 46 42 38 37

output index
Sweden Switzerland netherlands germany uSa Finland denmark israel uk canada korea Hungary iceland new Zealand norway estonia France ireland austria czech republic luxembourg Japan belgium Slovenia australia Spain portugal italy turkey Slovakia poland chile greece mexico
59 58 52 51 50 50 49 49 48 48 48 48 48 47 44 44 43 43 42 41 41 41 40 39 37 35 34 33 30 30 30 30 26 23

efficiency index
Sweden Switzerland netherlands germany israel korea uSa turkey estonia czech republic Finland France newZealand denmark iceland uk Slovenia canada norway austria italy Japan Hungary portugal belgium Spain ireland luxembourg poland mexico Slovakia chile greece australia
0.92 0.88 0.86 0.86 0.83 0.81 0.80 0.80 0.79 0.78 0.78 0.77 0.76 0.76 0.76 0.76 0.76 0.75 0.72 0.71 0.70 0.70 0.69 0.69 0.68 0.67 0.65 0.65 0.64 0.63 0.62 0.62 0.61 0.59

Source: INSEAD Innovation Rankings

64 | Minerals CounCil of australia

Key Minerals Innovations
country
autonomous copper mining Microwave based enhanced ore recovery CHIlE

developer
• Codelco at El Teniente • e2v technique to be applied at rio Tinto’s Kennecott utah Copper Mine • Sandvik/Inmet at Phyasalmi • lKAB at Kiruna iron ore • rio Tinto in the Pilbara • rio Tinto in the Pilbara

date developed
• PfS completed 2008 • Start up planned for 2017 • vermiculite application demonstrated 2011 • Copper trials to begin in late 2012 • Testing began in 2003 • The first project was commissioned in 2005 • 1970s • 2008 • Trials from 2007 • Opened 2010

in use in australia?

✗ ✗
• Trials began 2008 • large scale fleets from 2012 • Planned for 2014

uK/uS

automated trucks
driverless trains autonomous drilling remote operations centre

fINlAND SWEDEN AuSTrAlIA AuSTrAlIA

✓ ✓

Source: BAEconomics; Rio Tinto; Sandvik; press search

To maximise the dividends from our innovation spend, we should: • fix the shortfall of tertiary and technical graduates • reverse changes to the r&D tax credit system to re-incentivise commercial application of new technologies • foster the development of a home-grown, innovative services cluster by catalysing growth through initiatives including: o facilitating access to capital markets o Identifying and retaining Australian innovation leaders needed to seed a new cluster • review publicly funded basic research programs, including CSIrO’s activities, for appropriateness and applicability.

4.3.3 Reorient the workplace relations framework towards deals that reward more output with more pay
regaining productivity improvement requires reworking the current workplace relations environment to place productivity gains at the centre of workplace conversations. In

the long run, growing labour productivity is essential to economic progress. Over the past 40 years, growth in labour productivity accounted for around 80% of the growth in Australian per capita incomes.63 Productivity Commission Chairman Gary Banks has made the point forcefully that: “… industrial relations regulation is arguably the most crucial

In its current form, the Fair Work Act works to reduce flexibility and productivity.

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[area of regulation] to get right. Whether productivity growth comes from working harder or working ‘smarter’, people in workplaces are central to it. The incentives they face and how well their skills are deployed and redeployed in the multitude of enterprises that make up our economy underpins its aggregate performance. It is therefore vital to ensure that regulations intended to promote fairness in Australia’s workplaces do not detract unduly from their productivity.”64 Australia’s fair Work legislation was intended to increase the productivity, flexibility and fairness of workplaces. In its current form, however, the fair Work Act works to reduce flexibility and productivity.65 We should bias the workplace relations framework towards deals that reward more output with more pay. This requires provisions which: • encourage direct, collaborative relationships between the employee and employer that foster productivity improvement for mutual benefit. This means moving away from a framework geared primarily to adversarial dispute resolution.66 • limit union involvement in establishing agreements to representatives nominated by employees to encourage efficient and fair bargaining processes.

• reintroduce the sole and dominant purpose test for adverse action claims. This would prevent employer decisions from being unlawful simply as a result of minor factors that did not influence an employer’s decision to act. • allow recourse to limited arbitration within strict time limits where genuine efforts to establish greenfield agreements fail, reducing the risk of major projects missing critical timeframes.67

port facilities, infrastructure will inevitably be shared between multiple users. In the Hunter valley, for example, terminal infrastructure is shared by 10-15 producers, with track infrastructure further shared with passenger trains and other non-coal freight users. Sharing infrastructure can offer benefits such as minimising environmental and community impacts. The Australian experience, however, is that shared access systems typically suffer from three problems: • delayed and asynchronous expansion of port and rail capacity. With multiple infrastructure solutions available, a lack of accountability for debottlenecking sees risk averse infrastructure owners delay critical investments. Poorly sequenced expansions can lead to mismatches in port and rail capacity. for example, whilst the Australian rail Track Corporation has acknowledged that new track would alleviate congestion in the NSW rail system, it has also argued that above-rail operators should construct new train depots and provisioning stations as part of the solution. Prior to the introduction of ‘take or pay’ provisions within the NSW Capacity framework Agreements, infrastructure owners were reluctant to invest ahead of demand, as there was no certainty of cost

4.3.4 Align owner and user interests to optimise infrastructure investment
Efficient and timely infrastructure development is critical to ensuring ongoing productivity growth. The importance of cost effective infrastructure, with capacity matched to production, is obvious. Australia’s iron ore exports can currently take advantage of single user infrastructure chains. These chains are highly efficient. for example, BrEE reports that single user operated iron ore export chains in the Pilbara have historically operated at utilisation rates of 95%.68 In these circumstances, unified control of investment and operational decisions maximises productivity and cost competitiveness. In other commodities, where individual users lack the scale to support dedicated rail and

66 | Minerals CounCil of australia

recovery. Some port capacity in Queensland has never operated at close to nameplate capacity, at least in part due to constraints on the rail networks feeding the terminals. • inefficient use of existing capacity. Experience in both the NSW and Queensland coal chains has shown that operators who do not bear the true cost of delays are not incentivised to lift performance. Poor coordination of scheduling coal movements between mines and loading on ships constrains the coal chain and contributes to bottlenecks. Thus, the socialisation of capacity losses – typically the

case in shared infrastructure – fails to provide appropriate incentives for individual producers to lift performance. • Patchy regulation of infrastructure owners. Infrastructure regulation prevents owners of infrastructure from extracting unreasonable returns from producers. However, varied regulations lead to large differences in allowed returns. for example, returns on the new rail links in Queensland are much higher than the regulated returns on existing assets.69 unreasonable user charges damage the cost competitiveness of projects, discouraging investment.

They also increase friction between producers and asset owners, leading to delays that could see Australia miss opportunities for investment. Combined, these problems substantially reduce the performance of Australia’s multi-user infrastructure chains, particularly as existing infrastructure is extended and becomes more interlinked. BrEE reports that multi-user coal infrastructure in the Eastern states operated at 85% of capacity prior to recent expansions. This figure is already below that observed in iron ore chains. Of more concern, utilisation is falling as demand and complexity have grown.70

Coal Chain Operational Performance
capacity utilisation
Percent of port nameplate 100% 90% 80% 70% 60% 50% 0% 2002 2003 2004 2005 2006 2007 2008 2009

Port Waratah coal system dBct abbot Point
2010 2011

port nameplate capacity growth
Index, 2002 capacity = 100

200 180 160 140 120 100 80 0 2002 2003 2004 2005 2006 2007 2008 2009 2010

dBct abbot Point Port Waratah coal system

2011

Source: Port authority data; PJPL analysis

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67

These problems compromise the development of new infrastructure as well as the operation and investment in existing facilities. for example, coordinating investment in the Queensland coal chain is made difficult by complex interactions between mine, rail and port assets with diverse ownership. A number of critical expansion projects are targeting a final investment decision in 2014. If these projects are delayed, there is a real risk that there will be insufficient infrastructure for projected export volumes.71 Optimising infrastructure requires deliberate action to improve the alignment between asset owners and users. This will

not be achieved without policy intervention: unlike users, asset owners are not fully incentivised to optimise infrastructure. Comparisons of the value of a lost tonne to different parties make this clear. Below rail operators and infrastructure funds earn a regulated rate of return on their investment, meaning a lost tonne may cost them very little or even nothing, depending upon the regulatory arrangements. By comparison, producers lose the marginal contribution (sale price less marginal production cost) on every missed tonne. Achieving this alignment means introducing reforms that:

• Ensure appropriate differentials in access charges, to lessen the prospect of rent seeking behaviour from monopolist owners • Maximise throughput from existing infrastructure by introducing: o user control of assets, even if owned by third parties, as is in place at Dalrymple Bay Coal Terminal (DBCT); or o Independent measurement of the cause and impact of delays, as planned for NSW, and imposing penalties reflective of the true value of lost time on responsible parties.

Optimising infrastructure requires deliberate action to improve the alignment between asset owners and users.

68 | Minerals CounCil of australia

4.3.5 Reform approvals and commit to stable resource taxation to lower government risk
Perceptions of government risk are strong drivers of resource investment. Companies will demand increased returns to invest in countries where government policy risk is a constant presence. Moreover, mining companies are simply much less willing to invest in higher risk jurisdictions when lower risk alternatives exist.

Two issues are critical to reducing perceptions of government risk in Australia. firstly, without changing approvals standards, mining approvals processes need to be overhauled to improve speed and enhance predictability. Currently mining approvals are multi-step processes requiring proponents to interact with numerous departments and authorities across all levels of government. Western Australia’s process is among the least

complicated. Projects which are of national environmental significance require up to five different levels of assessment, each of which is appropriately rigorous but with a high degree of overlap.72 There is obvious potential for needless delays stemming from process duplication, unclear requirements and under-resourced government departments. Currently, protracted approvals processes impose substantial

State Mining Approvals Process – Western Australia Example
calculation and lodgement of environmental performance bounds

Port Waratah Mining proposal/ coal system statement of mineralisation report

application for mining tenement

concessions and endorsements issued on title

statutory environmental approvals

• Minimum 35 objection period • Determination by Minister of Mines • Concurrent with - Native Title Act notice s29 - Approval from Environmental Minister if >50% of proposed area is on reserved lands - Written consent from the land owner and occupier

• Consent from Minister of Indigenous Affairs if relevant • Dep. of Mines and Petroleum for approval of plan of operations and environmental safeguards

• Environmental Protection Act approvals - Clearing of native vegetation permit - Plant or tailings storage works approval - Operating licence for producing waste water, solid or gas • Groundwater abstraction licence (RWI Act 1914) • Disturbance to rare flora approval (WC Act 1950) • Dep. of C&EP approvals - Project management plan • Bulk dangerous goods licence

Mining approvals processes need to be overhauled to improve speed and enhance predictability.

Source: WA Department of Mines and Petroleum

WE NEED A CO-OrDINATED APPrOACH TO rEGAIN Our COMPETITIvE EDGE | 69

costs and delays on project developers. This has not always been the case. In 1998, for example, Macarthur Coal’s Coppabella project entered production only 15 months after the resource had been identified.73 By contrast, final approval for the Wandoan coal project is not expected until late 2013, more than six years after the application for mining lease and environmental authority was made in May 2007.74 Similarly, when the Alpha coal project and the South of Embley bauxite project began approvals in 2008, construction was planned for 2010. final approval has yet to be granted for either project, and approvals dates remain uncertain.75 The risk of unplanned delays rapidly erodes incentives to invest. A hypothetical coal mine investment, with similar economics to the ‘at risk’ Watermark project, illustrates the principal issues: • Delays lengthen the time between an initial investment in acquisitions and study costs to the commencement of production. This reduces the value of future revenues in ‘today’s dollars’ – that is, after taking into account the combined impact of inflation and the cost of investment opportunities lost in the meantime. • Currently, delayed revenues are particularly damaging, as they prevent access to more attractive near-term prices.

Companies will demand increased returns to invest in countries where government policy risk is a constant presence.
These two related effects are sufficient for investments to become unattractive given modest delays. At a Watermarkstyle project, a delay of more than three years means future cash flows (in terms equivalent to today’s dollars) can no longer pay for initial acquisition and study costs. unexpected delays also cause other problems not captured in a strictly financial analysis. By causing disruptions to project schedules, delays complicate dealings with suppliers. With key suppliers typically operating at or near capacity, schedule changes often translate into increased costs or unavailability of key components.

These delays also contribute to an overall perception of increased risk, in the construction phase through raising the prospect of additional delays, in the operations phase, and when assessing the potential for future brownfields expansions. Many investment decisions, particularly those requiring large infrastructure investments, anticipate multistage developments. These later investments are typically highly profitable. Increased risk associated with their execution impacts directly on decisions about initial project stages. Three types of approvals reform are needed: • introducing clear and predictable requirements and timeframes for all approvals and managing planning department performance. The standards, requirements and technical studies required for approval should be made clear from the outset of the process. Clear timeframes should be established for processing, and statutory limits considered. Planning department performance should be measured and managed for improvement. This may require increases to departmental resources. • Managing approvals through a single point of contact responsible for progress against clear timeframes and benchmarks. Current multilevel approvals systems will

70 | Minerals CounCil of australia

Project Delays – Impact on NPV for a Typical ‘Watermark Like’ Project*
Percent of base case NPV 100% 80% 60% 40% 20% 0% (20%) (40%) (60%) 0 1 2 3 4 5 years delay**
* Assumes acquisition and studies costs of A$60/t of capacity; operating costs of A$73/t; capital costs of A$133/t of capacity; 8% WACC; 30 year mine life; broker consensus thermal coal prices and exchange rates ** Delay to both construction costs and revenues Source: Wood Mackenzie: Broker Consensus prices; PJPL analysis

typical delay for australian coal projects

nPV=0

not function smoothly without deliberate coordination effort. South Australia’s lead agency model for the assessment of significant projects could serve as a model for all states.76 under the South Australian model, project proponents are allocated a case manager who coordinates all development, environment and licensing approvals processes with a view to delivering projects with ‘minimum risk in minimum time’.77 South Australia targets six months for mineral lease approvals for major mines, well below national benchmarks of one to two years. for example,

approvals for Prominent Hill took five months and JacinthAmbrosia took seven months. • eliminating needless process duplication. To accelerate decision making, duplication between state and federal processes should be removed. This includes accrediting state environmental approvals as equivalent to federal approvals under the Environment Protection and Biodiversity Conservation Act. Secondly, minerals taxation arrangements in Australia should be stabilised to restore investor confidence. Prior to the rSPT debate, decades of minerals taxation stability allowed Australian investors

and governments to share in consistent, long-term minerals production growth. Investors consistently ranked Australian mining policies as amongst the most attractive in the world. The rSPT debate, however, put Australia’s reputation at risk. Australia’s policy attractiveness fell from 6th to 17th among mining peers, below Zambia, Ghana, and Peru.78 Although ultimately settled, the rSPT debate left a legacy in terms of policy uncertainty and higher government risk. As reported in the fraser Institute’s 2011-12 Survey of Mining Companies, Australian states and territories now rank down in the middle of the pack based

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71

Attractiveness of Australia for Minerals Investment
rank of australia’s policy settings in encouraging exploration
Rank (of countries/provinces surveyed)
0 2 4

rSpt debate

Increasing attractiveness

on tax regime attractiveness to investment – between 30th and 61st of the 93 nations and provinces examined. Almost half of the survey respondents viewed the overall taxation regime as a deterrent to investment in Western Australia and Queensland, while more than half cited it as a deterrent in New South Wales.79 Economic analysis from bodies such as the World Bank has highlighted the importance to a ‘good investment climate’ of minimising the costs caused by taxation and policy uncertainty.80 The essential characteristic of investment in mines and access infrastructure such as railroads or ports is that it is sunk and irreversible investment. If economic outcomes turn out to be good, the investment is valuable. However, if economic outcomes turn out to be bad, the investment cannot be shifted to an alternative economic use. In this context, even small changes in taxation settings can have large impacts on future investment by virtue of increasing government risk.81 Governments at all levels in Australia should commit to stable and competitive tax and royalty regimes to ensure investor confidence in our resource taxation arrangements. ■

6 8 10 12 14 16 18 02 03 04 05 06 07 08 09 10 2H10 11 12

respondents believing australia’s taxation regime deters investment
Percent of respondents
60%

rSpt debate

50%

40%

30%

20%

10%

0% 02 03 04 05 06 07 08 09 10 2H10 11 12
Source: Fraser Institute Mining Survey

Getting it right means being more attractive to investors than our competitors.

concluSionS

5

74 | Minerals CounCil of australia

CONCluSIONS |

75

SECTION 5

Conclusions
Australia’s mineral resources remain fundamentally attractive despite weaknesses in our current competitive position. If we get their development right they will deliver enormous benefits to Australia. Getting it right means delivering new volume from projects that are more attractive to investors than those of our rapidly proliferating competitors. right now, we are not well positioned. Our burning platform is a structural competitiveness problem. Across mineral commodity sectors, Australia’s cost position has declined markedly relative to our competitors. As a result, market share gains of earlier decades have been replaced by stagnation or share losses, while new projects have become less attractive just as new rivals have emerged. regaining our competitive edge in minerals resources will require immediate and coordinated action, as well as a new program of structural reform and renovation. Australia has the capacity to formulate and implement such a reform program, as was demonstrated in the 1980s and 1990s, but first we must acknowledge our competitiveness problem. In 2012, a huge opportunity is at risk. Australia’s challenge is to ensure that in years to come we are not talking about an opportunity lost. ■

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77

APPENDIx

Modelling the economic impact of a lost opportunity
As part of preparing this report, the Minerals Council of Australia commissioned BAEconomics to conduct macro-economic modelling aimed at understanding the scale of the competitiveness challenge facing Australia’s minerals industry and the opportunity at risk as a result. This appendix describes the modelling approach. and feedback effects, and allow for possible shifts in production and consumption in response to policy changes.

A.1 BAEGEM
The analytical framework used in this assessment is BAEGEM, BAEconomics’ general equilibrium model of the world economy. BAEGEM is a recursively dynamic CGE model. The model is solved in one-year time steps. for each time step, BAEGEM simulates the dynamics of large numbers of economic variables, such as capital and labour productivity, prices and output of goods and services, trade and investment flows between economies, and the use of labour, capital, land and natural resources. The core model code of BAEGEM is built around the concepts of the GTAP model.82 The full model code is constructed over and above the core model code with four interlinked modules, including: the government module; the greenhouse gas emission

A. The analytical framework
The increasing economic interdependence between industries, countries and markets has added a new dimension of complexity to the development, evaluation and implementation of policies. In this regard, Computable General Equilibrium (CGE) modelling has become a popular tool for assessing the potential economic effects of policies. The advantage of using CGE models in comparison with other modelling tools is that they incorporate interactions between various parts of the economy, account for flow on

78 | Minerals CounCil of australia

module; the technology mix module; and the energy module. The development of these modules is designed to increase the capability of BAEGEM to analyse domestic and international policies, and impacts of economic shocks.

Table 1: Regional and sectoral coverage
regional/national economies australia united states canada eu27 russia rest of europe china india indonesia Japan, korea and taiwan rest of asia central and south america Middle east & north africa sub-saharan africa Production sectors Crops livestock Forestry Fishing coal oil gas coke nuclear Fuel petroleum products iron ore other minerals Food chemicals, rubber and plastics non-metallic minerals manufacturing iron and steel non-ferrous metal electricity Heat Services road transport Water and air transport

A.2 BAEGEM database
The BAEGEM database is based on a number of sources. The social accounting matrix (SAM) of the BAEGEM database is based on the GTAP v8 database with a base year of 2007. The GTAP v8 database covers 129 countries/regions across the world and 57 commodity groups. for the purpose of enhancing the capability of modelling individual mining commodities, the commodity groups in BAEGEM have been expanded to 70. Disaggregated mining commodities (in addition to those already included in the GTAP v8 database) include black coal, brown coal, coking coal, iron ore, bauxite, copper ore, gold, uranium, titanium and zircon. The emissions database is sourced from the International Energy Agency (IEA), the united National framework Convention on Climate Change (uNfCCC) and the uS Environmental Protection Agency (EPA), and covers around 99% of the global greenhouse gas emissions in 2007. The data in the technology mix and energy modules are sourced from IEA and the World Bank. In the present analysis, the BAEGEM database was aggregated into 14 regional/ national economies

and 23 production sectors, with a particular focus on the coal and iron ore industries (Table 1). It is assumed that each production sector produces a unique commodity. Production and export volumes of each commodity

are determined endogenously inside the model based on a set of exogenous projections of population, labour supply and economic growth for each economy. The projections of population, labour supply and real GDP from 2010 to 2040 are summarised in Tables 2, 3 and 4.

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79

Table 2: Population growth projections in the reference case (% a year)
economies australia united states canada eu27 russia rest of europe china india indonesia Japan, korea and taiwan rest of asia central and south america Middle east & north africa sub-saharan africa
Source: United Nations and BAEconomics’ simulations

2011-20 1.3 1.0 1.2 0.4 0.2 1.1 -0.1 2.1 1.8 0.2 1.2 1.5 2.1 2.8

2021-30 1.0 0.7 0.5 0.2 -0.2 0.8 -0.7 1.5 1.1 -0.2 0.7 1.3 1.7 2.7

2031-40 0.7 0.9 0.6 0.1 -0.3 0.7 -0.1 1.0 0.4 -0.3 0.5 1.3 1.4 2.4

Table 3: Labour supply growth projections in the reference case (% a year)
economies australia united states canada eu27 russia rest of europe china india indonesia Japan, korea and taiwan rest of asia central and south america Middle east & north africa sub-saharan africa
Source: United Nations and BAEconomics’ simulations

2011-20 1.3 0.8 0.9 0.2 -0.1 0.5 0.3 1.3 0.9 0.0 1.1 1.0 1.7 2.4

2021-30 1.0 0.7 0.7 0.1 -0.3 0.3 0.0 0.9 0.6 -0.2 0.8 0.7 1.3 2.2

2031-40 0.7 0.6 0.5 0.0 -0.4 0.2 -0.2 0.7 0.4 -0.3 0.5 0.4 1.0 1.9

80 | Minerals CounCil of australia

Table 4: Real GDP growth projections in the reference case (% a year)
economies australia united states canada eu27 russia rest of europe china india indonesia rest of asia central and south america Middle east & north africa sub-saharan africa
Source: IMF and BAEconomics’ simulations

2011-20 2.8 2.6 2.4 1.8 3.9 3.7 7.6 8.4 5.6 4.9 4.2 4.2 5.1

2021-30 2.7 2.3 2.2 2.0 3.9 3.9 5.2 6.1 5.0 4.3 4.1 4.1 5.0

2031-40 2.3 2.4 2.3 1.8 3.3 3.8 3.2 5.1 4.5 3.9 4.0 3.8 4.7

B. Scenario characteristics
The modelling is designed to assess the impact on the Australian economy of alternative mining investment environments. The policyrelated shocks distinguishing a Competitive scenario (the reference case) from an alternative, less benign Headwinds scenario were developed in consultation with PJP and are summarised in Table 5. In the Headwinds scenario, the Australian Government is assumed to maintain the MrrT and to fully implement its Carbon tax and emissions trading scheme based on

current revenue expectations. In addition, the current regulatory environment for workplace relations is maintained, project approvals delays continue and investments in education and innovation are too low. Productivity growth in the mining sector therefore lags the Competitive scenario and policy uncertainty means that foreign investors impose an additional risk premium on Australia. The tax rates on revenue from the iron ore and coal sectors are maintained at the same levels after 2013. The modelling implementation assumes the new mining tax paid by the iron ore and coal sectors from 201213 is about $4 billion dollars a year and the share of the new

mining tax paid by the iron ore sector is about $3 billion dollars a year, consistent with the MrrT estimates from the Australian Government. The Headwinds scenario assumes greenhouse gas emissions are taxed at a rate of $23 per tonne CO2-e in 2012-13. After 2012-13, the carbon tax per tonne of CO2-e increases by 4 per cent a year in real terms, consistent with the carbon tax policy shock implemented in Treasury modelling. However, in the Headwinds case, Australia’s major trading partners are assumed not to change their climate change policy settings from those in 2010. In contrast, Treasury has assumed that countries around the globe,

MODEllING THE ECONOMIC IMPACT Of A lOST OPPOrTuNITy |

81

Policy-related shocks in the Headwinds scenario
shock Mrrt and royalties description Additional 4 per cent tax on revenue for the iron ore sector and 1.5 per cent for the coal sector from 2012-13. $23/tonne CO2-e on Australian economy from 2012-13 with an annual real increase of 4 per cent after 2012-13 50 basis points above the risk premium in the Competitive case

carbon tax or clean energy future Pacakge

Political risk premium

Multifactor productivity in the mining sect

reduced by 1 percentage point relative to the Competitive case

including the united States, China, India and all African countries, impose a carbon tax on their economies progressively from 2012-13 under global action to limit greenhouse gas emissions. It is clear that no such globally harmonised policy action is taking place on greenhouse gas emission reductions. The risk premium increases by 50 basis points in the Headwinds policy scenario. The higher risk premium in comparison with the Competitive case is driven by greater tax and regulatory uncertainty. under the BAEGEM modelling framework, an increase in the risk premium in a region will have a negative effect on investment.

under the Headwinds scenario, multifactor productivity in the mining sector is reduced by 1 percentage point relative to the Competitive case. As noted in the report, much of the impact uncovered by the modelling is associated with this productivity lag. The modelled scenario for productivity is considered a reasonable (indeed conservative) one based on the impacts of past product and labour market reforms on measured productivity trends in Australia and the long-run variability in mining sector multifactor productivity. ■

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Opportunity at risk

Regaining our competitive edge in minerals resources

The easy assumption that Australia will inevitably be a competitive minerals supplier and the location of choice for new investment because of our natural endowment can no longer be sustained. large market share gains over earlier decades have been replaced by stagnation or share losses. Australia’s cost position has declined markedly and new projects have become less attractive just as new, strong rivals have begun emerging. regaining our competitive edge in minerals resources will require immediate and coordinated action, as well as a new program of structural reform and renovation. Without action, a huge opportunity will be lost.

Minerals council of australia level 3, 44 Sydney Ave, forrest ACT 2603 PO Box 4497, Kingston ACT Australia 2604 P. + 61 2 6233 0600 | f. + 61 2 6233 0699 w. www.minerals.org.au | E. [email protected]

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