I have been considering getting back into HGO but first I wanted to understand the impact of the RRT on Kanmantoo.
Having been a long term holder of HGO I had previously built a simple model of the Kanmantoo project to assess its value under different conditions.
Last night I dusted off the model, updated the figures and added a quick and dirty RRT.
The impact of the RRT on Kanmantoo was far greater than I had expected. I, to some extent, had thought the RRT could not be as bad as the miners were saying and also though there must be at least a modicum of truth in some of the claims being made by the Government.
However, after modelling the RRT on Kanmantoo, I am shocked by the effect of the RRT on economics of mining projects.
Kanmantoo is hit particularly hard because it is a low capital cost project with a short life.
Here is a simplified example to illustrate the impact of the RRT. Lets say HGO are able to extend the life of Kanmantoo by 1 year. That is worth roughly $175m in revenue for HGO. Subtract operating costs of $75m leaving a mine operating profit of $100m (keeping the figures round to make the calculations easy). Under the RRT, HGO gets to deduct the government bond rate return on the capital invested in the project which equates to roughly $6m pa. The remaining $94m ($100m - $6m) is then hit with the 40% RRT. BANG - there goes $36m straight off the bottom line. That leaves HGO with $56.4m +$6m capital allowance. - BANG there goes $18.7m in company profits tax leaving HGO with $43.7m.
So HGO gets to keep 43.7% of the profits from extending the life of Kanmantoo whilst the Government gets 56.3% of the profits for doing nothing.
In stark contrast, under the existing royalty regime HGO was expecting to pay a royalty rate of 1.5% of the value of product mined for the first 5 years and 3.5% thereafter. (plus company tax)
The negative effect of the RRT on mining economics is so large that I just dont think it can be implemented in its current form. It would be absolute madness. It will stop projects, it will cost jobs and it will send capital overseas.
But the RRT is firmly on the Rudd agenda and there remains a serious risk that it may be implemented. In the interim there is going to be a huge amount of uncertainty, delays and difficulty in financing new projects.
Until I become confident that the RRT is history I am sitting on the sidelines. The added uncertainty of the global economy is adding further impetus to my cautious thinking.
(I would be very happy to be corrected if my example of the workings of the RRT is incorrect)
HGO Price at posting:
30.5¢ Sentiment: Hold Disclosure: Not Held
