QUEENSLAND’S COMMENTS ON NEW DEVELOPMENTS – 2006 UPDATE
Treatment of Specific Purpose Payments (SPPs)
Queensland supports the proposed treatment of new SPPs commencing in 2004-05.
Queensland also supports the proposal to not backcast the new payments commencing in 2005-06 (Australian Technical Colleges and National Water Initiative – Living Murray).
With regard to Australian Technical Colleges, the impact on State budgets is still largely unknown at this stage. It is expected at least some of the funding for Australian Technical Colleges will be provided to private consortia rather than States, thereby reducing the quantum of SPP funding. In fact, Australian Technical Colleges may result in additional expenditure for States as the Colleges are expected to be eligible for State funding as government or non-Government schools.
Abolition of State Taxes
Queensland considers Option (i) – include the effects of phasing out of taxes when they affect the data used in the assessments – is the appropriate option for dealing with the abolition of state taxes in the 2006 Update.
In addition to the practical benefits of simplicity and lesser data requirements, compared with backcasting, this option is consistent with the current treatment of tax changes initiated by individual States, including reforms related to the IGA.
For example, when New South Wales abolished bank accounts debit tax from 1 January 2002, the Commission did not make any changes to the assessment method for Financial Transaction Taxes. Queensland considers this situation to be comparable as it involved an individual State abolishing a tax listed in the IGA, with the timing of abolition determined by that individual State.
The State taxes in question should allow for even greater flexibility than debits tax, as the IGA simply requires they be reviewed (rather than abolished per se) and does not give any indication of timing of any abolition flowing from the review.
Further, the timetables presented by the six States and Territories may be subject to revision. As a result, Queensland does not consider there is sufficient certainty regarding the abolition of these taxes for the Commission to accurately backcast average tax policies, even for
2006-07. In reality, the Australian Government Treasurer has indicated the Commonwealth will announce ‘a response designed to get tax cuts for people in New South Wales and Western Australia’ before 1 July 20061.
With regard to the specific assessments, Queensland does not consider option (i) would present any problems for the current method of assessing Financial Transaction Taxes. Indeed, as some of the taxes included in this category are to be abolished or reduced by some States on 1 January 2006, option (i) appears to be more equitable than backcasting in the 2006 Update. Queensland also considers there would not be any changes to the assessment of Stamp Duty on Conveyances required for the 2006 Update.
Queensland accepts the decision whether to continue the assessment of Stamp Duties on Shares and Marketable Securities is not as clear cut. However, the duty is to be applied in four jurisdictions during 2006-07 (noting it is to abolished in Queensland from 1 January 2007), which represent a majority of the Australian population and a majority of the tax base. Therefore, Queensland considers the current method for assessing Stamp Duties on Shares and Marketable Securities should be retained in the 2006 Update. This decision could be again considered in the 2007 Update, noting the potential for changes in each State’s abolition schedule.
Taking each of these factors into account, Queensland considers the Commission should include the effects of phasing out of taxes when they affect the data used in the assessments. This approach could be revisited for future updates if there were a significant change in circumstances – such as uniform changes to State taxes.
Financial Assistance Grants relativities
Queensland accepts the calculation of FAG relativities adds significantly to the workload of Commission staff. However, there is significant potential for the share of GST to fall below the guaranteed minimum amount (GMA) in some States, particularly with the abolition of debits tax being factored into the GMA from 2005-06 onwards. As the GMA calculations are still a very important factor in Commonwealth-State financial relations, Queensland supports the continued preparation of FAG relativities.
Queensland notes the acceptance of option (i) in relation to the abolition of State taxes may result in less additional complexity than option (ii) in calculating FAG relativities. If the gradual reform of State taxes, following individual schedules, is not backcast, there would be no need for method change in the FAG assessments – as the effects of the taxes being phased out would flow through the data used by both the GST and FAG assessments.
Queensland supports reviewing the need for the discount currently applied to the value of coal produced in New South Wales. Queensland understands the coal industry in New South Wales benefited significantly from higher coal prices in 2004-05, based on financial information reported by publicly listed companies. As a result, Queensland does not support any discount being applied to the value of coal produced in New South Wales in 2004-05.
Queensland Treasury has undertaken some research into the profitability of the New South Wales coal mining industry in 2004-05. Some key findings are provided below.
Companies with coal operations in New South Wales have reported large increases in profit in 2004-05, particularly in the second part of the year, as coal prices have risen. According to ABARE2, the export value of steaming coal ranged between $54 and $65 per tonne during 2004-05, with an average value of $60 per tonne. In comparison, the average export value of steaming coal was $41 per tonne in 2003-04.
The export value of coking coal ranged from $72 to $126 per tonne in 2004-05, with an average value of $86 per tonne, compared with the average value of $58 per tonne in
2003-04. While the value of coking coal is still higher than that of steaming coal, the average export value of both steaming and coking coal values rose by just under 50% in 2004-05.
Although coal prices have risen significantly, there has not been a significant increase in volume to date. This is likely the result of lag times in developing additional mineral resources and infrastructure capacity. ABARE’s list of major black coal projects indicates a number of mine expansions and new projects in New South Wales were either under construction or committed to, as at April 20053. These projects are expected to increase New South Wales’ black coal mining capacity by approximately 13 million tonnes per annum.
A number of publicly listed companies have coal operations in New South Wales. An overview of the latest results of these companies is provided below to demonstrate the strong profitability of New South Wales coal mines in 2004-05.
Coal and Allied Industries Ltd (managed by Rio Tinto)4
Coal and Allied is a major coal producer based in the Hunter Valley with annual production of almost 30 million tonnes, a majority of which is thermal coal for export. Coal and Allied report on a calendar year basis, with the 2004 annual result and 2005 half year results both showing significant increases in profitability.
In 2004, net profit after tax was $111.4 million compared with $0.1 million profit after tax in 2003. The increase in profit was attributed to improved market conditions, such as higher coal prices, increased production and lower demurrage costs. Further, the new management services agreement with Rio Tinto delivered benefits of $15 million for the year.
The higher coal royalty introduced from 1 July 2004 was listed as one of the items – along with the strong Australian dollar and increased oil prices – having a negative effect on the result. However, the outlook for 2005 was positive with the only concern being the inability of coal infrastructure in New South Wales to accept expanded production in response to the stronger market conditions.
In the first half of 2005, net profit after tax was $126.4 million (for six months), compared with $3.3 million in the first half of 2004. However, production volumes increased by only 3% due to allocation limits at the coal loading terminal in Newcastle. The half year result made no mention of royalties as an impact on profitability.
Following the acquisition of Austral Coal, a coking coal operation based in the Southern coalfield of New South Wales, Centennial has 15 coal mines in New South Wales and is one of the largest underground coal producers in the state. Centennial is currently developing Anvil Hill, a major open-cut mine in the Hunter Valley, which is expected to commence production in 2008 and supply more than 7 million tonnes per annum of thermal coal for export and domestic markets.
Approximately two-thirds of Centennial’s sales are for domestic electricity generation, resulting in around 45% of revenue being fixed by long-term contracts. Even so, Centennial listed higher coal prices in the last quarter of 2004-05 as a factor contributing significantly to profitability. In 2004-05, sales from continuing operations rose by 40% and pre-tax profit from continuing operations rose by 15%.
Centennial considered 2004-05 to be a year of transition to higher output/higher margin mines and is positioned for a strong result in 2005-06.
Excel Coal operates both underground and open cut mines in New South Wales, producing a range of products including thermal coal, hard coking coal, semi-hard coking coal and coke. Excel’s production increased by approximately 10% in 2004-05, to almost five million tonnes. Excel plans to more than treble production by 2008-09. A majority of Excel’s new operations will be located in New South Wales, with an open cut mine planned for Mudgee and an underground longwall expansion for an existing open cut mine at Wambo. Excel expect the Wambo longwall mine to be highly productive, with free on board (FOB) cash costs comparing favourably to Wambo open cut and other Hunter Valley producers.
Excel’s 2004-05 results were significantly higher than forecast. Net profit, at $95.1 million, was 132% higher than forecast in the company’s prospectus, while revenues were 65% higher than forecast. As profits exceeded the forecast by a greater margin than revenues, the result indicates profit margins were significantly better than anticipated. Excel’s results presentation does not provide much commentary about market conditions, but as they enjoyed a 65% increase in sales revenue on a 10% increase in production volumes, it is reasonable to assume Excel also received significant benefit from higher coal prices.
Excel indicated the coal industry was facing significant cost pressures in relation to business inputs, such as fuel, explosives, steel, tyres and labour. However, Excel made no mention of the impact of royalties.
Gloucester Coal is another New South Wales coal miner which enjoyed a significant increase in profitability in 2004-05. Gloucester achieved a pre-tax operating profit of $6.5 million in the second half of 2004-05, compared with a $5.6 million operating loss in the same period of 2003-04. This turnaround was attributed to an increase of more than 50% in coking and thermal coal sale prices, with FOB cash costs maintained at less than $40 per tonne.
Gloucester’s new coking coal contract prices took full effect in the last quarter of 2004-05, resulting in significant margin improvement, as Gloucester received a 119% increase in contract prices compared with the previous year. Following these price increases, Gloucester considers the company’s financial outlook has strengthened considerably, with the company looking forward to a record result in 2005-06.
Gloucester mentions the royalty increase in 2004-05 has added approximately $3 per saleable tonne onto the total cash cost of production. However, the company’s production and profitability both increased during 2004-05.
Although BHP Billiton reports on a consolidated basis, it is possible to extract information relating to coal operations in New South Wales. Supplementary information accompanying BHP’s 2004-05 Report shows metallurgical coal turnover from the Illawarra region was over 50% higher in 2004-05 than 2003-04. This translated into a significant rise in earnings before interest and tax (EBIT) to US $76 million in 2004-05, compared with US $11 million in 2003-04. There was a greater than 60% increase in turnover of metallurgical coal from Queensland in 2004-05, with EBIT increasing by about 280% compared with 2003-04.
In relation to energy coal, turnover from operations in the Hunter Valley increased by more than 50% in 2004-05, resulting in EBIT of US $102 million, compared with a US $5 million loss in 2003-04. It is not clear how much of this coal was exported and how much used for domestic electricity generation.
BHP’s commentary indicates the gains in both metallurgical and energy coal can be attributed to higher export prices. BHP makes mention of higher price-linked royalty costs in Australian metallurgical coal operations, but does not separate the impact of the change to New South Wales royalty rates from the impact of higher coal values on Queensland’s ad valorem collections. The discussion of energy coal does not mention royalties as a factor influencing results from this product.
The only coal project commissioned by BHP during 2004-05 is Dendrobium, an underground operation in the Illawarra region of New South Wales. This project commenced production in April 2005 and has a capacity of 5.2 million tonnes per annum of raw coal. As this project is listed under ‘carbon steel materials’, production is expected to be largely metallurgical coal, rather than energy coal.
Xstrata Coal is the world's largest producer of export thermal coal and a significant producer of coking coal. The company produces, on a managed basis, more than 50 million tonnes of coal per annum in Australia. Xstrata’s Australian operations are diversified between New South Wales (57%) and Queensland (43%).
Xstrata Coal’s New South Wales operations include both underground and open cut mines, the majority of which are located in the Hunter Valley with the remainder in the western coalfields. Included in the New South Wales portfolio is the newly developed low-cost high productivity Beltana highwall, longwall punch mine, considered to be one of the lowest cost operations of its kind in Australia.
Xstrata’s 2005 interim report, covering the second half of 2004-05, reports operating profit from coking coal operations in Australia were US $97.4 million, compared with US $21.2 million in the second half of 2003-04. Operating profit from thermal coal operations in Australia were US $326.6 million in the second half of 2004-05, compared with US $189.5 million in the same period of 2003-04.
Xstrata’s commentary regarding thermal coal indicates exports from New South Wales were higher in 2004-05 than 2003-04 due to new production capacity and ongoing improvements to the coal supply chain. Xstrata secured an average contract year price (effective 1 April 2005) of around US $54 per tonne FOB with Japanese power utilities, representing a 19% increase over the price achieved the previous year. Xstrata considers export growth has been held back by infrastructure capacity constraints, indicating they would expand production if these constraints were reduced.
Production costs for thermal coal fell by 3% in real terms during the year, due to continued productivity improvements at Beltana (Hunter Valley) and a significant reduction in demurrage costs, offset by an increase in the cost of mining inputs such as fuel, steel and explosives. Xstrata expects further productivity gains in 2005-06 to drive down cash costs.
Xstrata does not make mention of any impact of changes to the royalty regime in New South Wales.
With regard to coking coal, Xstrata’s contract price of US $135 per tonne for hard coking coal is similar to prices achieved the previous year, while the price for New South Wales semi-soft coking coal has risen to an average level of US $80 per tonne, compared with
US $40-45 per tonne last year.
Coal Mining Methods
The coal royalty regime imposed by New South Wales differentiates between open cut and underground mining operations, while the Queensland regime does not. Queensland considers this to be a policy decision made by New South Wales, which was possibly influenced by the number of low profitability underground mines which previously existed in the state. The Australian Coal Association10 notes that there were 123 mines in Australia producing black coal in 1999, of which 60 were underground and 63 open cut. At the end of 2004, there were 37 underground and 62 open cut mines, indicating a net reduction of 23 underground mines over that period.
As there are a number of new, highly productive, underground mines currently under development in New South Wales, the profitability of underground mines is expected to be roughly equivalent to open cut mines in the near future. Dr Nikki Williams, the Chief Executive of the NSW Minerals Council, has implied this is currently the case. In a speech on changes to royalties in NSW, Dr Williams said, “there is also every indication that the differential rate structure of the new royalty system will disadvantage the open cut sector compared with the underground sector, and the shallower underground mines compared to those deeper underground. You don’t have to be a rocket scientist to see that this has the potential to impact on relative profitability.11”
In the same speech, Dr Williams referred to a study by mining consultants Minarco, which found there was little correlation between depth of cover and mining costs. According to Dr Williams, Minarco concluded the more profitable mines tended to have higher depth of cover and that, contrary to the New South Wales Government’s assertion, the new royalty regime will actually impose higher royalty costs on the least profitable mines.
While Queensland accepts the CGC will separately assess open cut and underground mining, at least until the 2010 Review, Queensland considers the profitability of underground mining is similar to open cut mining. Therefore, Queensland supports the removal of the discount for New South Wales coal production for both open cut and underground mining.
The profitability of coal mining in New South Wales improved significantly in 2004-05.
Each of the companies discussed above indicated higher coal prices – for both coking and steaming coal – resulted in higher profits in 2004-05.
Companies which experienced marginal profitability, or made losses, in 2003-04, such as Coal and Allied Industries and Gloucester Coal, experienced strong profits in 2004-05.
The increased royalty rate was mentioned by some companies as resulting in higher costs, although there was no indication the higher royalty rate resulted in decreased production or mine closures.
All coal companies listed above were either increasing their production capacity or, where export capacity constraints were an issue, were maintaining existing capacity.
Comments made by companies indicated higher labour, fuel, steel and tyre costs had more influence on the cost of producing coal than the increased royalty rate.
Based on their increased profitability in 2004-05, Queensland considers all New South Wales coal mining companies were able to face average royalty rates.
Queensland considers the quality of coal to be much more significant in determining profitability than the method of production. As coal quality is captured by measuring the value of production, Queensland does not support a discount being applied to black coal in New South Wales for either open cut or underground methods of production.
Conveyances – Victoria’s Policy Change
Queensland supports the unit trust adjustment no longer being applied to Victoria, on the basis the Commission consider Victoria’s policies are in line with other States.
Victoria’s First Home Bonus
Queensland agrees with the view that Victoria’s First Home Bonus is largely a substitute for stamp duty exemptions or concessions and supports treating the bonus as a refund of duty.