Issue: 295
Sent: 21-03-2012 11:17:03
In this issue:

Resource Sector Profits Not So SuperA How To Book Of Self Managed Super Funds
Return to full article list
HomeFree weekly newsletterSelf Managed Super Fund ArticlesContact usLogin

Resource Sector Profits Not So Super

Click here to buy - A How To Book of SMSF's by Tony Negline
John Robertson

The Australian parliament is set to pass the mining tax that has blighted government political fortunes for the past two years. Doubts remain, however, about just how "super" the profits of the resources industry in Australia are likely to be.

A 480% rise in resource industry profitability to $77 billion (pre-tax) are just two of the big numbers that have dominated a generally sub-standard public policy discussion on the taxation of the mining industry.

As multibillion dollar numbers have been batted about over two years, the discourse has failed to address directly when profits are excessive and, therefore, when higher taxes are justifiable.

Australia has a progressive personal tax scale. Higher rates of tax apply to higher incomes but there is a physical limit to how many hours an individual can work. Consequently, the level of income is treated as a proxy for individual welfare and ability to pay as it is reasonably assumed no one can work more than 24 hours a day.

At a corporate level, no such constraint exists because the level of profitability depends, to a large extent, on how much capital is invested not on how many hours are worked.

The level of profitability, taken alone, is economically meaningless. A $100 million profit is huge if it required just one dollar of investment but unimpressive if it required a one billion dollar investment and $20 million a year in sustaining capital.

According to numbers released this month by the Australian Bureau of Statistics, the Australian resources industry invested $69.7 billion in 2011, $303 billion over the 10 years to the end of 2011 and $391 billion over the last 20 years.

These amounts only include investment within Australia and do not include the extensive overseas activities of Australian-based companies.

Any judgment about the size of profits in the resources industry needs to take account of the history of investment. Based on analysis undertaken by E.I.M. Capital Managers, there should currently be $62.6 billion in annual pretax profits.

Such an amount would represent a 374% rise from the profit level actually achieved in 2004. Despite the apparent size of the numbers, such an outcome should be construed as nothing special and simply the minimum that should be required of the industry if it is to be regarded as a sound custodian of the nation's financial resources.

As it happens, the industry did better than this target in 2011 by 23%. In this sense, there was an excess profit and, perhaps, some basis for debate about whether this should be subjected to some form of progressive taxation.

In a highly cyclical industry, however, 23% is not much of a buffer. Last year, spot iron ore prices fell by 35% at one stage. The Australian dollar swung by 15% on more than one occasion. Operating cost inflation has been running at 7-8% a year in the industry. In the fourth quarter of 2011 alone, industry profits fell by 15%.

The cyclically strongest conditions for the industry have probably passed. By the end of 2012, profits could once again run below target as they have done for over 70% of the time since 1990.

The most compelling financial feature of the industry may not be its super profits but rather its inability to sustainably build profits to a level that reflects the amount of investment that has occurred. The golden goose might simply be a backyard chook.

There is another feature of the profit and investment data from the Australian Bureau of Statistics worth noting: the return on capital invested in the resources sector is not much different to the return in the non-mining parts of the economy.

If anything, the financial performance of the resources industry has been rather disappointing. The aggregate numbers suggest Australia would be better off, at the margin, with a dollar going into a non-resource investment, given a choice.

Perhaps the resources industry has foregone its strongest argument against being more heavily taxed, namely, that there is nothing special about its financial performance.

Share this article
Click to share this article on Facebook Click to share this article on Twitter

Previous article         Next article

If you liked this article and would like more by email, subscribe! It's free.

[Bold fields are required]

Your details

Your alternate email address is used only if messages to your primary email address are returned to us.


Do you work in the financial services industry?

This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.

Site design by Raycon