Contemporary Issues in Mining Leading Practice in Australia

Contemporary Issues in Mining
Also by Nigel Finch
BEST PRACTICES IN MANAGEMENT ACCOUNTING (with G. N. Gregoriou)
FUNDAMENTALS OF CORPORATE FINANCE (with Jonathan Berk, Guy Ford, Peter

DeMarzo and Jarrad Harford)
Contemporary Issues in
Mining
Leading Practice in Australia
Edited by
Nigel Finch
The University of Sydney, Australia
Selection and editorial content © Nigel Finch 2012
Individual chapters © the contributors 2012
Softcover reprint of the hardcover 1st edition 2012 978-1-137-02579-1
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First published 2012 by
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Contents
List of Tables vii
List of Figures viii
Acknowledgements ix
Notes on Contributors x
Overview 1
Part I Strategic Perspectives

1 An Overview of the Business History of the
International Mining Industry 9
Simon Mollan and David Kelsey
2 The Role of Mining in the Australian Economy 27

Nigel Garrow and Tom Valentine
Part II Operational Perspectives

3 Transportation Issues of Australian Coal and Iron Ore 47
Elizabeth Barber
4 MRO Procurement: Best Practices Framework for

Capital Equipment 69
Ananda S. Jeeva
Part III Financial Perspectives

5 Practical Problems in Mining Valuations 83
Wayne Lonergan and Hung Chu
6 The Tax Accounting Interface in the Mining Industry

in the Context of IFRS 100
Les Nethercott
7 Carbon Tax: Economic Impact on the Latrobe Valley 122

Mereana Barrett, Svetlana Maslyuk and Daniel Pambudi
v
vi Contents
Part IV Disclosure Perspectives

8 Permissive and Uninformative Reporting of
Clean-Up Costs 143
R. G. Walker
9 Capital Management Determinants of Financial

Instrument Disclosures in the Extractive Industries:
Evidence from Australian Firms 158
Grantley Taylor and Greg Tower
10 Transnational Corruption and Conflict Minerals 174

David Chaikin
Index 197
Tables
1.1 World production of selected non-ferrous metals 12

1.2 Largest mining companies in the world 20
1.3 Top 40 mining companies head office locations 24
2.1 Contributions to the rate of inflation 37
2.2 A simple econometric model of the Australian economy 39
2.3 Simulation of the model with higher commodity prices 41
7.1 Operating mines at the Latrobe Valley 126
7.2 Estimated resident population in Latrobe Valley,
the state of Victoria and Australia 127
7.3 Labour force participation in Latrobe Valley and Victoria 128
7.4 Average salary and wage income 129
7.5 Electricity generators in the Latrobe Valley 130
7.6 Advantages and disadvantages of carbon taxes 131
7.7 Carbon tax impact on brown coal mining and
electricity generation: simulation results 135
9.1 Pooled multiple regression results 168
vii
Figures
1.1 Comparative prices (five-year moving average),

selected metals 14
1.2 Tin production and price 15
1.3 Growth in world non-ferrous metal production
and world GDP 16
2.1 Australia’s terms of trade and resource exports 31
viii
Acknowledgements
We would like to thank Lisa von Fircks at Palgrave Macmillan for guid-
ing us through the project. We would also like to thank Siew-Ching
Lim for the excellent work in editing this manuscript. Thanks also to
the anonymous referees who assisted in the selection of articles for this
book and to each of the authors for their generous contribution of time,
knowledge and expertise. While all care has been taken, neither the
publisher nor the editor is responsible for the accuracy of each chapter
written by the contributors.
The editor would like to thank the Australian Bureau of Agricultural
and Resource Economics and Sciences for their generous permission in
allowing the use of Figure 2.1 ‘Australia’s Terms of Trade and Resource
Exports’.
ix
Contributors
Elizabeth Barber is an academic at the UNSW Canberra campus where

she lectures logistics. Her extensive experience and knowledge has led
to her being called as an expert witness in numerous transportation
(ports and railways as well as rail/road competition) and bulk freight
movements (including iron ore and coal exports). Her research interests
include the theoretical aspects of power and influence in supply chains,
military logistics, humanitarian logistics, inventory analysis and per-
formance metrics used in supply chains. She continues to follow her
inventory and warehouse management interests with small consultan-
cies in most Australian capital cities. Elizabeth has lectured both under-
graduate and postgraduate logistics and supply chain management for
a number of years. Prior to specialising in this area, she taught across a
broad range of economics and business courses.
Mereana Barrett is Senior Lecturer in the Bachelor of Humanities

at Te Whare Wananga o Awanuiārangi (Indigenous University), New
Zealand. Her research interests encompass accounting and account-
ability, stakeholder engagement, sustainability reporting and the
impact of climate change in rural Victoria. Mereana holds a Bachelor of
Management Studies (BMS) and Master of Management Studies (MMS)
(Distinction) from Waikato University, New Zealand, and a Ph.D. from
the Department of Accounting, Finance and Risk at Glasgow Caledonian
University (United Kingdom).
David Chaikin is Associate Professor at the University of Sydney

Business School. Prior to his academic appointment he was a practising
lawyer specialising in multi-jurisdictional investigations, transnational
commercial and criminal litigation as well as offshore corporate and
banking law. He has held appointments as Senior Assistant Secretary of
the Australian Attorney-General’s Department and Senior Legal Officer
of the London-based intergovernmental body, the Commonwealth
Secretariat, and has worked as a consultant to the United Nations, the
OECD-based Financial Action Task Force and the Asia/Pacific Group on
Money Laundering. David teaches in the areas of banking and finance
law, corporate and commercial law and asset protection/management
of wealth risks. He has been a tenured lecturer at the London School
of Economics and Political Science and a lecturer at Kings College,
x
Notes on Contributors xi
University of London. David’s research expertise is in comparative cor-

porate law, financial crime, tax evasion and money laundering, finan-
cial services law and regulation, offshore finance, private banking and
wealth management. He is a recipient of an ARC Discovery Grant and
has been a lead consultant on major international research projects in
Europe, the Americas and Asia.
Hung Chu is Director at Lonergan Edwards Associates Ltd, Sydney.

He has a Masters degree in Finance and Banking from the University
of Sydney and a Ph.D. in Finance from the University of Technology,
Sydney, where he graduated on the Chancellor’s List for Exceptional
Scholarly Achievement in Ph.D. research. Hung’s career includes over
12 years of expertise in the provision of valuation services. He has pub-
lished widely in academic and practitioner journals.
Nigel Finch is an associate professor at the University of Sydney

Business School. He has published more than 100 scholarly articles
in the areas of accounting and financial decision-making since com-
mencing his academic career in 2005. Nigel is rated among the top 250
business authors in the world according to the Social Science Research
Network (SSRN) and he is actively engaged in management education
and business advisory in Australia and Asia. Nigel is the editor of the
Journal of Applied Research in Accounting and Finance, editorial board
member for Journal of Intellectual Capital and Managerial Finance, and
co-author of Fundamentals of Corporate Finance (2010) and Best Practices
in Management Accounting (2012). He holds degrees in accounting, busi-
ness and law and a Ph.D. in business law. His professional qualifications
include membership of CPA Australia and the Institute of Chartered
Accountants in Australia. He is a member of the Business Council of
Mongolia, the peak advocacy group promoting increased trade and
investment in Mongolia, and is an associate director at corporate advi-
sory firm Beerworth + Partners.
Nigel Garrow is Lecturer in Management at Macquarie Graduate School

of Management. He has over 30 years’ senior management experience
in the United States, Europe, Australia, Asia, the Middle East and Africa,
including 15 years as Managing Director or Chief Executive Officer
mainly in fast moving consumer goods (FMCG) or business-to-business
firms in the food industry. He has extensive experience in international
business, including in several acquisitions, organisational restructur-
ings, development and implementation of business growth strategies.
His research focus is the area of mergers and acquisitions in Australia.
xii Notes on Contributors
Ananda S. Jeeva is Senior Lecturer in procurement and supply man-

agement at the School of Information Systems, Curtin University. His
research interests include procurement, supply and logistics manage-
ment and its related areas. Ananda has served on the steering com-
mittee of the Chartered Institute of Purchasing and Supply Australia,
setting the professional agenda for the Australasian region. A well-
regarded speaker, he has presented widely at national and international
academic and trade conferences, delivered plenary speeches and con-
ducted master class workshops. He is a member of the review panels of
several international journals.
David Kelsey is a senior administrator at York St John University Business

School, where received his postgraduate qualifications in International
Studies. His research experience spans international mining and extrac-
tive industries focused on the political economy of the international
mining industry, in particular examining labour relations, trade union-
ism and corporate social responsibility.
Wayne Lonergan was Corporate Finance Partner at Coopers Lybrand

(now PricewaterhouseCoopers) for 23 years, prior to setting up an inde-
pendent valuation practice in January 2001.With over 35 years’ experi-
ence in Corporate Finance and Valuations, Wayne has been responsible
for numerous assignments in both public and private companies as well
as various government departments with particular emphasis on valu-
ations and consequential loss assessment. He has also been a regular
influential contributor to professional literature, and has held numer-
ous and senior roles in the Securities Institute of Australia, including
three years as National President and Chairman of numerous subcom-
mittees on capital market-related matters.
Svetlana Maslyuk is Lecturer in Economics at the School of Business

and Economics, Monash University. Her research interests include
energy and natural resource economics, economic development and
sustainable energy consumption, and applied time series economet-
rics. She holds a Ph.D. in Economics from Monash University, and is
an esteemed contributor to journals such as Energy Policy and Energy
Economics.
Simon Mollan is Lecturer in International Business at the University

of Liverpool Management School. His research interests include the
business history of the international mining industry, the develop-
ment of international financial centres, African economic development
Notes on Contributors xiii
and international taxation. He was previously a research associate at

the Institute of Hazard, Risk and Resilience at Durham University, and
before that taught International Business at York St. John University
Business School.
Les Nethercott is Associate Professor at the School of Accounting, La

Trobe University, where he lectures on taxation. He has co-authored
the Australian Society of Accountants CPA Advanced Taxation Module
in the CPA programme as well as the Australian Taxation Study Manual
and Master Tax Examples (CCH Australia). Les publishes extensively
on Taxation and Financial Accounting in refereed journals both in
Australia and abroad. He also conducts the International Accounting
Study Program for the School of Accounting, which visits several large
companies and regulatory bodies in Europe and England.
Daniel Pambudi is a consultant (data analysis) for Livestock

Information, Sector Analysis and Policy Branch, the Food and Agriculture
Organisation of the United Nations. His research is to disaggregate the
world livestock economic value, land use and gas emissions into more
detail livestock sectors for updating the world livestock Computable
General Equilibrium (CGE) model. He also estimated tourism contribu-
tion to the Australian state/territory economy including state/territory
tourism satellite account 2003–04, 2006–07, 2007–08 and 2008–09.
Daniel has a Ph.D. in CGE modelling from the Centre of Policy Studies,
Monash University.
Grantley Taylor worked for several years in the mining industry and
the Australian Taxation Office before joining Curtin University in
2005. He completed his Ph.D. in 2008 and has published extensively
and successfully supervised several postgraduate students. His research
interests include governance, disclosures, issues relating to the resources
industries, taxation and financial accounting.
Greg Tower is a research professor at the School of Accounting, Curtin

Business School. He is a Certified Public Accountant with a research
doctorate, and has successfully obtained external grant funding of
over $500,000. Greg has supervised numerous Doctoral, Masters and
Honours students. He has published over 130 research articles in jour-
nals such as International Journal of Accounting, Journal of Accounting and
Public Policy, Abacus, Higher Education, British Accounting Review, Advances
in International Accounting, Financial Accountability and Management, and
Accounting and Finance.
xiv Notes on Contributors
Tom Valentine graduated from the University of Sydney with a B.Ec.

(first class honours and the university medal) and from Princeton
University with an MA and Ph.D. He has taught in a number of Australian
universities including the Australian National University and is cur-
rently Visiting Professor, Macqauire Graduate School for Management.
He has published 16 books and around 100 papers in refereed journals.
Tom played a major role in the Campbell Inquiry of 1979–81, a contri-
bution which was recognised in the 2006 Presidential Address of the
Economic Society as one of the major contributions of economists to
economic policy over the last 30 years. He was also the joint author of
the Study of New South Wales Taxes on Financial Transactions (1985) and
in 2000 acted as consultant to the ACCC on credit cards. In 2005 he
chaired a committee to evaluate the performance of the Telstra corpo-
rate treasury. He has also acted as consultant to government enquiries
and many financial organisations and as an expert witness in numerous
financial cases. Tom is listed in Who’s Who in Australia and Who’s Who
in Australian Business. In 2006 he was named a legend by the Financial
and Treasury Association.
Robert Walker is Honorary Professor of Accounting at the University

of Sydney. He is a third-generation charted accountant and has been
an important commentator in the debate on privatisation of state-
owned assets and public private partnerships in Australia. His account-
ing research has focused on accounting disclosure in the public sector
as well as feral accounting in areas such as infrastructure and SGARA
assets and provisions, commitments and site restoration costs. He has
been a regular contributor in journals such as Abacus and Australian
Accounting Review.
Overview
0.1 An overview of the business history of the

international mining industry
This chapter surveys the international business history of mining from

the mid-nineteenth century to the present in order to put into context
the development and the economic contribution of the mining sector.
While necessarily wide-ranging, the chapter focuses on the following
areas. The growth of mining business is discussed with reference to
production, prices and other economic indicators. The development
of mining businesses is then surveyed from the first era of globalisa-
tion (from the mid-nineteenth century to 1914), through the twentieth
century, and to the present. The issue of consolidation in the sector
through merger and acquisition is considered, as well as the role of
state-owned enterprises (SOEs) and cartels. The organisational forms of
mining enterprises are discussed with reference to the capital require-
ments of mining. What emerges is a story of a dynamic business sector
that has weathered the storms of wars, recessions and nationalisations.
From small-scale prospectors in the nineteenth century to networked
firms coordinated by financiers in the early nineteenth century, to the
large-scale multinational firms seen today, mining companies have
made a sustained contribution to growth in the world economy, a posi-
tion which they look set to retain.
0.2 The role of mining in the Australian economy
This chapter examines the role of the mining industry in the Australian
economy. First, it indicates the contribution that the industry makes to
economic aggregates such as gross domestic product (GDP), investment,
1
2 Contemporary Issues in Mining
employment, exports and the current account balance. Second, it

attempts to measure the indirect (multiplier) effects of the mining
industry. The conclusion is that the mining industry is the major
driver of the Australian economy. A final section considers the mineral
resource rent tax.
0.3 Transportation issues of Australian coal and iron ore
The Australian export minerals industry is a leading user of transport

and logistic services. Australia is the largest exporter of black coal in
the world and a significant exporter in iron ore. Both ores are shipped
by rail from inland mines to huge bulk sea ports. Black coal is exported
from the east coast whilst iron ore is exported from northern ports on
the west coast. In both cases, railways are used as the critical transport
link from the mines to the ports, and are seen as the choke point along
the total supply chain for these export commodities. The ownership
and control of these railways are completely different, which makes it
an interesting study. Australian export coal flows are suffering from dis-
parate ownership of mines and railways, and calls for dominant supply
chain participants to improve these flows are currently being expressed
in Australia. If Australia changes its export coal supply chains to fall in
line with its Chinese counterparts, it will become more globally com-
petitive. The export iron ore flows are some of the most efficient in the
world. The key mining companies have owned and built these railways
over the past 40 years, but recent regulatory interference has distorted
this ownership, enforcing regulations that will not tolerate restrictions
to use of these privately owned railways by other mines operating in
the area.
Suggested improvements to the current supply lines of coal from both
the Queensland and Hunter regions of Australia to China’s main coal
ports of Caofeidian, Jintang and Qinhuangdao are discussed. These
three ports handle up to 80 per cent of China’s coal carrier volume and
are linked from the pit to port to control the coal flows.
0.4 MRO procurement: best practices framework for

capital equipment
Maintenance, repairs and operations (MRO) of capital equipment is a

very critical component of asset management and sustainable opera-
tions. Increasingly short product life cycles affect the availability of
parts and components for continued MRO of plant and equipment.
Overview 3
Procurement activities must consider the product life cycle of expen-

sive industrial products like plant and machinery in terms of contin-
ued supply and replenishment of spare parts. In continuous operations/
manufacturing industries, the production process must operate without
disruptions. Procurement is suggested as a strategic tool in risk manage-
ment, spend management and total costs reduction, and is crucial in
sustaining competitive advantage within the product life cycle. This
chapter investigates the concept of procurement activities during the
product life cycle stages of capital equipment and develops a best prac-
tices framework for reducing supply risk and sustaining spare parts
availability.
0.5 Practical problems in mining valuations
Whilst rarely applied in practice, the use of differential discount rates to

explicitly allow for the changing risk profile of a mining project is theo-
retically appealing. The severe financing constraints faced by success-
ful explorers seeking to achieve producer status create opportunities
for established producers with significant existing cash flows to unlock
substantial value by acquiring these successful explorers. The appropri-
ate assessment of the extent to which a control premium is payable
in such cases requires a proper appreciation of the liquidity concept
which has not received proper recognition and appropriate treatment
in a mining valuation context.
0.6 The tax accounting interface in

the mining industry in the context of IFRS
The interface of tax and accounting concepts has troubled account-

ants and tax advisors for many years. This issue has been complicated
with the decision by the Australian Accounting profession to adopt the
International Financial Reporting Standards (IFRS) in 2005. However,
the adoption of IFRS raises a number of issues for mining companies
concerning accounting the treatment of pre-production expenditure.
This chapter seeks to examine these issues and also the tax issues that
may arise from the adoption of IFRS in the mining industry.
0.7 Carbon tax: economic impact on the Latrobe Valley
On 24 February 2011, the Australian Prime Minister Julia Gillard

announced a new framework for establishing a fixed price on carbon and
4 Contemporary Issues in Mining
reducing the nation’s greenhouse gas (GHG) emissions as the long-term

policy response to climate change. The framework included a proposal
to implement a transitional carbon tax on producers from 1 July 2012.
The impact of this tax is likely to have substantial effects on Latrobe
Valley, which has the most GHG-intensive coal-fired power stations in
the country. The aim of this research is to provide an assessment of the
proposed carbon tax in the Latrobe Valley using the Australian TERM
(The Enormous Regional Model) Computable General Equilibrium
Model. The advantages of this model include its ability to deal with
the impacts of shocks that may be region-specific. We found that the
introduction of the tax is likely to cause a reduction in real GDP, wages
and employment both regionally and Australia-wide.
0.8 Permissive and uninformative reporting of

clean-up costs
The Australian mining industry does not have a good record in report-
ing on the future costs of restoring mine sites. This chapter notes that
Australian miners have often failed to comply with accounting stand-
ards and statutory requirements for reporting on their (domestic) obli-
gations, and discusses recent reporting practices in this area and their
shortcomings. It briefly reviews some recent proposals for the issue of
an international accounting standard dealing with ‘stripping costs’.
Finally, it offers some recommendations about how practices could be
improved – particularly for those entities engaged in mining activities
at a number of sites or in different countries. The merits of capitalising
projected costs of site rehabilitation, along with the capitalisation of
mine development expenditure, are questioned.
0.9 Capital management determinants of financial

instrument disclosures in the extractive industries:
evidence from Australian firms
This chapter investigates the communication patterns of Financial

Instrument Disclosures (FIDs) within the annual reports of Australian
listed extractive resource companies over a four-year longitudinal
period (2003–2006). Statistical analysis demonstrates that the capital
management score of firms, comprising capital raisings, the occurrence
of mergers and acquisitions and international operations, is positively
significantly associated with FID patterns. Firm size, profit and the level
of firm borrowings are also statistically positively related. In contrast,
Overview 5
overseas stock exchange listing of firms is negatively significantly asso-

ciated with FID patterns. This chapter contributes to an understanding
of the extent, trends and rationale behind resource firms’ FID disclo-
sure practices in Australia.
0.10 Transnational corruption and conflict minerals
The global mining business faces a series of interrelated financial crime

risks, including transnational corruption, organised crime and con-
flict minerals. These legal and reputational risks have become more
important because of the new international standards governing cor-
porate behaviour and the rising expectations of governments, investors
and civil society. There is a trend of increased active enforcement of
anti-bribery laws in countries such as the United States, Switzerland,
Germany and the United Kingdom. The major implication is that coun-
try risk and structural risks inherent in the mining business must be
addressed by comprehensive due diligence systems. Another challenge
is conflict minerals, which have had a devastating impact on resource-
rich developing countries in Africa. The enactment of a new US law to
curtail conflict minerals will impose significant new risks on mining
companies which are listed or traded on US securities markets.
Part I
Strategic Perspectives
1
An Overview of the Business
History of the International
Mining Industry
Simon Mollan and David Kelsey
1.1 Introduction
Anatomically, modern humans have existed at least for the last 200,000
years. For 95 per cent of the history of our species, up until about 10,000
years ago, human technology was limited to what could be made out of
bone, stone, wood and other easily rendered organic matter. Then, in
the period archaeologists refer to as the Bronze Age, humanity began to
make tools out of metals. From then on the relationship between min-
ing, metals and technology and the contribution to economic growth
have been intimately connected. While complex, the impact of this
relationship in its broadest sense is fairly clear: without mining the
development of technology would have been slow to non-existent, the
development of a monetary economy would probably not have hap-
pened at all and the main sources of fuel (coal and later oil) and raw
materials required for industrial activity would not have been obtain-
able. Without mining there could not have been an industrial revolu-
tion, and from that stems, in part, the basis of all economic activity
which has led to the economy of the present (Diamond, 1997; Clark,
2007). Minerals and fuels extracted by mining are an essential part
of the global economy – without them there would and could be no
cars, computers or consumer durables; construction techniques would
have been different and in many respects more limited; and buildings
themselves would have been harder to light and heat. It is therefore
true to say that mining enterprise has played and continues to play a
major role in shaping the history of humanity, and its significance and
impact is and has been enormous. Understanding the history of mining
9
10 Simon Mollan and David Kelsey
enterprise is therefore important, because the decisions, choices and

developments of mining enterprises of the past have laid the founda-
tions for the corporations of the present.
As an academic discipline, business history has been heavily influ-
enced by the pioneering work of Alfred Chandler and the related eco-
nomic theory of transaction economics (Chandler, 1990; Williamson,
1985). The Chandlerian perspective on the development of the modern
corporation has stressed the need for an understanding of the econo-
mies of scale and scope that were increasingly exploited by firms in
order to reduce unit costs and establish market dominance. The insights
of transaction-cost economics that have underpinned this approach
have illuminated much about the logic of the firm at an economic level,
in particular about how large multinational firms emerge and are sus-
tained, through the vertical integration of productive functions, and
through horizontal expansion both national and international. These
ideas might feed the notion, with reference to mining enterprises, that
the development of the international mining sector – dominated as it
is now by a few very large corporations – was the inevitable result of
an inexorable process of exploration and development, followed by cor-
porate consolidation, merger, acquisition and amalgamation, with the
resulting behemoths being able to exploit economies of scale and scope
to coordinate the international movement of capital and diffusion of
technology, and to dominate markets consequently. This is, however, a
problematical and overly deterministic view of the development of busi-
ness and a specific industry. Constraints, informational limitations and
diversity of choices all had the ability to shape the outcome of business
activity. For example, the work of Schmitz highlights that ‘technologi-
cal pressures rather than transactional considerations have been more
significant in the mining and smelting sectors’ (Schmitz, 1986: 292).
This chapter will suggest that a further factor must also be considered,
namely, the features of contemporary capital markets and the nature of
risk management as mediated through the corporate form, in particular
before 1914. The pre-1914 British capital market – which was the main
source of investment in the global mining business – supplied capital in
large volumes to many thousands of companies, rather than concentrat-
ing capital in a small number of companies from the outset. The reason
for this is that the opportunities and technologies required to develop
mining operations were, respectively, speculative and sufficiently basic
to mean that alternative modes of knowledge and risk management
could be used, namely, the ‘Free Standing Company’ (FSC) (Wilkins,
1989). As a result, a great number of relatively small companies were
An Overview of the International Mining Industry 11
formed to probe for mining opportunities. However, many FSCs were

linked together in networks which, while only loosely integrated, never-
theless, can be considered as proto-multinationals. Following changes to
the nature of the international economy in the course of the twentieth
century, and by exploiting new opportunities and taking advantage of
innovations, the present international mining sector emerges from this
proto-multinational era. Large-scale multinational enterprises (MNEs)
are formed through merger and acquisition to exploit both economies
of scale and scope in both horizontal and vertical vectors of integration:
the emergence of both cartels and state-owned enterprises (SOEs) in the
mid-twentieth century as a result of nationalisation during decoloni-
sation and – latterly – the rapid growth of China. During the middle
years of the twentieth century, the rapidity of growth of the mining
industry slowed somewhat before resuming more rapid growth in the
last 25–30 years. During this later period, large mining MNEs have once
again numbered among the world’s largest corporations, often operat-
ing alongside and in partnership with SOEs. This chapter therefore pro-
vides a survey of the development of the modern business of mining
from 1850 to the present, and is organised as follows. The first section
establishes the patterns of production in non-ferrous metal mining from
1850 to the present. The second section examines the development of
mining corporations from 1850 to 1914. The third section explores the
amalgamations of mining companies and the emergence of cartels and ,
we have decided to exclude coal mining as well as oil and gas extraction;
instead, our focus is on non-ferrous metal mining companies.
1.2 Production and prices
As Table 1.1 indicates, there has been a significant and substantial increase
in the world production of non-ferrous metals between 1851 and 2009.
The combined tonnage produced of bauxite, aluminium, chromium,
copper, lead, manganese, nickel, tin, tungsten and zinc increased by
1,180.63 per cent between 1851 and 1900, by 649.31 per cent between
1900 and 1950 and by 1381.5 per cent between 1950 and 2009. Between
1851 and 2009, the overall increase in the measured output of the met-
als listed above was well over 10,000 per cent. Though the two world
wars and the great depression dented the outward expansion of produc-
tion, it is clear that in the last century and a half the mining industry
has continued to grow in response to the needs of the world economy.
The great surge in the production and consumption of minerals from
the 1850s onwards was because of the process of industrialisation in
Table 1.1 World production of selected non-ferrous metals, 1851–2009 (thousand tonnes, except where stated)
Gold Mercury Silver

(tonnes) Bauxite Aluminium Chromium Copper Lead Manganese (tonnes) Molybdenum Nickel (tonnes) Tin Tungsten Zinc
1851–1860 1,897.2 – – – 665.80 1,239.60 – 18,375.0 – 0.0 9754.0 192.20 – 724.4

1861–1870 1,669.7 – 0.01 – 980.60 2,412.10 – 27,505.0 – 1.3 12,721.0 251.20 – 1,344.6
1871–1880 1,578.7 – 0.01 – 1,283.60 3,373.10 35.0 35,577.0 – 5.3 20,694.0 393.40 – 1,889.7
1881–1890 1,581.8 20.9 0.35 – 2,252.50 4,748.10 1,053.0 39,544.0 – 11.1 31,053.0 583.20 – 3,029.1
1891–1900 3,142.5 268.5 26.62 205.5 3,763.40 7,060.80 4,929.0 39,746.0 – 59.1 50,408.0 812.80 – 4,232.0
1901–1910 5,677.5 2,069.0 176.9 791.5 6,818.70 9,868.10 13,231.0 36,173.0 0.9 149.9 56,808.0 1,030.70 27.8 6,670.1
1911–1920 6,363.5 5,600.0 937.0 1,684.5 11,094.30 10,926.30 16,895.0 37,813.0 5.8 353.1 56,847.0 1,271.60 210.7 10,211.7
1921–1930 5,674.4 13,341.0 1,880.0 2,457.0 13,585.30 14,460.00 21,015.0 38,607.0 9.2 366.5 74,445.0 1,527.30 75.7 12,930.0
1931–1940 8,654.0 25,361.0 3,862.0 3,124.0 16,242.00 14,773.00 13,231.0 37,450.0 91.2 840.0 64,500.0 1,569.50 153.6 15,383.0
1941–1950 7,767.0 75,950.0 12,774.0 5,820.0 23,263.00 14,443.00 19,200.0 56,640.0 178.3 1,468.0 56,300.0 1,396.60 211.6 19,289.0
1951–1960 8,643.0 183,157.0 31,117.0 12,740.0 32,910.00 21,645.00 50,175.0 65,630.0 293.7 2,352.0 62,100.0 1,705.70 373.3 29,522.0
1961–1970 12,304.0 411,135.0 70,932.0 18,540.0 52,910.00 28,427.00 68,520.0 91,165.0 564.1 4,569.0 81,970.0 1,867.90 377.4 43,874.0
1971–1980 10,369.0 788,449.0 132,322.0 29,160.0 72,416.00 34,906.00 92,200.0 82,713.0 909.9 7,204.0 99,290.0 2,202.90 447.4 58,301.0
1981–1990 7,242.0 907,900.0 162,200.0 32,730.0 81,820.00 33,600.00 86,200.0 64,200.0 1,032.6 8,262.0 136,500.0 2,035.00 470.8 66,410.0
1991–2000 10,289.0 1,171,000.0 210,900.0 40,190.0 108,390.00 30,230.00 72,810.0 20,610.0 1,236.2 10,760.0 158,000.0 2,176.00 384.5 75,080.0
2001–2009 11,190.0 1,583,000.0 289,100.0 50,420.0 132,600.00 30,790.00 92,370.0 13,730.0 1,568.0 13,070.0 181,800.0 2,440.00 505.0 91,010.0
Source: Schmitz, 1979 and Kelly and Matos et al., 2010.

Western Europe and North America, when mining was a consequence

and fuelled further growth. Similarly, the rise in production and prices
in recent years has been fuelled by rapid economic development in the
‘emerging markets’, especially India and China. Table 1.1 also indicates
something of the expansion of the range of metals mined, a list which
has expanded considerably as the productive processes of modern man-
ufacturing have required metals such as cobalt, coltan, platinum and
others, many of which are vital to the production of electronic circuits
used in computing and telecommunications.
Figure 1.1 indicates the price movement of selected metals since 1851.
While there have been upward price movements in recent years due to
increased demand, price levels are not uniformly above their historical
trend. Both zinc and nickel prices are below their historical high levels,
while tin is quite markedly below it. Copper, however, is dramatically
above its historical price levels. The relationship between price, produc-
tion and demand is not always a straightforward one.
Take, for example, Figure 1.2. This indicates that there has been a
general upward trend in tin output, despite being disrupted by war and
recessions. However, the price rises of the last decade are nothing com-
pared to the rise in prices between the mid-1930s and circa 1980. This
was in part connected to the creation of tin cartels in the late 1920s
and early 1930s, which sustained prices for the next 50 years or so, the
cooperative actions eventually ending in the mid-1980s (Jones, 2005).
However, the volume of tin produced has continued to rise notwith-
standing fluctuations in price and, by extension, corporate revenue
from tin sales. While overall demand for metals has increased fairly
consistently since the 1960s, the ability to extract metals from lower
ores and the creation of substitute materials (e.g., the use of sand to
create optical fibres for telecommunications connections, rather than
using copper wire) both had exerted a downward pressure on produc-
tion and on prices (Mikesell and Whitney, 1987), meaning that the
upward pressure on both must have been due to increases in demand
conditions, price fixing or a mixture of both. Only recently with the
growth of the emerging markets have prices soared upwards again. The
voracious appetite of China for copper to equip the rapidly expanding
Chinese electricity distribution network, for example, is one factor that
has resulted in copper prices recapturing the highs of the pre-Global
Financial Crisis era. China’s consumption of copper has also resulted in
an important market for copper trading emerging in Shanghai, to com-
plement the more established market of the London Metal Exchange
(Financial Times, 2 February 2011).
180000 Copper US$ per tonne 2009 prices Nickel US$ per tonne 2009 prices
160000
160000
140000 140000
120000 120000
100000 100000
80000 80000
60000 60000
40000 40000
20000 20000
0 0
1851
1858
1865
1875
1879
1886
1893
1900
1907
1914
1921
1928
1935
1942
1949
1956
1963
1970
1977
1984
1991
1998
2005
1851
1858
1865
1875
1879
1886
1893
1900
1907
1914
1921
1928
1935
1942
1949
1956
1963
1970
1977
1984
1991
1998
2005
5000 Zinc US$ per tonne 2009 prices 50000 Tin US$ per tonne 2009 prices
4500 45000
4000 40000
3500 35000
3000 30000
2500 25000
2000 20000
1500 15000
1000 10000
500 5000
0 0
1851
1858
1865
1872
1879
1886
1893
1900
1907
1914
1921
1928
1935
1942
1949
1956
1963
1970
1977
1984
1991
1998
2005
1851
1858
1865
1872
1879
1886
1893
1900
1907
1914
1921
1928
1935
1942
1949
1956
1963
1970
1977
1984
1991
1998
2005
Figure 1.1 Comparative prices (five-year moving average), selected metals, 1851–2009
Source: Schmitz, 1979 and Kelly and Matos, 2010.
$50,000 350000.0
Tin production (tonnes)
$45,000
300000.0
Tin price (2009 US$ per
$40,000
tonne)
$35,000 Value of tin produced (2009 250000.0
US$ m)
$30,000
200000.0
$25,000
150000.0
$20,000
$15,000 100000.0
$10,000
50000.0
$5,000
$0 0.0
1869
1875
1881
1887
1893
1899
1905
1911
1917
1923
1929
1935
1941
1947
1953
1959
1965
1971
1977
1983
1989
1995
2001
2007
Figure 1.2 Tin production and price, 1869–2009
Source: Schmitz, 1979 and Kelly and Matos, 2010.
As implied also in Figure 1.2, Figure 1.3 indicates the close relation-
ship between increases in production of non-ferrous metals and the
expansion (and cyclical contractions) of the world economy between
1950 and the present day. Given the central importance of raw materi-
als to industrial production, this is unsurprising. Copper is an example
of one metal that is critical to economic activity, as the ‘red metal’ is
a vital component in electrical devices and the creation of electricity
distribution networks.
1.3 Development of the international mining business

to 1914
European non-ferrous metal mining took place up until the nineteenth

century in areas it had been mined since medieval times. The technol-
ogy used for this mining had not changed substantially for centuries.
However, the use of hydraulic engines in the eighteenth century and
then steam engines in the course of the nineteenth century began to
change what was technically possible. The advent of rock drills in the
nineteenth century, for example, was also a significant boost to mine
productivity. The first steam-powered rock drills became available in
the 1850s, and were followed in 1863 by Alfred Nobel’s invention of
dynamite. These inventions had a significant effect on the structure
0.25 0.08
0.2 Non-ferrous 0.07

metals
0.06
0.15
0.05
0.1
0.04
0.05
0.03
0
0.02
1950
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
–0.05 0.01
–0.1 0.00
Figure 1.3 Growth in world non-ferrous metal production and world GDP,
1950–2008
Source: Schmitz, 1975; Kelly and Matos, 2010; Maddison, 2010.
of the international mining business. First of all, the new techniques

meant that mining was possible in areas and rock which previously
had been impossible to mine. This opened up opportunities for new
mines. In turn this increased competition which largely shifted the
sites of production away from the traditional European mines, and
towards new mines in the Americas and, eventually, in Australia and
Africa. Copper was produced in mines in the southwest of England
in the eighteenth and nineteenth centuries, but once there were dis-
coveries elsewhere – notably in Rio Tinto in Spain and also in North
America – the English mines became uncompetitive, triggering migra-
tion overseas of miners with expertise in mining copper ore. The skills
and knowledge of European miners were an essential factor in allowing
these new opportunities to be exploited – and created a vital techni-
cal link between European companies and the development of mines
overseas. It should not be forgotten that these companies also used
local indigenous labour, often under incredibly harsh conditions, at
the same time as actively preventing the skills transfers and promotion
of indigenous workers which might now be considered as a positive
benefit to be derived from the expansion of multinational business
(Temple, 1972; Prain, 1975).
At least initially, however, the new opportunities afforded by the
gold discoveries of the nineteenth century were associated with labour
means of extraction, often under terrible conditions, but undertaken by

migrants voluntarily, at least in the United States. Take, for example, the
early development of the Californian gold fields in the mid-nineteenth
century (giving rise to the famous ‘49ers’), which followed the discovery
of gold in 1848, and saw men risking dangerous passage to California
to engage in panning for gold. This involved sorting through pay dirt
from streams and rivers using a variety of relatively simple machines
and techniques. At a time when labourers in the east of the United
States were paid just US$1 per day, panning could hope to yield as much
as US$20 per man per day. Nevertheless, the work was hard and the
communities which grew up around the nascent mining industry were
riddled with gambling, drinking and other vices. As Ronald Prain put it
(himself later a Chairman of Zambian-based mining companies):
Companies were formed and broken overnight as prospectors fought

for their claims and for financial backing for their ventures. Bogus com-
panies flourished; unscrupulous speculators thrived; corruption was
rife; and nearly every mining enterprise became entangled in a web of
litigation as rivals contested titles and shares. Under any circumstances
mining is a rugged business and it was never tougher than in the early
days of the great boom in North America. (Prain, 1975: 32)
Even as gold discoveries in the United States multiplied – including the

famous Comstock Lode in Nevada, but also including other finds in
Colorado, Idaho, Montana, Dakota, and in British Columbia in Canada –
the findings on the surface were quickly exhausted. Getting at the
gold beneath the ground was not something which prospectors could
undertake, at which point organised companies began to be formed as
vehicles to supply the high capital cost required to undertake under-
ground mining. Not only was extraction from underground expensive,
but in order to separate the metals (gold and silver, as well as lead, zinc
and copper) from the ore, smelting had to be undertaken, which again
required technical expertise and capital costs to build the necessary
facilities (Temple, 1972). By the time of the the final gold rush of the
nineteenth century to the Klondike in Canada, mining had matured as
an industry and had distinct organisational forms and relationships to
the capital markets.
In 1886 gold was discovered at Witwatersrand in the Transvaal. This
was, as is widely acknowledged, critical to the development of min-
ing business, and on which there is an extensive and rich literature.1
Additionally, discoveries of gold in Australia in 1851 (which contributed
to the growth of the colony, boosting its population, and fuelling the
need for all kinds of goods, much of them imported from overseas), as
well as less significant discoveries in India and elsewhere prefigured a
boom in mining investment. Once again there is a rich literature asso-
ciated with these developments, especially with reference to the share
mining bubble of the 1890s where dubious company promoters ramped
the securities markets for shares of companies with little or no realistic
prospect of producing gold in order to reap the benefit for capital gain.
The spuriousness varied from company to company. In some cases there
was clearly fraudulent intent on the part of the directors and the com-
pany promoter (Phimister and Mouat, 2003). In other cases, however, it
was informational limitations which encouraged inappropriate invest-
ments (Mollan, 2009). Thus between 1875 and 1913 the total British
foreign direct investment (FDI) in non-ferrous metal mining companies
rose from £11.3 million to £240.0 million, while the number of compa-
nies rose from 39 to over 900. However, the overall number of mining
companies launched – many with no chance of ever becoming going
concerns – was over 8,000 in this period (Harvey and Press, 1990). The
effect was to pour capital into the mining sector. While much of it was
wasted, there is good evidence to suggest that the lower costs of raising
capital caused by the enthusiasm for mining shares brought allowed
workable mines to be developed. These companies have often been
considered as FSCs following the pioneering work of Mira Wilkins in
the field of the early multinationals (Wilkins, 1989). However, from the
outset it has been noted that many companies were linked together by
common directors, company promoters, mining engineers and cross
shareholding, or some combination of these organisational ties (Harvey
and Press, 1990; Mollan, 2009). This is an important structural feature,
because it allowed risk to be managed carefully by those at the fulcrum
of what were often very complex organisational structures. While these
insiders certainly manipulated the market for their own ends, the vagar-
ies of technical evidence on the basis of which investment was made
did not often allow for large amounts of capital to be safely invested.
Instead, by using the vehicle of the FSC, risk was spread into discrete
firms. If a prospecting company hit a rich vein of ore, then the share-
holders would find that there would be a genuine capital gain (aside
from general market increases). Moreover, as the mine was developed,
new capital was often sought, making the existing shareholders rich as
the restructuring often issued them with new shares. Mining invest-
ment before 1914 was, then, a little like buying a lottery ticket. If the
firm failed then only a small amount of capital was lost relative to the
plot of land that the specific company was exploring. While this might
ruin individual investors, it was not enough to sink the insiders in the
market – especially those people at the centre of the networks of com-
panies. Thus the structure of the Victorian capital market for mining
securities before 1914 was essential to the growth of the international
mining business. One firm of mining engineers – John Taylor and
Sons – was at the centre of one such network of interlinked companies.
In 1910 the total value of the capital in this group has been estimated
at £5.59 million in paid-up capital. An atomised collection of firms, the
larger companies in this group would be seen as important. However,
in today’s prices, the value of the whole group would be £523 million,
making it at least comparable to the world’s larger mining companies of
today (Mollan, 2004). It was also in this period that corporations with
names familiar today began to emerge (see Table 1.2).
1.4 Amalgamation, cartels and SOEs:

the mining industry in the twentieth century
The history of the international mining industry in the mid-mid-mid-

century is dominated by the amalgamation of firms into larger verti-
cally and horizontally integrated multinational mining corporations,
the development of cartels and the emergence of. The expansion of
firms to form multinationals was in large part connected to increas-
ing capital costs associated with technological advancements which
followed the depletion of easy to access ores. As ore bodies declined in
richness, extraction became more difficult and more capital intensive.
The discovery of porphyries (disseminated copper deposits), for exam-
ple, is a case in point. The extraction of copper from such low-grade
ore required technical capacity and a large-scale operation. Where at
the beginning of the twentieth century there were around 3,000 cop-
per mining companies in the United States alone, the world supply of
copper was in fact derived from only 250 mines, of which just 58 were
in the United States, and as much as three-fifths (Prain, 1975). This
trend progressed in the twentieth century when ‘the capital required
to open up any sizeable mine [was] often beyond the means of any one
company or group of companies, and large international consortia have
to be formed backed by the most powerful financial institutions before
such a project [could] be put to development.’ (Prain, 1975: 31) The his-
tory of Rio Tinto is a good example of the development of large-scale
multinationals. Formed in 1873 to invest in copper mines in Spain, Rio
Tinto quickly established itself as a major world producer of both copper
Table 1.2 Largest mining companies in the world, 1912–2008 (ranking among all firms in brackets)
Rank 1912 1956 1992 2008
1 Anaconda (5) National Coal Board (10) Ruhrkohle (81) BHP Billiton (21)
2 De Beers (12) Anaconda (55) British Coal (219) Vale do Rio Doce (25)
3 Rio Tinto (13) American Metal (67) RTZ (258) Rio Tinto (30)
4 Utah Copper (22) ASARCO (77) CRA (370) China Shenhua Energy (52)
5 Phelps Dodge (23) Kennecott (84) De Beers (392) Anglo-American UK (81)
6 ASARCO (24) International Nickel (110) Zambia Industrial (457) Xstrata (93)
and Mining
7 Rand Mines (39) Phelps Dodge (113) Codelco-Chile (462) Barrick Gold (222)
8 Crown Mines (40) Anglo Platinum (246)
9 International Nickel (44) China Coal Energy (311)
10 Calumet and Hecla (49) Goldcorp (327)
11 Consolidated (52) Eurasian Natural Resources (364)
Gold Fields
12 Harpener Bergbau (53) Impala Platinum (374)
Source: 1912, 1956 and 1992 data are taken from Schmitz (1995). 2008 data taken from the FT Global 500, 2008 (http://www.ft.com/reports/
ft5002008). Ranking for 1912 is based on stock market valuation; rankings for 1956 and 1992 are based on gross sales; ranking for 2008 based on market
capitalisation.
and sulphur. In the period before 1914 the company was very success-
ful, this being reflected in its share price which exchanged ‘between
nine and 19 times the nominal value in the first decade of the century’
(Harvey, 1981: 2). Diversification then followed through investments
made around the world but especially in Africa. Rio Tinto eventually
pulled out of Spain in the 1950s connected to problems with Franco’s
regime (Jones, 2005). Over the next few decades the firm continued
to expand through merger and acquisition. In 1962 it merged some of
its assets with Consolidated Zinc to form CRA Ltd. This firm initially
diversified into the related areas of oil and gas as well as cement and
chemicals, though these activities were discontinued in the late 1980s.
Around the same time Rio Tinto acquired BP’s mining interests (Jones,
2005). In 1995 Rio Tinto Zinc (RTZ) and CRA were unified under a sin-
gle directorate spanning two incorporations – Rio Tinto Plc (domiciled
in Britain) and Rio Tinto Ltd (based in Australia). This dual structure
in many senses resembles the relationship between the Central Mining
and Investment Corporation (domiciled in London) and Rand Mines
(South Africa), the holding companies for the Wernher, Beit and related
mining finance houses which owned mining companies in South
Africa in the early twentieth century (Cartwright, 1965). The same type
of arrangement is also present for BHP Billton, itself a product of merg-
ers and acquisitions over the years. Amalgamation also accounts for
the other large-scale mining multinationals such as Anglo-American,
which has a long history stretching back to mergers in South Africa in
the first half of the twentieth century (Innes, 1984). In the late 1980s
Mikesell and Whitney (1987) observed that while there were thousands
of small mining companies they accounted for less than 25 per cent of
global output and tended to mine for precious stones where economies
of scale and scope were less important. This echoes the situation of a
century earlier in terms of the concentration sources of output, but a
significant difference in the intervening years has been the rising capi-
tal costs of extraction. While small companies could and continue to
engage in exploration, only those with access to large amounts of capi-
tal could develop commercially viable mines on a large scale, and this
was critical in driving the amalgamation process.
As some of these larger firms began to dominate markets, so came
the possibility of establishing cartels. The tin cartel established in the
interwar period has already been touched on, but the mid-mid-mid-
century also saw cartels in other areas, notably in copper (which was
rather short; 1935–39) and also aluminium, where four cartels existed
in the first half of the century, and intra-industry association possibly
indicates continuity in this respect at least until the 1980s (Litvak and
Maule, 1980). Established to ensure or at least influence price stabil-
ity, cartels ultimately are rent seeking through manipulation of supply.
For Aloca this proved to be problematical when it was forced to sell
off Alcan (its Canadian subsidiary) and aluminium plants to competi-
tors following an anti-trust ruling in the United States in 1945. (Jones,
2005). As time went on, however, obvious inter-firm cartels gave way to
more complex business relationships, in particular joint ventures (JVs).
JVs, while not necessarily or always anti-competitive, can be so under
some conditions, though they can also emerge to overcome barriers to
entry, pool knowledge or reduce political risk and, are especially of rel-
evance in the international mining industry, to enhance economies of
scale at different stages of production (Hennart, 1988).
A further trend in the mining industry beginning in the 1960s and
1970s was the growth of state-owned enterprises (SOEs). This was partly
fuelled by the nationalisation of corporations in many developing coun-
tries as they pursued socialist policies, though this trend was not con-
fined, with other notable SOEs in France where all stages of aluminium
production were under state control, as well as partial stages of alumin-
ium production in West Germany, Italy, Norway and Spain. In Finland,
copper mining and refining were state-owned, while both France and
Germany had state-owned iron ore production. Radetski (1989) identi-
fies four reasons why nationalisation/state ownership occurred: to pre-
vent private profiteering and to assure mineral supplies; to avoid the
difficulty of taxing mining activities, especially in a multinational con-
text; to safeguard strategically important sources of supply; and – a little
opportunistically – to take advantage of the immobility of resources.
After all, ‘copper, like gold is only where you find it’ (Prain, 1975: 4). By
the late 1980s, as much as half of the mineral production of the devel-
oping world was conducted by SOEs, while perhaps as much as one of
global production was similarly in state hands. There were benefits to
SOEs, notably, the guarantee of state support thus avoiding or mitigat-
ing the impact of cyclical variations in world markets, the ability to bor-
row at sovereign state rates (or have the state do so for the SOE) and the
increased power of the state to direct management to improve the social
outcomes of the mining business. SOEs also avoid political risk because
of their relationship with the state, though this also incurs (different)
political risks as the SOE remains part of the political firmament of the
country in which it is located (Mikesell and Whitney, 1987). There were
also negative aspects as well, most critically the breaking of vertically
integrated supply chains and greater inefficiency in management. This
latter point occurred as a result of a number of factors: that at the point

of nationalisation the outgoing ownership and management – who had
often not been well-compensated for the forced acquisition of their
assets and the loss of their positions – were not well-disposed to assist
the incoming owners and management, as well as the tendency towards
cronyism, especially in the developing world. Thus in the 1960s and
1970s, nationalisation was seen as a threat to mining multinationals.
This has dissipated over time, largely replaced by the trend towards JVs
between SOEs and multinational corporations, sometimes giving way to
privatisations. A good example of this is the case of Ashanti Goldfields
in Ghana (Handley, 2007). This firm had been a British-based FSC at
foundation, before being absorbed by the Lonhro group after decoloni-
sation (with the Ghanian government taking a minority stake) to being
nationalised after a military coup in 1972 (with Lonhro still holding
a minority stake), at which point it was certainly a SOE, though with
some characteristics of a JV. In 1996 it was fully privatised and follow-
ing a merger in 2004, it is now part of the Anglo-American group.
1.5 Conclusion
By the 1980s, the main international mining companies were compara-

tively well-known. Firms such as Alcoa, Kennecott, Rio Tinto Zinc (RTZ),
Alcan and Broken Hill Pty (BHP) dominated the field, and many of their
successor companies continue to do so (see Table 1.2). To this group of
corporations are joined the SOEs and JVs. While production, distribu-
tion and marketing had remained chiefly in the hands of large-scale
vertically integrated multinational mining companies, there remained
a role for the world’s two principal international metal exchanges – the
London Metal Exchange and the New York Mercantile Exchange’s com-
modity division (COMEX) – in setting reference prices, even despite the
relatively low level of trade on these exchanges in comparison with that
conducted by the major multinationals (Mikesell and Whitney, 1987).
The main securities markets for mining companies are in London and
Toronto, which is the dominant logic behind the proposed merger (at the
time of writing) between the London Stock Exchange and the Toronto
Stock Exchange. Despite being located in a country without major min-
ing operations, London remains an important location for the domicile
of mining companies, reflecting the advantages conferred by presence
close to a major international financial centre. This can be seen in Table
1.3 which indicates that rankings equal along with Canada some 9 of
the 40 largest mining companies choose to domicile there.
Table 1.3 Top 40 mining companies head office locations, 2010
Canada 9
UK 9 (7)
USA 5
China and Hong Kong 5
Australia 5 (3)
South Africa 3
Russia 1
Peru 1
Mexico 1
India 1
France 1
Brazil 1
Note: RTZ and BHP Billiton are listed in both Australia and the United
Kingdom and so are double counted in this table. Figures excluding these
companies are included in brackets.
Source: PWC.
As Table 1.2 demonstrates, mining companies are resurgent among

the world’s largest companies. In this second era of globalisation they
are enjoying dominance and a pattern of growth which they previously
enjoyed only before 1914. An increasing number of countries, notably
China, display a huge thirst for the resources to sustain high levels of
growth. This has brought Chinese companies, and others, to pursue an
economic interest in Africa in particular that has contributed to high
levels of growth there in the last decade or so (Churu and Obi, 2010),
and this in turn has sparked a keen debate about the impact and role
that mining plays in developing countries (Campbell, 2001; Soloman,
Katz, 2008).
The history of the international mining business has been, then,
intimately connected with world economic development and from the
industrial revolution to the present this has intensified. Multinational
mining enterprises have grown in scale, scope and technological
sophistication. Political and economic developments in the twentieth
century have resulted in new corporate formations through state own-
ership and JVs. Control of natural resources have been important sites
of contest in international relations, and vital to many areas of con-
temporary international political economy, encompassing everything
from economic and social development to environmental protection.
Mining multinationals have survived the exigencies of world war and
economic depression, decolonisation and appropriation, and have
recently enjoyed the benefits of a sustained commodities boom that
has been only dented by the recent Global Financial Crisis and world
recession. Despite harvesting a wasting asset, such resilience, longevity
and the essential relationship between natural resources and growth in
the world economy suggest that the future of the international mining
industry will continue to be both dynamic and important, just as its
past has been.
Note
1. This historiography deals with a number of debates relating to the structure
and nature of the mining industry in South Africa that cannot be entered
into here, but, nevertheless, are important to a full understanding of the his-
tory of mining in South Africa. For a summary of this field, see Richardson
and van Helten (1984).
References
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Strategy and Public Policy, Allen and Unwin, London.
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1910’, Economic History Society Conference Proceedings, 64–75.
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Mining Companies in the Anglo-Egyptian Sudan, 1900–13’, The Journal of
Imperial and Commonwealth History, 37(2), 229–248.
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British Overseas Investment, 1894–1914’, South African Historical Journal, 49,
1–26.
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London.
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1870–1930’, Economic History Review, 39(3), 392–410.
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259–282.
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London.
2
The Role of Mining in the
Australian Economy
Nigel Garrow and Tom Valentine
2.1 Introduction
Australia is a resource-dependent economy. The performance of

the mining sector affects all Australians either directly, for example,
through employment and share ownership, or indirectly, through
capital investment and tax revenue. Australia is a global leader in the
extraction and export of a range of key minerals, and its relationship
with the growing Chinese economy places it in a favourable position
for future economic growth. However, the Australian mining industry
faces a number of challenges as it seeks to realise the potential which the
country’s endowment of mineral wealth offers; these challenges range
from economic factors such as commodity prices and terms of trade,
resource availability, the determination of the economic rent which the
sector earns and its subsequent redistribution, to environmental factors
including government policy on carbon pricing. How these challenges
are tackled will affect the Australian mining industry’s competitive
position in the global economy. The performance of the mining sector
affects the performance of other sectors of the economy through its
influence on exchange rates and its demand for scarce resources within
the economy; these influences form part of the debate on Australia’s
so-called ‘two-speed economy’ or ‘Dutch Disease’. The management of
Australian economic policy, whether it is the government managing
fiscal policy or the Reserve Bank of Australia (RBA) managing monetary
policy, must be grounded on a deep understanding of the current and
historical performance of the Australian mining industry and assump-
tions about future prospects and their key drivers.
The second section of this chapter will be a descriptive analysis which
examines the direct impact of the mining sector on the Australian
27
28 Nigel Garrow and Tom Valentine
economy via its effect on such variables as exports, the current account
deficit, investment, the exchange rate and the terms of trade. It also
considers the role of the mining industry during the Global Financial
Crisis (GFC).
The third section presents a simple econometric model of the
Australian economy which takes account of the indirect as well as the
direct effects of mining in the Australian economy. It illustrates the
ubiquity of commodity prices in driving the Australian economy.
The fourth section discusses the proposed Mineral Resource Tax and
its possible effects on the mining industry.
2.2 Direct impacts of the mining industry
2.2.1 History of the Australian mining industry

The Minerals Council of Australia defines the ‘minerals’ industry as
covering the exploration and mining of minerals and the associated
minerals processing industry (Minerals Council of Australia 2010). The
S&P/ASX 300 Metals and Mining Index comprises the largest listed
companies that are classified as being in the metals and mining indus-
try in Australia.
The mining industry has played a central part in the economic devel-
opment of Australia dating back to the early settlers in the middle of
the nineteenth century. Battellino (2010) identified five major mining
booms:
1. The 1850s Gold Rush, centred on the gold fields of Victoria

2. The late nineteenth-century mineral boom, following the discovery
of new minerals in Western Australia, Queensland and New South
Wales
3. The 1960s/1970s mineral and energy boom. A major driver was the
development of the Japanese economy
4. The late 1970s/early 1980s energy boom, following the second oil
price shock
5. The current mineral and energy boom dating from 2005, coinciding
with the rapid development of China’s economy
There is one very significant difference between the economic circum-

stances of the current boom and all the previous ones; the current
boom is occurring during a period when the Australian exchange rate
is floating and this has been significant in explaining how the current
boom has affected the Australian economy.
The Role of Mining in the Australian Economy 29
2.3 The mining sector and the Australian economy
Mining and services to mining accounted for 6.85 per cent of the gross
domestic product (GDP) (measured in chain volume) in 2009–10 with a
value of $83.8 billion up from 6.44 per cent in 2003–04, just prior to the
start of the current commodities boom. Adopting this measure for the
size of the mining and related services sector, the rate of growth for this
sector during the past six years has averaged 3.9 per cent and ranged
from 1.9 per cent per annum to 8.5 per cent per annum. In 2009–10 the
growth rate was 2.5 per cent with the services to mining falling 10.4 per
cent and mining excluding services rising 4.0 per cent.
The resources sector (minerals and energy resources) share of goods
and services exports in 2009–10 was 51.5 per cent, up from 37 per cent
15 years earlier (1994–95) and from 23.1 per cent in 1982–83.
Since mining is such a significant component of Australia’s GDP
and, specifically, Australia’s exports, one would expect a high correla-
tion between Australia’s current account deficit and mining exports,
and that is the case. A regression estimated from EViews for the period
from 1969–70 to 2009–10 showed that mining exports (MINEX) were
negatively correlated with the Australian current account deficit (CAD)
whilst the exchange rate of the Australian dollar with the US dollar (FX)
was not significantly correlated with the current account deficit.
CAD = –1500.75 + 11110.77FX – 0.41MINEX R² = 0.78 d = 1.59

(–1.77) (1.60) (–4.31**)
The figures under the coefficients are t-values and asterisks indicate
the degree of significance. One asterisk indicates significance at the 5
per cent level and two asterisks indicate significance at the 1 percent
level. R² is the coefficient of determination and d is the Durbin–Watson
statistic.
During the nine-year period to 2008–09 the current account deficit
became worse whilst the level of mining exports increased (because
investment (I) was significantly higher than savings (S) during this
period), and as the exchange rate of the Australian dollar with the US
dollar increased.
In addition to its contribution to Australia’s exports, mining is a
significant and growing contributor to Australia’s new private capital
expenditure (NPCE). NPCE, Australian Bureau of Statistics Cat. No.
5625.0, refers to the acquisition of new tangible assets and includes
major improvements, alterations and additions. In 2009–10 mining,
which for this purpose includes petroleum and gas, spent $34,756
million on NPCE, which represented 32.8 per cent of total NPCE in
Australia that year; mining’s expenditure was down 8.5 per cent in
2009–10 compared with the prior year. Since just before the start of the
current boom in 2003–04 mining’s expenditure on NPCE has increased
by 255 per cent, accounting for 51 per cent of Australia’s total growth
in NPCE during this period. In 2003–04 mining accounted for 17.1 per
cent of total NPCE. Mining investment as a share of GDP increased
from 1.8 per cent in 2004–05 to 3.7 per cent in 2009–10. In 2009–10
approximately 25 per cent of mining’s NPCE was spent on equipment,
plant and machinery (with the remaining 75 per cent spent on build-
ings and structures), which represented a decline on the previous year
of 12 per cent, whereas mining’s expenditure on buildings and struc-
tures fell 5.7 per cent.
Mining capital expenditure from 1969–70 to 2009–10 (CAPEX) was
significantly positively, correlated with new MINEX with a t-statistic of
4.00. Mining capital expenditure is also correlated with its lagged value
with a t-statistic of 3.58.
CAPEX = –603.32 + 0.13MINEX + 0.53CAPEX(t–1)

(–2.78**) (4.00**) (3.58**) R² = 0.97 d = 1.07
From 2001–02 to 2009–10 new mining capital expenditure (CAPEX2)

continued to be significantly positively correlated with new mining
exports (MINEX2) with a t-statistic of 16.37.
CAPEX2 = –8029.56 + 0.30MINEX2 R² = 0.98 d = 2.98

(–4.83**) (16.37**)
The two-speed economy is a condition in an economy which arises

when one sector of that economy, often the commodities sector, grows
rapidly causing the exchange rate to rise and monetary policy to be
tightened and as a result causes the sectors not responsible for the dis-
ease to decline. During the current boom Australia’s currency has been
significantly negatively correlated with its current account deficit.
Although mining is a significant contributor to Australia’s GDP it
accounts for just 1.6 per cent (173,000 in 2009–10) of the employed
workforce; however, this represents a 60 per cent increase on 2003–04
when mining accounted for just 1 per cent of the workforce. In the
1970s and 1980s mining accounted for 1.3 per cent to 1.5 per cent of
the employed workforce.
Also, 72 per cent of the gross value of Australian mineral production

in 2007–08 came from Western Australia (48 per cent) and Queensland
(24 per cent), with all states enjoying growth in production since 2003–
04, during which time the total value of production increased by 129
per cent. By gross value three commodities (petroleum 26 per cent, coal
24 per cent, and iron ore and concentrate 19 per cent) account for 69
per cent of mineral production with the next largest product by value
being copper ore and concentrate at 6 per cent. In terms of export val-
ues black coal (metallurgical and thermal) accounted for 26.5 per cent
of Australia’s exports of mineral commodities by value in 2009–10 at
$36,410 million, iron ore and pellets 25.2 per cent, refined gold 9.5
per cent, crude oil and refinery feedstock 7.0 per cent, and liquefied
natural gas (LNG) (at $7,789 million) 5.7 per cent. A politically sen-
sitive mineral export for Australia is uranium; in 2009–10 Australia’s
exports of uranium oxide were $751 million. Australia possesses 34 per
cent of the world’s economic uranium resources recoverable at low cost
(below US$80/kg) (BMI 2010). The development of the Olympic Dam
project in South Australia is expected to result in a significant increase
in Australia’s uranium exports after 2013.
Australia’s terms of trade have increased significantly since 2001–02
(Figure 2.1) with changes in mineral commodity prices having a sig-
nificant influence. Recent commodity prices have been very volatile
(Dwyer, Gardner et al. 2011). An analysis of commodity price volatility
by the RBA concluded that this is due to the fundamentals of supply and
120 180,000
Resource Exports (RHS) Terms of Trade (LHS)
160,000
100
140,000
80 120,000
AUD million
100,000
Index
60
80,000
40 60,000
40,000
20
20,000
0 0
71 0
73 2
75 4
77 6
79 8
81 0
83 2
85 4
87 6
89 8
91 0
93 2
95 4
97 6
99 8
01 0
03 2
05 4
07 6
09 8
0
19 –7
19 –7
19 –7
19 –7
19 –7
19 –8
19 –8
19 –8
19 –8
19 –8
19 –9
19 –9
19 –9
19 –9
19 –9
20 –0
20 –0
20 –0
20 –0
20 –0
–1
69
19
Figure 2.1 Australia’s terms of trade and resource exports.

Source: Based on ABS data accessed under a Creative Commons Attribution 2.51 Australia
licence by ABARES.
demand for these commodities and not, to date, due to the effects of
financial activity in commodity derivatives markets (Dwyer, Gardner et
al. 2011). Figure 2.1 compares Australia’s terms of trade with its resource
exports. For example, since 2003–04, the price of Gold London has
increased by 180 per cent up to 2009–10, iron ore average export price
by 227 per cent, thermal coal 115 per cent and crude oil 148 per cent.
From 1969–70 to 2009–10, Australia’s current account deficit (CAD)
was negatively correlated with the terms of trade (TOT) at the 10 per
cent level and significantly positively correlated with the one-period
lagged current account deficit (CADt–1) with an R² of 0.83.
CAD = 11304.28 – 238.11 TOT + 0.83CAD(t–1) R² = 0.83 d = 2.00

(1.44) (–1.82) (5.42**)
The profile of Australia’s commodity exports has changed consid-

erably since 2003–04. In 2003–04 Japan was the largest resources
export customer for Australia accounting for 26 per cent, followed
by the Republic of Korea at 11 per cent, China 9 per cent, and India
8 per cent. The same four countries were the largest customers for
Australian resources in 2009–10 but there have been changes in posi-
tion with China the largest at 28 per cent, Japan second at 23 per
cent, followed by India at 11 per cent and Korea 10 per cent. By far
the most significant change in China’s imports from Australia is the
dramatic increase in iron ore, with all the volume increase in iron ore
exports from 2003 to 2009 accounted for by China. Iron ore accounts
for approximately 60 per cent of the increase in China’s imports from
Australia with significant contributions from both price and volume
changes.
2.4 Mining and Australia’s economic outlook

and key drivers
Non-residential investment in Australia, as a share of GDP, has increased

substantially since 2001 (Reserve Bank of Australia 2009), largely as a
result of the increase in mining investment which has grown from 1.5
per cent of nominal GDP in 2000–01 to nearly 5 per cent at the end of
the last decade.
But will this trend be sufficient to support projected growth in the
mining sector, and what is the anticipated mix of projected investment
particularly in the area of infrastructure? Currently the largest projected
increase in investment expenditure is in LNG, which includes $43 bil-
lion for the Gorgon project, and the $12 billion Pluto project.
The RBA suggests that investment in this sector alone could increase
from about 0.5 per cent of GDP at present to 2.5 per cent within the next
four to five years (Reserve Bank of Australia 2009), with the potential
for LNG exports to rival coal and iron ore as a share of total exports.
Business Monitor International (BMI 2010) are forecasting average
growth for the mining industry of just over 6 per cent per annum over
the five-year period to 2014, with mining’s contribution to GDP increas-
ing from 6.79 per cent in 2009 to 8.17 per cent by 2013.
The main driver of the mining sector outlook is the continued indus-
trialisation of China with its voracious appetite for raw materials, espe-
cially in steel making, and for which iron ore is a significant component.
Alongside its demand for raw materials, China is also demonstrating an
appetite to invest in Australian mining companies. It is not only in
Australia that China is investing; China is also investing in Mongolia,
Kazakhstan and Africa.
2.5 The mining industry’s role in Australia’s recovery

from the GFC
In Australia the index for the top 200 companies listed on the Australian
Stock Exchange (ASX) fell by about 40 per cent between mid-2008 and
early March 2009 in line with the major stock markets around the
world, and the Australian dollar depreciated by about 30 per cent as
capital was withdrawn from the country and adopted a ‘flight to safety’
strategy with the US dollar acting as a magnet for such funds. These
movements reflected Australia’s sensitivity to global financial markets
rather than fundamental flaws in its economy. But Australia’s economy
then rebounded, partly aided by the monetary policy adopted by the
RBA.
Glenn Stevens, Governor of the RBA, in his opening statement to
the Senate Economic References Committee (Stevens 2009) highlighted
four factors which contributed to Australia’s better recovery from the
GFC than most other economies. They were:
1. Australia’s financial system was in better shape than most other

economies at the outset of the GFC
2. The resilience of Australia’s trading partners, notably China, through
the GFC
3. The ongoing demand for Australia’s mineral resources and the terms
of trade
4. The Commonwealth Government’s healthy fiscal balance which
meant that Australia entered the GFC virtually debt free
Strength of demand for the mining industry’s products and the devel-
opment of the Chinese economy, assisted by its rapid economic policy
response to the GFC with a marked loosening of monetary policy and
significant injection of fiscal support, all assisted the mining sector’s larg-
est customer in avoiding the most adverse consequences of the GFC.
However, as the OECD (2010) highlighted, ‘Australia’s key challenges
are medium-term; ensuring a balanced expansion, especially in the
context of the mining boom that has gathered pace. Strengthening
supply especially in infrastructure, housing and labour markets is
needed to ensure non-inflationary growth and smooth reallocation of
resources’.
‘Australia faces a shortfall in infrastructure, which could worsen with
the demand pressures exerted by the mining boom, population growth
and environmental concerns’ (OECD 2010, p. 16). The growth in min-
ing exports has placed pressure on port and rail infrastructure with
demand for freight expected to double between 2000 and 2010 (BTRE
2006).
The projected growth rate of Australia’s economy, predominately
from mineral exports to China, will continue to place a substantial
strain on most aspects of infrastructure, notably ports, railways, energy
and water.
2.6 Commodity prices and the Australian economy
2.6.1 Introduction
The purpose of this subsection is to show that commodity prices are the
crucial variable affecting the Australian economy through their impact
on the mining supply chain and suppliers of goods and services to
industry participants. A simple way of demonstrating this proposition
is to calculate the principal components of measures of performance of
the economy. Principal component analysis is applied to a set of varia-
bles to determine which variables in the set form coherent independent
subsets independent of each other (see Tabachnick and Fidell 2007, ch.
13). In this case EViews was used to calculate the principal components
of the series for the unemployment rate (UR), the growth in nominal
GDP (%ΔY), the rate of inflation (INF) and the all ordinaries index (AO)
over the period 1985–2010.
The first principal component (the one explaining the largest per-
centage of the variance of the series) is:
PC = –0.540UR + 0.532%ΔY + 0.559INF + 0.337AO

This component can be identified as a measure of economic activity in

Australia. It has a correlation of 0.81 (significant at the 1 per cent level)
with the commodity price index in Australian dollars (CPA).
In the following sections we
● Consider the impact of commodity prices on the rate of inflation

● Present a simple econometric model of the Australian economy
which is driven by the commodity price index
2.6.2 Commodity prices and inflation

The effect of commodity prices on inflation can be considered by parti-
tioning the rate of inflation into two components:
● A component representing the excess of the rate of growth of non-

wage income over the rate of growth of real GDP
● A component representing the excess of the rate of growth of nomi-
nal wages over the rate of growth of output per head (productiv-
ity)
The national income identity in a simplified form is:
PY  W
where P = implicit GDP deflator

Y = output (in constant prices)
W = wage income (compensation of employees)
= non-wage income (of which the gross operating surplus is a
major component)
1 W
P +
Y Y
1 W E
= + ⋅ (E = employment)
Y E Y
1 w
= +
Y Prod
where w = average earnings and Prod = output per head (productivity)
Therefore,
dP 1 d dY 1 dw w dProd
 ⋅  2⋅  ⋅  ⋅
dt Y dt Y dt Prod dt Prod 2 dt
Therefore, the rate of inflation is:
1 dP ⎛ ⎞ ⎛ ⎞
⋅  ⎜⎜ 1 ⋅ d  1 ⋅ dY ⎟⎟ w ⎜⎜ 1 ⋅ dw − 1 ⋅ dProd ⎟⎟
P dt P.Y ⎝⎜ ⎟ ⎜
dt Y dt ⎠ P.Prod ⎝ w dt Prod dt ⎠⎟
Let b = the share of non-wage income in total income
w w W
and note that   1 b
P.Prod P.Y/E P.Y
where W is total wages.

Then
1 dP ⎛1 d 1 dY ⎞⎟ ⎛ 1 dw 1 dProd ⎞⎟
⋅  b ⎜⎜⎜ ⋅  ⋅ ⎟ + (1 − b) ⎜⎜⎜ ⋅ − ⋅ ⎟
P dt ⎝ dt Y dt ⎠⎟ ⎝ w dt Prod dt ⎠⎟
This equation partitions inflation into two sources. The first, weighted
by the share of non-wage income in total income, is the extent to which
the rate of growth of non-wage income exceeds the rate of growth of
output. The second, weighted by the share of wages in income, is the
extent to which the rate of growth of wages exceeds the rate of growth
of productivity. Inflation is, therefore, divided into its sources – growth
in non-wage income and growth in wage costs. The second component
is a measure of wages overhang.
The results of this partitioning are given in Table 2.1. INF is the rate
of inflation based on the implicit deflator for GDP, w is average weekly
earnings; PCONT is the contribution of the growth in non-wage income
and WCONT is the contribution of the growth in wages. Specifically,
the contributions are defined as:
WCONT  c (Rateof growth of wages  Rateof growth of productivity )

PCONT (1 − c)(Rateof growth of non -wage incomeRate of growth of output )
c shareof wages in income
PCONT was calculated by deducting WCONT from the rate of

inflation
Table 2.1 indicates that increases in non-wage income play as impor-
tant a role as wage increases in causing inflation. It will be useful to
examine the factors determining these contributions. CPA is the RBA
commodity price index in Australian dollars, UR is the unemployment
rate, W is average weekly earnings and t is a time trend. The CUSUM OF
SQUARES TEST indicates that the equations are stable.
Table 2.1 Contributions to the rate of inflation, 1985–2010
Year WCONT PROFCONT

1985 4.59 4.03
1986 2.22 2.45
1987 2.99 4.37
1988 2.65 5.81
1989 3.11 4.70
1990 3.90 1.45
1991 1.67 –0.04
1992 0.30 0.83
1993 –0.20 1.47
1994 0.05 0.73
1995 1.76 1.05
1996 2.01 0.42
1997 1.26 –0.66
1998 –0.29 1.32
1999 0.68 –0.39
2000 0.80 1.96
2001 2.81 2.42
2002 0.11 2.30
2003 1.17 1.19
2004 1.55 2.68
2005 2.33 2.22
2006 2.17 2.65
2007 2.65 1.61
2008 2.83 3.09
2009 –1.69 1.29
2010 2.69 3.43
PCONT = 7.859 + 0.0525Δ%CPA – 0.560UR – 0.157t

(5.11**) (3.39**) (3.58**) (4.16**)
R2 = 0.606
d = 1.29
WCONT = 4.424 + 0.236Δ%W – 0.360UR – 0.111t + 0.0475Δ%CPA

(253**) (2.70**) (2.52**) (3.02**) (3.96**)
R2 = 0.744
d = 2.35
These equations show that both components of inflation increase

with commodity prices and fall as the economy slows. We will see in
the next subsection that commodity prices affect the unemployment
rates.
2.6.3 A simple econometric model of the Australian economy

The form of the model of the Australian economy is provided in the
following illustration:
GB
CPUS ER CPA
Y
UR
INF
CPUS = commodity price index in US$ Y = nominal GDP in the final quarter
CPA = commodity price index in A$ of each year
ER = A$/US$ exchange rate UR = unemployment rate
GB = government borrowing (deficit) INF = rate of inflation
This model illustrates the self-adjusting nature of the Australian econ-

omy which was introduced by the financial deregulation of the 1980s,
especially the floating of the Australian dollar in December 1983. For
example, an upswing in commodity prices will cause the Australian
economy to boom. However, it will also cause the Australian dollar to
appreciate so that commodity prices in Australian dollars do not fluc-
tuate by as much as commodity prices in US dollars, moderating the
boom caused by the strong global market for commodities.
This process works in reverse as well. If the global economy is having
a negative impact on the Australian economy, the exchange rate will
depreciate, stimulating it. This happened during the Asian Crisis and
the unemployment rate actually fell over that period. The same thing
was happening at the end of 2008 during the GFC. However, the fiscal
expansion initiated at that time pushed the exchange rate up and pre-
vented the adjustment process.
The exchange rate is also affected by domestic saving because this
determines the amount of funding which the Australian economy must
obtain from overseas. An increased inflow of funds will cause an appre-
ciation of the exchange rate. Government borrowing is dissaving and,
other things being equal, an increase in it will cause the currency to
appreciate.
The variables not defined in Table 2.2 are defined below. The data
were obtained from the Statistical Tables on the RBA website. Δ stands
for the change in the variable and %Δ stands for the percentage change
in the variable.
Table 2.2 A simple econometric model of the Australian economy, 1985–2010
INF = 13.99 + 0.082%ΔCPA + 0.914INF –1 – 0.292t – 1.052UR R2 = 0.854

(5.38**) (4.82**) (1.55) (5.37**) (4.76**) d = 1.69
P = P–1 + INF . P–1

100
%ΔY = 0.0246 + 0.484%ΔY–1 + 0.00107%ΔCPA
(1.82) (3.02**) (2.89**)
+0.000718%ΔAO R2 = 0.469
(2.19*) d = 1.92
Y = Y–1(1 + %ΔY)
AO = –417.2 + 33.25CPA + 0.240DJ R2 = 0.935

(2.00*) (6.30**) (10.00**) d = 1.17
(A0  A01 )
%ΔAO = 100
A01
RY = Y/P
ΔRY = RY – RY(–1)
UR = 0.587 + 0.800UR–1 – 0.000195ΔRY – 0.000139ΔRY–1

(0.28) (7.74**) (4.72**) (3.38**)
+0.0753RW – 0.0115CPA R2 = 0.919
(2.01*) (1.08) d = 1.55
ER = 0.607 + 0.00527CPUS – 0.148 D01 – 0.00111S

(26.17**) (6.35**) (2.72**) (3.84**)
+ 0.000932GB R2 = 0.767
(1.63) d = 2.29
CPUS
CPA = 0.652 + 0.751 R2 = 0.999
Er d = 1.95
(2.46*) (191.03**)
(CPA  CPA1 )
%ΔCPA = 100
CPA1
P = implicit GDP deflator

AO = all ordinaries share price index
t = time trend
DJ = Dow Jones share price index
RW = real wages (average weekly earnings deflated by P)
D01 = dummy variable which takes the value unity in 2001 and zero
otherwise
S = personal saving
Table 2.2 is a simple econometric model of the Australian economy,

estimated from annual data from 1985–2010. It has been estimated by
ordinary least squares on the EViews software, but the two-stage least
squares estimates are very similar. All the equations apart from that for
AO are found to be stable by the CUSUM OF SQUARES test.
The model was also tested in a dynamic simulation. The variables ER,
Y, UR and INF were estimated by the model without bias. That is, the
regression of the actual variable on the value predicted by the model
had an insignificant constant term and a slope coefficient insignifi-
cantly different from zero. The correlations of the actual and forecasted
values were, respectively, 0.909, 0.999, 0.862 and 0.813.
The econometric model shows that the structure outlined in Figure
2.1 does indeed provide a good explanation of the Australian economy.
That is, it is an economy which is largely driven by commodity prices.
The econometric model includes a further channel through which
commodity prices affect the economy – through their impact on share
prices which in turn affect the growth in income.
The impact of commodity prices can be examined by a counterfac-
tual simulation in which CPUS is 10 per cent higher than its actual
value. In Table 2.3, an asterisk indicates the value resulting from the
original simulation of the model and two asterisks indicate the effect of
higher commodity prices.
The results in Table 2.2 indicate that an increase in commodity prices
would have led to a higher exchange rate and nominal income. However,
the unemployment rate and rate of inflation would have been largely
unchanged. Indeed, although there is an initial increase in the rate of
inflation, it adjusts to a value slightly below that resulting from lower
commodity prices. This result illustrates the self-balancing character of
the Australian economy.
2.7 Economic rent and the mineral

resource rent tax
Economic rent is a measure of the surplus return which a provider of a

factor of production earns over and above their required return for the
provision of that factor in economic activity. In the mining sector, the
definition for this excess return and the means by which government
may take a share of it as part of their tax revenue has been a source
of heated debate between the Australian federal government, Treasury
and the mining industry. In 2007–08 the gross operating surplus in the
mining sector was $63 billion or 53 per cent of revenue, compared with
$26 billion in 2003–04 and 46 per cent of revenue; $30 billion of the
Table 2.3 Simulation of the model with higher commodity prices
Year ER* ER** Y* Y** UR* UR** INF* INF**
1985 0.6655 0.6655 62437 62437 8.6 8.6 4.4 4.4

1986 0.7225 0.7384 67357 68226 8.3 8.1 4.5 5.2
1987 0.7306 0.7481 63257 74594 8.5 8.2 5.8 6.3
1988 0.7738 0.7969 81029 82646 8.5 8.2 7.1 7.4
1989 0.7552 0.7771 87045 88851 8.5 8.3 4.8 5.0
1990 0.7497 0.7711 92491 94426 8.8 8.7 3.8 4.0
1991 0.7382 0.7582 96740 98791 9.3 9.2 2.4 2.5
1992 0.7373 0.7571 101649 103794 9.5 9.5 2.1 2.1
1993 0.7143 0.7326 106017 108256 9.5 9.5 1.3 1.4
1994 0.7158 0.7349 111658 113995 9.4 9.3 1.8 1.8
1995 0.7331 0.7538 119529 121937 8.6 8.6 2.6 2.6
1996 0.7222 0.7429 127910 130482 7.9 7.9 2.8 2.7
1997 0.7065 0.7266 137173 139694 7.5 7.5 2.8 2.8
1998 0.6701 0.6872 144416 147002 7.4 7.4 1.8 1.8
1999 0.6618 0.6778 152318 154977 7.5 7.5 1.7 1.6
2000 0.6664 0.6841 161671 164432 7.4 7.5 2.6 2.6
2001 0.5077 0.5256 177778 180584 6.8 6.8 5.2 5.1
2002 0.6378 0.6557 184555 187480 6.7 6.7 0.9 1.0
2003 0.6441 0.6631 193631 196684 7.0 7.0 1.7 1.7
2004 0.6781 0.7018 209488 212602 6.3 6.3 3.4 3.4
2005 0.7426 0.7732 228043 231166 5.1 5.2 4.6 4.5
2006 0.7790 0.8163 249629 252667 4.3 4.3 5.3 5.2
2007 0.7946 0.8354 271825 274772 3.7 3.7 5.0 4.9
2008 0.9817 1.0433 296961 299561 3.4 3.5 6.2 6.0
2009 0.7333 0.7754 311924 313664 4.3 4.3 2.7 2.7
2010 0.9236 0.9826 332816 335254 4.1 4.1 3.6 3.5
Source: ABS and Authors calculations.
$37 billion increase in gross operating surplus was spent on investment

(Reserve Bank of Australia 2009).
Oil and gas account for the largest share of the gross operating surplus
earned by the mining sector.
In theory, resource rental taxes do not alter investment decisions since
they are returns in excess of the opportunity cost which will include a
risk-adjusted rate of return on capital. The Petroleum Resources Rent
Tax (PRRT), a predecessor of the Mineral Resource Rent Tax (MRRT),
consists of ‘cash flow tax levied at a constant rate of 40% on annual
positive cash flows’ (OECD 2010, p. 71), negative cash flows carried
forward. The MRRT is modelled closely on the PRRT and includes an
‘uplift rate’ set equal to the government’s long-term bond rate plus 7 per
cent. The MRRT only applies to coal and iron ore.
The OECD (2010, p. 15) support the government’s plan to shift the
focus of taxation of non-renewable resources from output-based royalties
to rents; in fact, they go so far as to recommend the elimination of roy-

alties to be replaced by ‘a well-designed resource rent tax extended to all
commodities and all companies irrespective of their size’.
In practice, economic rent is difficult to measure (Davidson 2010).
Finance theory provides one answer to this problem – the Capital Asset
Pricing Model (CAPM) (Frino, Chen et al. 2006, pp. 196–217). It says
that the return on any asset is determined by its relationship with the
market return. Specifically,
Rι = rf + β(rm – rf )
where rι is the return on asset I, rf is the risk free-rate of return (e.g., the
long-run bond rate), rm is the market return and β is a coefficient deter-
mined by the relationship between the return on this asset and the
market return. A β of unity indicates that the return on the asset is the
market return. A β above unity indicates that the return on the asset is
more volatile than the market, that is, that the asset is riskier than the
average of the market.
CAPM also determines the cost of funding for a company which issues
the asset concerned (say, a share). The equity premium (rm – rf ) is histori-
cally around 6–7 per cent. If the β for mining is unity, its cost of fund-
ing is twice the government cost of funding (the long-term bond rate).
However, the β for mining is likely to be above unity; in March 2011,
the β for the metals and mining sector in Australia was 1.27. Therefore,
the initial approach of using the long-term bond rate is unsupportable.
This analysis refers to the ex post situation, that is, to existing min-
ing operations. However, we need to consider the ex ante decision to
undertake prospecting for and creating new mines. Such activities may
depend on the possibility of earning economic rent in the future and if
the ‘uplift rate’ is too low, mining activity could be curtailed.
The Australian economy is increasingly dependent on international
debt markets, and in consequence the escalating costs of such debt
as risk pricing increases, such that the escalating investment require-
ments of the mining industry continue to place pressure on the cur-
rent account deficit. The Organisation for Economic Cooperation and
Development (OECD) suggest that this pressure on international debt
should be eased by government adopting policies designed to increase
domestic saving, thereby facilitating the mining investment funding
from lower cost and less volatile sources of funds. Net foreign liabilities
are currently about 60 per cent of GDP, with total foreign liabilities
nearly 150 per cent of GDP. Increasing savings will serve to ease the
pressure on the current account deficit and potentially ease some of the
pressure on the Australian dollar, to the benefit, in particular, of non-
mining export businesses. As the economy continues to recover and
stimulus spending reduces, government expenditure should be smaller
than tax revenue, thereby increasing gross savings and further reduc-
ing the current account deficit. A buoyant mining sector will make a
significant contribution to escalating tax revenue.
The increased mining sector revenue (Australia 2009, pp. 7–12) and the
sector’s future prospects (Christie, Mitchell et al. 2011, pp. 1–7) present
challenges and opportunities for the accumulation and deployment of
the financial gain being derived from the current mining boom and fund
raised from the MRRT. One possible avenue for the government to pursue
is to pay the proceeds of the tax into a dedicated savings fund, possibly
similar to the Future Fund established in Australia in the mid-2000s as
suggested by former Australian Treasurer Peter Costello (2011, p. 63). This
has the potential to reduce the current account deficit whilst capitalising
on the gains during the ‘boom’ phase of Australia’s economic cycle.
2.8 Conclusion
The mining industry makes a clear and growing contribution to the

Australian economy through its contributions to GDP, investment,
employment, exports and the current account balance. However, these
direct effects do not appear to be large enough to justify the attention
paid to the industry. It is therefore necessary to look at the total (direct
and indirect) effects of mining to understand its importance to the
economy. The analysis in this chapter shows that commodity prices
are the major driver of the Australian economy. This effect begins with
a major impact on the value of the Australian dollar. This depend-
ence is a blessing, creating prosperity on average, but it is a mixed one.
Commodity prices move in wide circles and this makes the Australian
economy and currency relatively risky.
The final section considers the Mineral Resource Rent Tax. Such a tax
could be justified if it only falls on true economic rent and if its pro-
ceeds are accumulated in an independent investment fund. However, if
it cuts into the expected level of profits, it could cause serious damage
to the Australian economy.
Note
1. http://creativecommons.org/licenses/by/2.5/au/
References
Battellino, R. (2010), ‘Mining Booms and the Australian Economy’, Bulletin of the
Reserve Bank of Australia, 63–70.
BMI (2010), ‘Australia Mining Report, Q2’, Business Monitor International,
London.
BTRE (2006), Freight Measurement and Modelling in Australia, Bureau of
Transport and Regional Economics, Canberra.
Christie, V.,Mitchell, B., Orsmond, D., and van Zyl, M. (2011), ‘The Iron Ore,
Coal and Gas Sectors’, Bulletin of the Reserve Bank of Australia (March Quarter,
2011), 1–7.
Costello, P. (2011), ‘Times of Plenty and Lost Opportunity’, The Weekend
Australian Financial Review.
Davidson, S. (2010), No Respect for Super-Profit Taxation, The Centre for
Independent Studies Limited. St Leonards, New South Wales, 13–25.
Dwyer, A., Gardner, G., and Williams, T. (2011), ‘Global Commodity Markets –
Price Volatility and Financialisation’, Bulletin of the Reserve Bank of Australia
(June Quarter, 2011), 49–57.
Frino, A., Chen, Z., Hill, A., Comorton-Forde, C., and Kelly, S (2006), Introduction
to Corporate Finance, Frenchs Forest, New South Wales, Pearson Education
Australia.
Minerals Council of Australia (2010), The Australian Metals Industry and the
Australian Economy, available at <http://www.minerals.org.au>.; last accessed
28 May 2012
OECD (2010), OECD Economic Surveys: Australia 2010 (OECD Economic Surveys.
2010–21, Supplement 3).
Reserve Bank of Australia (2009), The Level and Distribution of Recent Mining Sector
Revenue, January 2009, 7–12.
Reserve Bank of Australia (2009), Statement on Monetary Policy, Reserve Bank
of Australia.
Stevens, G. (2009), ‘Statement to Senate Committee’, Bulletin of the Reserve Bank
of Australia October 2009, 18–19.
Tabachnick, B. G. and Fidell, L.S. (2007), Using Multivariate Statistics, Boston,
Pearson.
Part II
Operational Perspectives
3
Transportation Issues of Australian
Coal and Iron Ore
Elizabeth Barber
3.1 Introduction
This chapter provides an analysis of the transportation and supply

chains of Australian iron ore and coal production. The first section
will explain and analyse the coal exports from the eastern coast of
Australia whilst the second section will cover the iron ore exports from
the northwestern deserts of Australia. Both resources rely heavily on
rail transport to the export ports and both rail networks involved with
these minerals have experienced recent controversy. China’s demand
for coal to generate electricity is the largest in the world.
Similarly, iron ore is a critical raw material for steel production. The
steel industry in China is the backbone to its economic growth and
required nearly 60 per cent of the world’s iron ore to produce 50 per cent
of the world’s steel production in recent years. This growth is expected
to increase. Australia is the world’s biggest iron ore supplier followed by
Brazil and India.
Coal and iron ore exports to China are important to the Australian
national economy. This means that as more Chinese domestic electric-
ity and steel production occurs, Australian coal and iron ore production
and export supply chains must remain viable to maintain its export
volumes. The transportation to the ports must flow smoothly to retain
economic viability. This chapter analyses the transport of both coal in
the eastern Australian states and iron ore in the northwest of Western
Australia. Outcomes from this analysis suggest that there are some
choke points along the supply chains.
The synchronisation of rail turnaround times to meet shipping sched-
ules in export ports should be aligned. The private/public collaborative
strategies of the production and transport facilities have not produced
48 Elizabeth Barber
the competitive efficiencies that are needed to keep the Australian coal
export market at its peak. Calls for privatisation and collaborative dom-
inance to ensure that transport flows remain efficient have been forth-
coming and the recent announcement of the Queensland Railways (QR
National) public float reflects this need.
3.2 Australian coal production
Australia is the fourth largest producer behind United States and India,
producing 370 Mt in 2008 and 325 Mt in 2007 (OECD/IEA, 2008).
Australia is the largest exporter of black coal in the world. In 2008,
Australian domestic consumption was 144 Mt and the majority of the
remainder was exported to Japan, Korea and China (Australian Bureau
of Statistics, Australian Year Book, 2009).
Coal production in Australia is expected to increase through to
2030 and most of this production will be exported. The two main coal
producing areas are located in Central Queensland Basin and in the
Gunnedah, Sydney and Oaklands Basins in New South Wales (NSW).
The Central Queensland coal mines are a major exporter of black coal.
In 2010, there were approximately 48 coal mines in operation. A fur-
ther projected 38 major development projects are planned up till 2013
(Australian Bureau of Agricultural and Resource Economics (ABARE),
2009–10).
There are five coalfields within the three coal basins of NSW, namely,
the Hunter, Newcastle, Western and Southern coalfields located within
the Sydney Basin, with the Oaklands basin located on the southern
border with Victoria.
Coal production levels in Australia and its export (saleable) coal have
increased steadily to peak in 2008–09. During this year exports to Japan
were 104.4 Mt; to Taiwan were 26 Mt; to China were 25 Mt and to India
were 24 Mt (www.australiancoal.com.au).
The total value of Australian coal exports for 2008–09 was $58,373
million. The average price per tonne was $221.58 (www.australiancoal.
com.au). Japan and Korea have little coal reserves of their own, unlike
China, and so it is expected that the increase in production will be
exported to these countries.
3.3 Australian coal distribution networks
The world’s demand for coal is driven by the international coal price
and the capacity of the coal global distribution supply chains. Strong
Transportation Issues of Coal and Iron Ore 49
demand for coal continues as the demand for energy soars in Asia,
especially China. According to the Director-General’s Environmental
Assessment Report on the Kooragang Coal Terminal (April 2007),
Australia’s ability to respond to the continuing strong demand has been
limited by the constraints to capacity of land transport and port han-
dling infrastructure facilities (NSW Government, 2007).
Exports are totally reliant on rail and road transport to reach the
export facilities at the ports (ABARE, 2009). The land transport supply
chain from the mines to the export ports do not exceed 300 km with
many of the mines located within 100 km from their export ports.
Due to the proximity of the mines to the ports, short transit times can
provide a high degree of responsiveness to changes in demand. The
aim of rail transport is to meet the shipping schedules and ensure that
there is a tight loading turnaround time for the ships in port. This not
only depends on timeliness but also capacity matching to gain the
greatest efficiencies. Maritime transport accounts for approximately 90
per cent of international coal transportation. Over half of the total
delivered cost of Australian coal exported to China is apportioned to
transport costs. As coal is one of Australia’s most valuable export com-
modities, it is vital that the transport supply lines operate efficiently
and timely.
The Australian coal industry is serviced by nine coal terminals at
seven ports, all located on the east coast. Port ownership is a combi-
nation of public and private interests. The combined annual loading
capacity is currently 270.5 Mt. Time and capacity constraints exist that
point to the need for Australia to continue to improve its rail transport
from the mines to the ports, and port infrastructures must have the
capacity to meet the shipping schedules.
The following section will firstly consider the Queensland coal export
flows followed by the NSW coal export flows.
3.3.1 Queensland coal distribution export flows

3.3.1.1 Queensland Rail
Queensland’s coal supply chains flow from the mines in Central
Queensland by rail networks to three main ports. The rail network is
owned by the Queensland State Government with Queensland Rail
(QR) the sole owner of the infrastructure. Rail freight services are open
to private corporations. The coal lines are known as the Goonyella Coal
system which is a narrow gauge (3ft 6 in or 1,067 mm) electrified (25
kV–50 Hz) service. This system services 24 mines and currently operates
under a demand–pull model with the haulages being called forth from
50 Elizabeth Barber
the port authorities based on shipping schedules (www.qrnetwork.com.

au/networks/coal/Goonyella-system.aspx).
In 2008, QR National Coal hauled 184 million metric tons of coal,
operating 550 coal services a week from 56 mines. The operating trains
carried between 2,100 and 8,600 net tonnes of coal. The QR National
electric locomotives haul coal through the rail systems of Goonyella
and Blackwater. The QR National diesel electric locomotives operate
in the Newlands, Blackwater, Moura and West Moreton coal fields in
Queensland. They also haul coal in the Hunter Valley systems in NSW
(www.freight.qr.com.au/coal_freight/). There are balloon loops and
rapid overhead loading bins at all port terminals ensuring efficient
loadings. Coal trains in Australia are among the world’s longest (over 2
km), hauling on average 150 open-topped wagons.
3.3.1.2 Queensland coal ports

The rail distributes coal to six coal export terminals at four deepwater
ports in Queensland with the Dalrymple Bay, Hay Point and RG Tanna
terminals handling around 85 per cent of all export coal. The RG Tanna
port, located in Gladstone, is operated by the Australian Port Authority.
It is unique in being the only Australian port authority that operates as
a supervisor of the port besides owning and operating the cargo han-
dling facilities in the port including the bulk coal loading facilities at
RG Tanna Coal Terminal. It has a natural deepwater harbour protected
by outer islands. The four Clinton wharves are for the exclusive use
of coal exports. They can berth vessels of a maximum size of 220,000
tonnes and 315-m overall length. The RG Tanna Coal port is a multi-user
berth exporting coal from the mines in the Central Queensland Basin.
All coal is received by rail on a 24/7 operational throughput (Central
Queensland Ports Authority, COAG, Annual Report, 2006–07).
The distance from the mines to ports varies, although the nearest is
Moura mine about 189 km away and the most distant is Oaky Creek
mine at 394 km from port. There are three unloading stations allowing
three trains to unload simultaneously at 6,000 tph. The rail gauge is
1,067 mm. Linked to this are stockpiling facilities via conveyor belts.
The average train to enter the authority along the Moura line is 1.7 km
in length, with a payload of 4,200 tonnes, although the Blackwater line
produced an average payload of 7,150 tonnes per train in 2006. All wag-
ons are bottom dump wagons to hoppers under track. The rail balloon
loop at the TG Tanna port is 3 3.3 km and can stockpile at a rate of
3 6,000 tph. The annual receival capacity is 58 Mtpa. The conveyor
belt width is 1,800 mm with a receival speed of 5.1 m/sec. There are five
lines of overhead conveyor belts operating from the transfer point from
the unloading stations. These conveyors which are 18-m-high discharge
coal via travelling trippers, from either or both sides on to stockpiles at
a rate of 6,000 tph. This discharge rate is equal to the uploading rate.
The ship loading belts that lead from underground coal pits to stock-
piles can blend from a maximum of four different coal stockpile varieties
at any one time. The flow rate is computerised to synchronise with the
ship loading conveyors to the required blend rate. This is a value adding
function blending coal to match demand at the export port rather than
further up the supply chain. Expansion of Queensland’s Dalrymple Bay
port in 2009 increased its annual capacity to align with its blending
functions. The coal flow rates and port throughputs are seeking verti-
cally integrated structures to improve efficiency and to maximise port
capacities as competition between the ports together with regulatory
reforms and the need for expansion of the critical infrastructure sectors
is currently pushing this dynamic industry into restrictive practices
rather than commercially appropriate outcomes (COAG, Discussion
Paper, October, 2007).
Severe congestion in ports is causing stockpiling of coal at ports and
leaving ships waiting offshore for loading. Severe congestion at Newcastle
and Dalrymple Bay ports has led to delays in deliveries and price rises
(BITRE, 2008). The shortage of rail capacity from the mines to the ports
has also contributed to congestion further upstream in the coal supply
chains causing significant delays in the export coal flows (Saul, J. and
Cowling, J., 2009). Bulk shipping availability has been curbed world-
wide as Australian coal ports are not the only ones congested. Brazil
and China have also experienced high congestion restricting the sea
capacity of transportation.
3.3.2 NSW coal distribution export flows

NSW major coal production occurs in the Hunter Basin coal fields
located close to the major export coal ports at Newcastle. The furthest
coal mines are located 320 km northwest of Newcastle at Gunnedah
(The Joint Coal Board, 2009). They are serviced by the NSW rail infra-
structure which is leased by the Australian Rail and Track Corporation
(ARTC). The 60-year lease includes the NSW interstate track and the
Hunter Valley rail coal freight corridors. Pacific National is the primary
coal haulage operator (International Railway Journal, 2004). The most
northern coal field at Charbon in this rail system transports coal ini-
tially on diesel-operated railways which link to the electrified system at
Lithgow. The total NSW rail network servicing the NSW coal mines is
52 Elizabeth Barber
operated by Pacific National. It operates over 1,050 km of rail network

and services 31 rail loading terminals which have overhead loading
facilities and balloon rail loops (The Joint Coal Board, 2009).
The Newcastle port is operated by the Port Waratah Coal Services
Limited (PWCS) Company. It operates the world’s largest and most effi-
cient coal handling port, and handled over 1.22 Mt in January 2010 and
1.47 Mt in December 2009 (Osborne, 2010). Its two ports, Carrington
and Kooragang, handle all the export coal from the Hunter Valley coal
fields. (Sydney Ports Corporation, 2007–08; 2008; 2009) These port
infrastructures are being improved with major expansion of facilities
occurring at the Kooragang Island expansion now permitting a through-
put capacity of 120 Mt pa (ABARE, 2009). With 60 coal ships queuing at
sea waiting for entry to the Newcastle ports in December 2009, further
expansion is necessary not only in the ports but also in the ARTC rail
network (Kirkwood, I., Reuters.com, 10 March 2010). These ships queue
on average for 18 days for entry compared with half a day for normal
cargo ships (Sharples, B., Reuters.com, March 2010).
The Wollongong port is operated by the Port Kembla Coal Terminal.
This port exports all the coal from the southern and western coalfields
of NSW. This is a much smaller coal export terminal than the Newcastle
terminal, which is the largest coal port in the world. Port Kembla’s
maximum stockpile capacity is 850,000 tonnes whilst the Newcastle
stockpile capacity is 3.6 Mt. The relative actual throughputs for Port
Kembla from increased from 9.73 Mt in 2000–01 to 13.10 MT in 2007–
08, whilst the PWCS Kooragang and Carrington wharves at Newcastle
increased their export throughput, respectively, from 68.85 and 66.56
MT in 2000–01 to 88.98 and 91.40 Mt in 2007–08 (Source: Compiled
from 2009 The Joint Coal Board, pp. 146–147).
3.4 Domination issues in the Australian export coal

supply chains
3.4.1 The Queensland coal flows

A key issue concerns the perceived congestion on the coal rail tracks
in Queensland. Rail transport of coal to the ports is seen as a choke
point in the total supply chain. The total cycle time comprises min-
ing, stockpiling, transhipment by rail to the port, stockpiling and then
conveyor belt transportation to the bulk ship carriers. In 2004 the coal
mine producers expressed disquiet regarding the projected capacity
of the transport systems in view of the potential future coal export
demands. (ARTC, 2004; Queensland Government, 2004) A study was
commissioned to identify the supply chain constraints, recommend

throughput targets and future requirements in infrastructure needs.
It was found that inadequate rolling stock was causing problems,
and that rail- and port-contracted tonnages had not been achieved
(O’Donnell, S., 2007). The study did not incorporate the ship queuing
off the ports waiting to berth which is another congestion choke point.
Nevertheless, the recommendations were that the combination of the
rail and port constrictions to the Queensland coal export flows needed
urgent attention.
The study found that the large number of participants and stake-
holders associated with transportation was causing complexities and
lack of decision-making. (Queensland Government, 2008)Although
the coal producers in NSW and Queensland are fiercely competitive
on coal grades, prices and deliveries, they have a common interest in
gaining maximum performance from the supply chains delivering coal
to customers’ ships (King S, 2009). It was recommended that transpar-
ency of information was vital in improving performance, and a cen-
tral coordination role by one of the main participants should take on
smoothing the flows of coal to meet shipping schedules. The resolu-
tion seems to have changed over the years. The 2008–09 recessions
caused the Queensland State Government to experience massive defi-
cits and the Queensland Premier announced in Parliament on 2 June
2009 (Queensland Parliamentary Papers, June 2009) that a number
of the coal export ports would be sold and privatisation of the rail-
ways operations and rolling stock should occur. By July 2009, the sell-
off of coal rail track and some coal ports was retracted (Anonymous,
2009; Courier Mail, 29 July 2009). At the time of writing, the politi-
cal decision-making on these issues was still perceived to be volatile.
Nevertheless, the Premier, Ann Bligh, argued that private ownership
would lead to stronger collaboration compared to the existing public/
private collaborative efforts. Private ownership of the critical rail net-
works could hopefully lead to stronger leadership, ensuring that coal
flows would become more efficient.
On 8 March 2010, the Queensland Resources Council announced that
BHP Billiton Ltd, Xstrata, Rio Tinto and Peabody Energy Corp were lead-
ing the discussions of the mining companies to make an offer to pur-
chase the coal transport sections of the state rail network. (Anonymous,
2010) At the same time a bid for the mineral rail network was offered by
the IPO group (Queensland Resources Council, 2010). The consortium of
the mining companies offered something in the vicinity of $4.8 billion
for the inland rail tracks. It does not include any rolling stock or the bulk
54 Elizabeth Barber
and inter-modal freight services of QR. To date no formal announcement

has been made with the current Queensland Treasurer, Andrew Fraser,
advising that his preference is for a sale of the track and all the roll-
ing stock. Unions oppose the privatisation of the network (Anonymous,
www.TandLnews.com.au, May, 2010). If it does go ahead, it would be
more in line with the Chinese approach to the mining producers own-
ing the coal flows from ‘pit to port’. It could well create high competi-
tive barriers in the future if further mines are developed in the Central
Queensland Coal Basin. The ACCC appear strangely quiet on the matter.
That offer fell short of controlling the port coal flows as well, which in
some cases does occur in the Chinese coal flows. What happened was
that the Queensland Government finally gave the permission for a public
float of QR National which was successfully floated in October 2010.
3.4.2 The Hunter Valley coal flows

In the Hunter Valley, the Australian Rail Track Corporation’s (ARTC’s)
recent access proposal to overhaul the coal chain from the mines to the
ships to prevent the ‘infamous bottlenecks’ was rejected by the ACCC
(Kirkwood, I., Reuters.com, 10 March 2010). The aim of their proposal
was to expand the rail network capacity to align better with the expand-
ing port terminal capacities. When finalised, the aim of the proposed
new framework was that the ARTC would set the access charge for track
use and to their obligations to relate more rail capacity.
3.5 Summing up the Australian coal export

transportation issues
At present both the expansion of the rail distribution services in

Queensland and the port expansions in NSW are owned and operated
by different entities looking to change participating processes. There
are high levels of congestion due to the rail operations in Queensland
and notorious port congestion at Newcastle, NSW. (Ports Australia,
2010) Over the past few years, Australia has been able to afford the
high freight rates and bear some of the high congestion costs involved
in exporting coal worldwide. The main export coal is coking coal
(Australia accounts for 51 per cent of world exports), which is more
expensive than steam coal, but, nevertheless, China is now emerging
as a major supplier to itself and the competitive edge that Australia
has experienced in the past might not be available in the near future.
Transport costs are a large proportion of the total delivered price of
coal into China.
Alliances, mergers, cooperative agreements and the like occur

throughout the coal mining industry between the production and
upstream movement of coal to the smelters or electricity generation
plants. The concept of ownership seems to be the approach that the
Chinese coal production and logistics industry find the most efficient.
(Thomson, 2003)The domination occurs through ownership and con-
trol rather than the collaborative partnerships of the Australian coal
production and logistics industry.
Recently the Chinese approach is being seen in Australia as one to
duplicate. Efforts have been submitted by mine companies to expand
their holdings to the export coal supply chains to the ports. Some exog-
enous regulatory factors such as the very recent resource tax might
impede this movement of domination in the export coal supply chains,
but further research is required to monitor the fluid situation that is
unsettling the Australian export coal business at present. Nevertheless,
the coking coal destined for China and other Asian countries is expected
to increase rather than decrease up to 2030.
This section has demonstrated the importance of the transport
services of Australian export coal. These coal transport services must
improve either by dominant supply chain participant influences to
improve efficiency or by other methods such as the demonstrated
Chinese approach in order to retain their competitiveness.
PART TWO
3.6 Australian iron ore production
Australia produces around 17 per cent of the world’s iron ore and is ranked
second behind China (39 per cent) (Australian Minerals, 2010 – www.
australiaminesatlas.gov.au). The major iron ore suppliers in Australia are
BHP Billiton and Rio Tinto. A smaller third supplier is Fortescue Metals
Group (FMG). All iron ore mines are open-cut and located in the Pilbara
region of Western Australia. Rio Tinto is the largest producer which
operates and maintains all its own mining, railways and port facilities.
Rio Tinto is undertaking a $10 billon expansion plan to increase its iron
ore production by nearly one-third from 220 Mtpa to 333 Mtpa by 2015
(Macdonald, C., August, 2010). FMG is the latest iron ore producer to
the area. It started production in 2008. It mines from two mining hubs,
namely, Chichester Hub which includes its initial mine at Cloudbreak,
and its most recent mine at Christmas Creek, which is located approxi-
mately 50 km east of Cloudbreak mine and the Solomon hub.
56 Elizabeth Barber
BHP Billiton Iron Ore manages the Mount Newman Joint Venture.
These companies supply more than 80 per cent of the world’s iron ore,
holding immense power in the supply chain for steel products. The vol-
ume of exports increased steadily since 2003 whilst the value of these
exports increased dramatically due to massive price increases from
2003–08. China is the world’s largest importer of iron ore. The majority
of exports are transported from mines by dedicated heavy haulage rail
to dedicated bulk ports for bulk shipment to China.
FMG produces fine high-grade iron ore from its two mine sites at
Cloudbreak and Solomon.
3.6.1 Background
Iron ore from Goldsworthy, 100 km east of Port Hedland, in the early
1960s started the iron ore supply chain through Port Hedland to Asia.
In 1967 iron ore was found at Mount Whaleback and a 426-km dedi-
cated railway line was built to haul ore from Mount Newman to Port
Hedland. In 1986 Port Hedland dredged the main channel to increase
the tonnage to accommodate larger vessels using the port to ship the
bulk iron ore to Asia.
3.6.2 The two giants

3.6.2.1 Rio Tinto
Hamersley Iron Pty Ltd is 100 per cent owned by Rio Tinto and situated
along the Robe River. In 1996 Hamersley Iron celebrated its thirtieth
year of operations and their one billionth tonne of iron ore exported.
In 2009, Rio Tinto iron ore expansion works were completed, increasing
the capacity of the port facilities from 120 Mtpa to 145 Mtpa (Dampier
Port Authority, Annual Report, 2009).
3.6.2.2 BHP (Broken Hill Proprietary) Billiton

BHP Billiton Iron Ore company operates seven mines in the Pilbara
region. It continues to expand its production in the region. Most of these
high-grade iron ore mines are located near Mt Newman and the town
of Newman. The huge Mt Whaleback mine was established in 1968 and
has continued to grow into the largest single-pit open-cut mine in the
world. The small mines are also clustered around the town of Newman
but the Yandi mine is located 100 km northwest of Newman and the
Yarrie mine is located 200 km east of Port Hedland. Consequently, BHP
Billiton operates over 1,000 km of rail transport which links this net-
work of mines to two separate dedicated ports located on both sides of
Port Hedland.
3.7 Pricing
Over the past 40 years, the price of iron ore was negotiated between
these three major suppliers and the Chinese steel mills. It was under-
stood that once a major supplier had reached a pricing agreement with
a major steel company the rest would generally follow this set price
which would remain fixed for the remainder of the year. Negotiations
were undertaken by the China Iron and Steel Association (CISA) which
represented the collective Chinese steel mills. The benefits of such an
arrangement were greater efficiency and a strong risk reduction.
In the second half of 2008, the global economic crisis hit all major
commodity markets causing commodity prices to fall significantly.
Major price swings occurred on the iron ore spot market which enabled
some Chinese mills to profit from lower prices. When the spot market
for iron ore dropped below the contract price, some mills ignored the
contract price and used the spot market prices. When the spot market
prices rose above the contract price, some of the larger Chinese mills
purchased higher volumes to resell at a profit to smaller mills. During
2009, after passing the self-imposed June deadline, negotiations broke
down between the major three suppliers and the CISA (Pandya, 2009).
In 2009 BHP Billiton agreed to sell ore at a mixture of pricing rates
including a percentage of ore being sold at the spot market price, at a
quarterly contractually agreed price and on an indexed pricing rate.
The strategic focus on the iron ore supply chain has been one of
consolidation with the merging of some of the bigger iron ore min-
ing companies as well as the takeovers of numerous small producers.
It also enabled the Chinese manufacturers to consolidate their nego-
tiations through CISA which gave all manufacturers greater leverage
since they used a high percentage of the suppliers’ production and had
collusive bargaining power. The strategy also permitted long-term col-
laboration including potentially reward sharing negotiations due to the
consolidation and volume flows enjoying economies of scale and bulk
transportation.
With strong global demand for iron ore, the big three producers are
currently exploiting their power to maximum effect. Their aggressive
exploitation can jeopardise long-term supplier–manufacturer relation-
ships or at the very least provoke further counteractions by manufac-
turers. Australia is a small but advanced economy, and over the past
four decades has relied on its mineral wealth to provide a strong gross
domestic product (GDP). Foreign investment is used to finance its vast
mineral wealth, which has enabled the Chinese steel mills to invest in
58 Elizabeth Barber
the sector. Foreign investment uses a diversification strategy to develop

new suppliers and thus put pressure on the three major miners. FMG was
a smaller supplier that received financial assistance from the Chinese.
On 17 August 2009, CISA negotiated a discounted contract price for
iron ore with FMG in an attempt to demonstrate to the three major
suppliers that they were not completely dependent on them for their
iron ore. Unfortunately, FMG does not have the supply chain capacity
to move the amount of ore required to affect either the contract price or
the spot price of ore substantially.
Another strategy that the Chinese manufacturers attempted was to
increase their holdings in one of the major suppliers. The Aluminium
Corporation of China’s (Chinalco’s) bid to increase its stake at Rio Tinto
to 18 per cent required approval by Australia’s Foreign Investment
Review Board. The impact of this was not only to control prices and
perhaps return to the acceptance of the contract pricing model but to
increase investments in supply chain management proposals to pro-
vide alternate transportation facilities. BHP Billiton counter-attacked
with a collaborative strategy with Rio Tinto; as the latter was experi-
encing an over-exposure to debt, it accepted the BHP Billiton offer.
In June 2009 BHP and Rio Tinto signed binding agreements on a pro-
posed joint venture (Wallacep, 2009). Subsequent regulatory approv-
als for the joint venture were becoming increasingly apparent not to
eventuate so in October 2010 the agreement was terminated. These
two suppliers currently massively dominate the supply chains of iron
ore worldwide (www.accc.gov.au/content/index.phtml/itemId/952207/
fromItemId/751043). The CISA would like to return to the contract pric-
ing model but the strong demand for iron ore is keeping the Australian
export market of iron ore very healthy at present.
3.8 Australian iron ore distribution networks
Freight rates are a key cost component of Australian iron ore exports
with land transport and port costs accounting for similar costs as min-
ing the ore. The average Free on Board (FOB) cash cost of international
non-agglomerated iron ore production increased by over 80 per cent
between 2003 and 2007. Freight rates are a key component to profitabil-
ity. Freight rates collapsed in 2008 but surged again in early 2010.
3.9 Railways
The dedicated iron ore railways in northwest of Western Australia are

standard gauge and built to the heaviest US standards. The total rail
track in the region is over 1400 km in length (www.ispt.murdoch.edu.

au/ISIP/casestudies/Pilbara). It is dedicated to transporting bulk ore
from the mines to the ports. The major four railways are owned and
operated as follows.
3.9.1 Rio Tinto

Rio Tinto’s rail system links 12 mines with three shipping terminals. It
is the largest privately owned heavy freight rail network in Australia.
The original track was built between Dampier and Mt Tom Price in 1966
with spur lines gradually being built out to Marandoo, Brockman and
Yandicoogina (in 1998) mines.
Up until 2002, the Hamersley Iron and the Robe River Iron owned
and operated their own rail networks to the port, namely, the Hamersley
Railway Service and the Robe Railway Service, respectively. In 2002
they combined to form a single rail network operated by ‘Pilbara Rail’.
The original companies still retain ownership of locomotives, track and
rolling stock but the operations of the rail system are under the control
of the Pilbara Rail Company. It operates over 1,100 km of track moving
about 100 mts of iron ore per annum. It services about 11 mines into
the mainline system. A doubling of nearly 100 km of track on the main
line began in 2004 and provided a parallel line to improve flow capacity
upon its completion in 2006.
The huge trains that operate on these lines haul an average of 226
wagons with a load capacity of 105 tons each. A fully loaded train
weighs approximately 29,500 tonnes and is about 2.4 km in length.
Due to this weight and length three locomotives are used to pull the
load at the front and two push at the end of the train. In 2009 Rio Tinto
investigated the introduction of driverless trains which would lead to
a significant level of savings and improvements in rail-operating effi-
ciency. Each train comprises approximately 234 ore cars. The turna-
round cycle time is approximately 28 hours with a train movement
on the line approximately every half hour (www.riotintoironore.com/
ENG/operations497_rail.asp).
3.9.2 BHP Billiton

BHP Billiton operates two separate single-track railways: one from the
Mt Newman area (named the Mt Newman Railway Service) and the
other from the Yarrie mine (known as the Goldsworthy Railway Service)
to Port Hedland. The 426-km railway from Mt Newman to Nelson Point
port in Port Hedland is the longest privately owned railway in Australia.
It is also one of the most efficient. Each train hauls 200-210 cars each
carrying 125 tonnes of ore. These trains are nearly 4 km long and need
60 Elizabeth Barber
six 6,000 horsepower locomotives to pull the trains. The trips take
approximately eight hours to transport the ore over the distance.
There is also a smaller spur line into the Finucane Island port at Port
Hedland from the Yarrie mine which is 208 km running due east. The
trains along this track are smaller and typically one locomotive will
haul about 90 ore cars (www.bhpbilliton.com).
Port Hedland’s traffic control centre controls all train movements.
Weighing of the ore wagons are undertaken as they pass this centre. Rail
operations continue every day of the year with about a dozen loaded
and unloaded trains on the tracks each day continuing the transporta-
tion flows. Rail transport from the huge ore mines in the Mt Newman
area haul 208 rail cars each with a carrying capacity of 125 tonnes. The
trains are approximately 4 km long. The single rail trip from mine to
port takes approximately eight hours.
These rail trains are seen as part of the production process as each
shipment must meet specific volumes and sequences for blending pur-
poses at the ports for the final shipped ore product. The crushed ore
from the mines are sent from the mine to the rail stockpiles. The load-
ing on rail wagons is approximately 14,000 tonnes per hour. (Note the
difference between this rate and the ship loading rate of 10,000 tonnes
per hour but the bulk ship holds have a more continuous bulk capac-
ity than the rail wagons.) All these distortions need to be taken into
account when scheduling the types of ore, the timing of rail loading
and unloading to meet customer orders to be bundled into ships which
have tight loading schedules at the wharves.
It is not just a simple matter of all iron ore being the same. The mas-
sive Mt Whaleback mine produced exceptionally high-grade ore which
is often mixed to customer needs. Ore is also shipped in different prod-
ucts from lumpy ore to finely crushed ore (www.bhpbilliton.com/bb/
ourBusinesses/ironOre/rail.jsp).
BHP broke the record for the heaviest train with a weight of 99,734
tons which travelled 275 km between Yandi and Port Hedland on the
Mt Newman line. It was controlled by a single driver (www.railway-
technology.com/projects/hamersley).
3.9.3 FMG
The Pilbara Infrastructure Pty Ltd is a wholly owned subsidiary of FMG.
It owns both rail and port assets. Its purpose-built railway is the heaviest
haul line in the world with a 40 tonne axle loading design. It runs 288
km from the Cloudbreak mine to the Herb Elliott Port at Port Hedland.
The railway was constructed in a record time period of nine months
during 2006. The track was completed in February 2007, followed by

the first rail fleet of wagons delivered in November 2007, and the first
ore train to Port Hedland ran in April 2008. Construction of a local rail
workshop at Rowley Yard Workshop was completed in May 2008. By
October 2009, these trains were transporting a million tonnes per week.
It was truly a remarkable project.
It currently runs six trains daily. These new trains use state-of-the-art
technology including pneumatic braking systems which permit brak-
ing across the total length of the train simultaneously. The trains can
carry up to 32,950 tonnes of ore in 240 cars. Each train is about 2.7 km
in length and hauled by only two locomotives, which is half the typical
four locomotive haulage rate. The interesting fact is that all train move-
ments are controlled from Perth rather than in the region. The control
is over 1,600 km away from the actual railway tracks (www.fmgl.com.
au). This track transports one million tonnes of ore per week to the port.
The cycle time is approximately 19 hours. The speed of operations is
due to extremely straight track alignment, and the short rail distance in
the Hamersley basin.
3.10 Train wagon delicacies in load weights
The loading of ore cars is a delicate operation – if the wagons are

overloaded, this places stress on critical components causing failures.
Underloaded wagons also mean wasted capacity and poor network effi-
ciency. If an ore car is lightly loaded and sandwiched between fully
loaded cars, the stress can lift the light car off the rails leading to derail-
ments. Derailments not only damage the tracks but depending on where
the derailment occurs along the network, it can halt ore flows from the
mines to the ports. A derailment that could potentially disrupt produc-
tion at multiple mine sites is considered within the industry as major
and is said to be on par with the impact of a tropical cyclone. Repairing
the lines after a derailment can take days within which the stockpiling
of ore at the mine can reach maximum capacity forcing the mines and
their processing plants to shut down production. Further, if ships are
waiting for loading at the port area the financial impact in transport
costs increase and the lost revenue is counted in the millions (www.
theajmoline.com.au/mining_news/news/2010/sep-oct-print-edition/
efficiency).
The discrepancies between car load weights measured and estimated
during train loading operations at the mine site and those measured
at the port is vital. If the mine site has a weighing system with 2 per
62 Elizabeth Barber
cent accuracy, it could introduce a variability of around 2.3 tonnes per

loaded car. If this data is then aggregated and divided by the number of
cars to obtain an average weight per car it could show a variability of 10
tonnes per car per train. This scenario demonstrates the importance of
weighing cars accurately at the point of loading.
3.11 Third-party access to rail infrastructure
Although the main iron ore railways are privately owned, there is capac-
ity for third-party access to use the facilities under the State Agreement
Act in Western Australia. The main tenet states that freight from third
parties should be carried at reasonably negotiated terms and rates, under
the provision that this can be achieved without unduly prejudicing or
interfering with the owner’s existing operations. This is interpreted to
mean that where there is excess transportation capacity on any railway,
then third-party access is available. Despite this clear legal situation the
owners of the railways, Rio Tinto and BHP Billiton, are not willing to
allow third-party access, namely, FMG.
The battle for third-party access to the iron ore railway lines has been
waging since 2004 when FMG tried to gain access to BHP’s Mt Newman
line and Rio Tinto’s Hamersley line (www.ncc.gov.au). The four Pilbara
iron ore railways subject to access rights include:
● The Mt Newman Railway Service owned and operated by BHP

Billiton
● Operates from SE Pilbara to Port Hedland
● The Goldsworthy Railway Service owned and operated by BHP
● Operates from northeast Pilbara to Port Hedland
● The Hamersley Railway Service owned and operated by Rio Tinto
Ltd.
● Southeast and central Pilbara to Dampier port
● The Robe Railway Service owned and operated by Rio Tinto Ltd.
● Operates from west Pilbara to Cape Lambert port
FMG wanted access to the Rio Tinto line to transport iron ore from its
Solomon mine to a port (yet to be built) at Anketell. The recent battle
lines were drawn when the Treasurer, Wayne Swan, decided that:
● BHP’s Mt Newman Railway Service not be declared open to access

(thus affirming the previous Treasurer Peter Costello’s decision)
● BHP’s Goldsworthy Railway Service be declared open to access for

20 years
● Rio’s Hamersley Railway Service be declared open to access for 20
years
● Rio’s Robe Railway Service be declared open to access for 20 years
Rio Tinto and FMG appealed these decisions. The Australian Competition
Tribunal then reviewed the Treasurers’ decisions relating to all four
applications for access by FMG and on the 30 June 2010 handed down
the following decisions:
● Reaffirmed no access to the Mt Newman Railway Service

● Reaffirmed the Goldsworthy Railway Service access for 20 years
● Refused access to Rio’s Hamersley Railway Service
● Reduced the Rio’s Robe Railway Services access to 10 years
In essence, the Australian Competition Tribunal declared in July 2010

that the main railways should not be open to third-party access but that
the smaller and less used railways should permit third-party haulers.
The smaller Robe Railway Service line and BHP Billiton Goldsworthy
Railway Service, both of which have some spare capacity, was ruled
open to third-party access (National Competition Council: www.ncc.
gov.au/index.php).
Both Rio Tinto and FMG appealed these decisions. Rio Tinto appealed
the decision to declare the Robe Railway Service and FMG had two
appeals: (a) not to declare the Hamersley Railway Service and (b) to
reduce the declared Robe Railway Service from 20 to 10 years. On 4 May
2011, the Full Court of the Federal Court gave the following judgement
based on these appeals:
● Mt Newman Railway Service not declared, that is, no access

● Goldsworthy Railway Service declared 20 year access to 19 November
2028
● Hamersley Railway Service not declared, that is, no access
● Robe River Service not declared, that is, no access (www.ncc.gov.au)
3.12 Ports
There are two heavy bulk exports located in the Pilbara coastline of
northwest Western Australia. The most northern port is Port Hedland
64 Elizabeth Barber
which is used by Rio Tinto, and Dampier ports which lie approximately
200 km to the south is used by BHP Billiton. The value of commodi-
ties exported from Port Hedland and Dampier exceeded $40 billion in
2009–10. Competition for berths in these ports is almost as fierce as the
lengthy battles being fought between the mining companies over rail
infrastructures.
3.12.1 Rio Tinto – Dampier

In Dampier, iron ore is exported from the East Intercourse Island and
Parker Point facilities. Rio Tinto maintains, controls and exports through
the seven wharves at East Intercourse Island and its lay-by berth Parker
Point’s five wharves.
In November 2006 the world’s biggest ore carrier, Berge Stahl, loaded
at East Intercourse Island to transport iron ore to European steel mills.
The Dampier port is one of the few ports in the world able to accommo-
date the Berge Stahl fully loaded. In 2007, the Dampier port upgrade was
completed by Rio Tinto which increased the total capacity to 145 mtpa
with two new car dumpers, two new ship loaders and wharf extensions
to the Parker Point wharf. The two new ship loaders allow two vessels
to be loaded simultaneously. Further, the 600-m extension of the wharf
allows up to four vessels to be berthed at the same time. In 2009, a fur-
ther new ship loader was installed at the East Intercourse Island wharf
and during that year Rio Tinto exported two billion tonnes of iron ore.
The commodity throughput via Dampier ports for the past five years
from 2004–05 increased from 75,847 351 mtpa to 116 550 652 mtpa in
2008–09 (Dampier Port Authority, Annual Report, 2009).
Cape Lambert (also known as Port Walcott) is located just north of
the main Dampier ports of Rio Tinto. It was originally the port for Robe
River ore exports. It is still used and is currently being expanded to
service the Cape Lambert Port B development, which is to provide a
1.4-km-long access jetty and a double-sided iron ore wharf with two
berths and a ship loader. It is due to be completed in 2013.
3.12.2 BHP Billiton – Port Hedland

BHP Billiton exports through two separate ports located at opposite sides
of the Port Hedland harbour. The Nelson Point port services the ore
transported from the massive Mt Whaleback mine, the other localised
Newman mines and Yandi mine. The other port located at the other
side is Finucane Island port and it handles the Yarrie mine’s outputs.
Port Hedland can handle four bulk ore ships simultaneously. The typi-
cal ship load is 300,000 tonnes of ore. Ships can load at a flow rate of
about 10,000 tonnes per hour and thus it takes about 30 hours to fully
load each ship. The turnaround time is tight in port as about 800 ships
(and this rate is increasing annually) are loaded per annum.
To keep the flow loads pouring into the bulk holds of the ships a
complex conveyor system operates from the rail dumped stockpiles to
the ship loadings at the wharves. A conveyor system runs under the
harbour (in a tunnel approximately 1 km in length) to enable ore to be
transferred from Nelson Point port across to Finucane Island port. The
ore is dumped from the rail network into four main stockpiles, each
containing 200,000 tonnes of ore. Giant buckets scoop up the ore from
the stockpiles and transfer the ore to the conveyor system which links
to the ship loaders.
3.12.3 FMG – Port Hedland

FMG decided to develop a Greenfield site at Anderson Point just to the
south of Port Hedland to build its extended wharf in 2006. It reclaimed
over two million square metres of land. The wharf allows two vessels to
berth and due to its length it enables berthing regardless of tides. This
extra berth provides flexibility in shipping movements and markedly
reduces waiting times (www.fmgl.com.au, Ports Fact Sheet).
3.13 Domination issues in the Australian export

iron ore supply
Here we can see that unlike the coal networks in the eastern states the
transportation distributors are not the dominant player in the supply
chains but rather the producers of the ore. Both BHP Billiton and Rio
Tinto own the mines, the rail transport and the port facilities. This is
similar to their huge counterparts in China where the coal producers
own the mines, the rail systems, the port facilities and even the bulk
shipping lines.
The many coal mines in the eastern states of Australia are so depend-
ent on the original public rail system that individual coal producers had
limited negotiation power over rail schedules and track usage. Once the
railways became so congested that mines could not get their coal flows
to the harbour stockpiles efficiently, the urgent call for private owner-
ship and control occurred. The government interfered and backed the
call to sell the public network to a private consortium. This is the oppo-
site from the current situation in iron ore rail transportation.
The iron ore railways are privately owned by the two giant producers.
They want to keep their railways closed from other mine producers yet
66 Elizabeth Barber
public interference politically from the Commonwealth’s Treasurers’

decisions, the Australian Competition Tribunal and most recently the
Federal Court judgement all call for access for competitors to use these
railways. These opposing views are difficult to reconcile.
The different outcomes are related to the dominant player in these
resource supply chains. When the producers or suppliers of the resource
are the dominant participant along the supply chain the distribution
networks serve to retain and strengthen their domination. On the other
hand, when the distribution network or distribution services such as
the coal rail system and coal port authorities are critical constraints
to the coal export flows, their dominant position is eroded by their
inability to demonstrate expected efficiencies and effective distribution
services. It is not a public/private ownership debate as much as a domi-
nant retention in export supply chains. The private/public collaborative
strategies of the production and transport facilities have not produced
the competitive efficiencies that are needed to keep the Australian coal
export market at its peak. Thus calls for privatisation and collaborative
dominance to ensure the transport flows remain efficient have been
touted not only by the Queensland Government but by the mining
producers as well.
3.14 Conclusion
Both black coal and iron ore are bulk resources that are vital to the
Australian economy. Few people realise how dependent these exports
are on transportation. This chapter has attempted to highlight the
potential risks associated with these domestic links. It has also high-
lighted the Australian government’s interference. This interference is
contrasted to Chinese coal supply chains, where the mines own, con-
trol and dominate the mines, transport systems and facilities, including
the import shipping lines. The government interference in these two
export private industries is inconsistent with the coal railways being
privatised whilst the iron ore railway corporations are pressured by the
government to allow public access for competing producers.
The future is unsettled regarding the regulatory changes, but it is pre-
dictable with regard to the expansion of both the production of these
minerals and the associated transport infrastructure developments.
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Documents/Annual-Reports/2009-DPA-Annual-Report.aspx.
Energy Information Administration (EIA) (2010), U.S. Department of Energy,
Available at http://www.eia.gov/coal/.
King, S. (2009), ‘The ACCC’s Role in Coal Chain Logistics’, CEDA Queensland
Export Infrastructure Conference, Brisbane.
Kirkland, I. (2010), March 10th, ‘Hunter Coal Railway Access Scheme Sent Back
for Rewrite’, www.reuters.com.
Macdonald, C. (2010), ‘Rio Spends US$790m on Pilbara Port, Prelude to Push
to 330 mt.’ Australian Journal of Mining, 5 August 2010. http://www.theajmon-
line.com.au/mining_news/news/2010/august/august-05–10/top-stories/rio-
spends-us-790m-on-pilbara-port-prelude-to-push-to-330mt.
New South Wales Government, Department Planning (April 2007), Director-
General’s Environmental Assessment Report: Major Project Assessment, Kooragang
Coal Terminal – Proposed Increase to Throughput Capacity, Section 751 of the
Environmental Planning and Assessment Act 1979, April, 2007. www.plan-
ning.nsw.gov.au.
The Joint Coal Board (Australia and New South Wales), Coal Services Pty Ltd.,
New South Wales Department of Mineral Resources and New South Wales
Department of Primary Industries. (2009), New South Wales Coal Industry
Profile: Incorporating Coal Services Pty Limited. Statistical Supplement, 2009,
Department of Mineral Rources, St. Leonards, NSW.
O’Donnell, S. (2007), ‘Goonyella Coal Chain Capacity Review’, Transport and
Main Roads Department, Queensland Government Publication.Available at
http://www.tmr.qld.gov.au/Business-industry/Transport-sectors/Rail-services-
and-infrastructure/Goonyella-Coal-Chain-Capacity-Review.aspx.
OECD, International Energy Agency (IEA), World Energy Outlook, 2008, http://
www.iea.org/textbase/nppdf/free/2008/weo2008.pdf.
68 Elizabeth Barber
Osborne, P. (2010), Mine Companies Seek Rail Sale Alternative, Brisbane Times.
com, Available at http://www.brisbanetimes.com.au/queensland/mine-com-
panies-seek-rail-sale-alternative-20100308-ps8p.html
Pandya, M. (2009), ‘Iron Ore Price Talks Reach a Crossroads: Can China Get
What It Wants?’ Knowledge at Wharton, Finance & Investment, University of
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together/?searchterm=On December 5th.
4
MRO Procurement: Best Practices
Framework for Capital Equipment
Ananda S. Jeeva
4.1 Introduction
Maintenance, Repair and Operations (MRO) is a critical activity in capi-

tal equipment maintenance that helps organisations reduce operational
cost, reduce waste, reduce risks, increase reliability, eliminate produc-
tion downtime and increase competitiveness. MRO may be defined as
‘maintenance parts and components that are used in the production
process to produce the finished product’. Many firms make an initial
expensive purchase of plant and equipment, such as mining plant
equipment and manufacturing production plant, which have a long
operational life. Other operating plants for rail locomotives and wagons
have an operational life span of four to five decades. To sustain the
operational capability of these plant and equipment parts, components
and sub-assemblies must be continuously available throughout their life
span. Therefore procurement personnel must ensure that they are able
to source and procure the correct parts and components when required,
and also ensure its future availability when necessary.
Procurement activities include sourcing, tendering, contracting,
negotiation and purchasing. The organisational functions of procure-
ment include specifications development, value analysis, supplier mar-
ket research, inventory control and receiving. Therefore, procurement
competence may be defined as ‘the capability to develop and manage
the supply base within the organisational and production strategies’.
As the global business environment is constantly evolving and market
forces are unpredictable, procurement competence needs to be flexible
to adequately respond to changes in the environment affecting pro-
curement activities. Some of these changes include Product Life Cycle
(PLC) and the influence of new technology. PLCs are becoming shorter
69
70 Ananda S. Jeeva
and shorter, whilst customer demand for new technology is increasing.

These two common competitive forces drive the new models of con-
sumer products. But the industrial capital plant and equipment envi-
ronment sees these influences advancing less rapidly.
When new capital plant and equipment models are introduced into
the marketplace, older models become obsolete and many manufactur-
ers cease the manufacture of parts and components for obsolete mod-
els. This lack of availability of spare parts and components increases
the risk of capital equipment facing unplanned outage and produc-
tion processes grinding to a standstill, thereby affecting the financial
bottom line. To manage this risk, procurement activities must take
PLCs into consideration when procuring expensive plant and equip-
ment as whole of life. Ideally, expensive capital plant and equipment
costing millions of dollars should have extended life spans. Original
Equipment Manufacturers (OEM) need to ensure the continued avail-
ability of parts, components and sub-assemblies for these plant and
equipment for the complete life span. However, some market forces
such as mergers, amalgamations, technological advances and compe-
tition determine the long-term production of these parts and com-
ponents. However, there are some third party manufacturers who
produce these parts and components under license if there is long term
financial viability.
4.2 Implication of unavailability of

parts and components
A disruption in the supply of critical parts and components for plant

and equipment can bring a production and manufacturing factory
to a standstill, affecting all the entities along the downstream side of
their supply chain. This may result in loss of customers, loss of profits
from entities along the supply chain, loss of competitive advantage and
finally leading to the demise of the manufacturer. Lead time is also cru-
cial along a supply chain, as it affects all the entities along the chain.
Procurement activities need to consider the long-term constrictions
and effects of unavailability of parts and components. It is well known
that Sales and Operations Planning activities are driven by customer
demand and forecasting of future sales. Customer demand, substitute
products and future sales determines the PLC. OEM companies there-
fore produce parts and components accordingly. This chapter analyses
the literature and suggests a best practices framework for procurement
strategy from the perspective of the PLC.
MRO Procurement: Best Practices Framework 71
4.3 Background of procurement
This chapter also examines the theoretical underpinnings of procure-

ment and the PLC concept, and uses that theory to define and identify
the elements and dimensions of procurement in MRO, and its practical
responses to supply uncertainty. In order to do this, the definition of
procurement needs to be visited.
There are limited published academic definitions of procurement.
Lysons and Farrington (2006) define procurement as ‘the process of
obtaining goods or services in any way, including borrowing, leasing
and even force and pillage’. They also state that procurement is a wider
term than purchasing. Van Weele (2005) states that procurement is the
function of purchasing raw materials, supplies and other consumables.
This chapter defines procurement as ‘the process of need identification,
supplier identification, sourcing, contract administration and acquisi-
tion of goods and services’.
Procurement management has been promulgated as an effective busi-
ness strategy approach (Cox 1996) and is becoming a necessary busi-
ness strategy in many organisations (Tassabehji and Moorhouse 2008).
Supplier relationships are critical in procurement activities. A number
of recent publications are focusing on the importance of supplier rela-
tionships to the buying firm. Van Weele and Roszemeijer (1996) state
that procurement relationships focus on collaboration benefits. Seth
and Sharma (1997) also agree that purchasing approaches are chang-
ing from a transactional approach to a relational approach. This is fur-
ther agreed by Brennan and Turnbull (1999). Hence, an investigation
of operational relationships in supplier–buyer transactions is neces-
sary. Also, transaction costs arise from the costs of finding buyers and
sellers, and arranging, policing and enforcing agreements or contracts
(Parker and Hartley 2003). These collaboration benefits and relational
approaches must consider PLC in their purchasing and sales contracts
and if necessary in outsourced maintenance contracts.
Sales and Operation Planning is directly linked to manufacturing
operations. Production schedules are planned to accommodate mar-
ket demand. If market demand drops, production quota is reduced.
Similarly, production ceases in the decline stages of the PLC before stop-
ping altogether at the end of the life cycle.
However, production may still continue for the manufacture of parts
and sub-assemblies for MRO. This also depends on the viability and
economics of repair activities. Some products are not worth repairing
due to the high costs of labour. It may be more economical to purchase
72 Ananda S. Jeeva
a later model. However, in the mining industry, especially in the under-

ground mining sector, most equipment cannot be replaced and have
to be repaired immediately. MRO becomes critical to minimise down-
time and may involve sourcing and procuring the parts/components
to restore the services of the plant equipment if the part/component is
not in inventory at the mine site. Procurement personnel may need to
identify the location of the required part/components and transport it
to the required site within the shortest lead time.
If that part/component is not produced any longer by the OEM
manufacturer, alternate sources need to be identified. It is the task of
the procurement professional to locate other global locations of that
part/component. This requires supplier intelligence: the intelligence
or knowledge of the manufacturer, their products, their locations of
inventory, other consumers of those products, and so on. Knowledge
of other users of the same plant and equipment could lead to locations
and sources of MRO inventory. Hence, procurement is a critical activity
in MRO.
4.4 PLC and supplier intelligence
PLC may be defined as the course of a product’s sales and profits during
its lifetime which involves five distinct stages (Kotler and Armstrong
2008). These five stages are Product Development, Introduction,
Growth, Maturity and Decline. Each stage has its own distinct char-
acteristics that need to be considered in procurement activities. The
most critical consideration is whether there will be availability of parts
and components in the last stage and beyond. The pricing of parts and
components during these five stages is also important. Procurement
personnel must create and implement different procurement strategies
for each of these stages. These procurement strategies must be based on
data from supplier intelligence.
The first stage of product development also known as New Product
Development (NPD) does not affect MRO directly, but OEM and suppli-
ers must have knowledge of the long term supply risk of the materials
and components that are selected in the NPD stage. The second stage
of product introduction into the consumer market also does not affect
MRO directly as the finished product would not need parts and com-
ponents for repairs yet. The stages that affect procurement most are the
growth, maturity and more importantly the decline stage. The growth
stage is marked by a growth in sales, with readily available low costs
parts and components to boost sales. During the maturity stage, sales
growth would have slowed down due to a slowdown in demand and/

or competitive products; and a steady supply of parts and components
would be required. There would also be increased competition and the
price and availability of parts would be constant.
However in the decline stage, sales would be decreasing due to the
introduction of newer models and increased competition of substitute
products. The supply may exceed demand depending on market condi-
tions and promotional activities may reduce the selling price. After the
decline stage, production of the finished product may be terminated.
However, production may continue for parts and components depend-
ing on their demand, shelf life, number of total units sold and life span
of the finished product. The OEM would also determine when the final
production of parts and components may occur.
Some of the factors that may determine the stoppage of production
of parts, components and sub-assemblies for obsolete models would
be the inventory levels, who would carry this inventory and what are
the opportunity costs of carrying this inventory. If the current OEM is
merged or amalgamated with other organisations at any stage of the
PLC would depend on the new corporate and strategic directions.
This would cause concern for customers who still have good opera-
tional plant and equipment, and need spare parts. Therefore OEM have
to strategise their finished inventory for future demand for parts and
components. Two of the strategies are inventory management and out-
sourcing of continuance of the production of parts and components.
This creates another issue of who would be responsible for carrying
inventory and the ownership of design rights (Magnan, Fawcett and
Birou 1999). Therefore procurement personnel need to be aware of such
issues and plan alternate strategies for supply continuance of spare parts
and reduce supply risk.
OEMs may continue to produce sufficient parts and components for
a projected life span of their finished product. This may or may not be
sufficient depending on the number of operational plant and equip-
ment with their customers and expected or projected future demand.
The value and condition of these operational plant and equipment may
be related to replacement cost, ongoing operational costs, costs of spare
parts and asset specificity. Asset specificity (Jones and Zsidisin 2008)
may be due to the product’s uniqueness and human aspects of special-
ised training. It would be very difficult to value the uniqueness of a
product or more difficult to value the operational aspects of that same
unique product. The responsibility must be shared by both the supplier/
manufacturer and procurer on the availability of spare parts.
74 Ananda S. Jeeva
The procurer must ensure that they carry the correct part and quantity
for their projected life span of the plant and equipment. The procurer
must also be accountable for designing a maintenance procurement
plan with specific parts list with a chronological date for the expected
life span of the plant or equipment. Likewise, the supplier/manufac-
turer must also be responsible and accountable for after-sales customer
service in ensuring the availability of spare parts. This may be an ad hoc
arrangement that the manufacturer would be willing to produce parts
if and when necessary according to inventory levels, immaterial of time
forecasts. The OEM may also need to outsource their proprietary patents
for the production of obsolete parts and components to selected manu-
facturers. This, however, may increase price and extend lead time. The
other major impact that sometimes prevents manufacturers from con-
tinuing production of specific products is that their upstream suppliers
(tier 2 or tier 3) might not be able to supply the required raw materials or
components. This indicates that the supply risk flows along the supply
chain to the extreme end of the upstream side. Procurement person-
nel at the finished goods manufacturing plant and the end customer
must have supplier intelligence during the final stages of the PLC. This
enables them to make informed decisions about sourcing and procure-
ment, which leads to sustainable competitiveness.
The inability of upstream suppliers to supply raw materials and
components may also be due to obsolescence or lack of raw materials.
Manufacturers who produce the finished product are normally account-
able for quality, factory warranty, product guarantee and replacement
from the customers’ perspective. Hence, OEM also have to have supplier
intelligence. Supplier intelligence is defined as an ‘up to date knowl-
edge base of critical suppliers incorporating the suppliers’ market intel-
ligence, business intelligence, competitive capability, financial stability
including their suppliers’ suppliers’ intelligence in the long term’ (Jeeva
2008). This intelligence and knowledge extends upstream to the last
tier supplier. Supplier intelligence should provide sufficient data and
knowledge for manufacturers to forecast and predict and strategise their
short-term and long-term plans. Supplier intelligence should also pro-
vide knowledge of the suppliers’ suppliers’ PLC data. This provides addi-
tional information for negotiating better supply service levels.
4.5 PLC and risk management
Supply risk attributes change throughout the PLC stages. Each of the
five stages of the PLC has different supply risks. This risk is influenced
by the internal and external factors of the suppliers’ environment.

Hence, the procuring organisation must consider the risks for all the
five PLC stages.
4.5.1 PLC introduction stage

Low sales and profits – impacts on cost of product
New entry to market – impacts on cost of product
Price is high - has few competitors
Product promoted to selective customers and increase awareness
The status of spare parts, components are readily available
4.5.2 PLC growth stage

Higher consumer demand – higher price and possible price skimming
Promotion – wide advertising and exposure
Increasing sales – impact on cost and availability of spare parts
Increasing profits – impact on cost and availability of spare parts
Increasing market share – impact on cost and availability of spare parts
Improvements on product design – impact on cost and availability of
spare parts
Newer models updated – impact on cost and availability of spare parts
The status of spare parts, components are readily available
4.5.3 PLC maturity stage

No more improvements on product design – impact on cost and avail-
ability of spare parts
Start a new product design – impact on cost and availability of spare
parts
Advances in technology incorporated into newer models – impact on
cost and availability of spare parts
Price – reduce to match competitors new substitute products
Promotion – increased to differentiate from competitors
The status of spare parts, components are still readily available
4.5.4 PLC decline stage

Decreasing sales – impact on cost and availability of spare parts
Decreasing profits – impact on cost and availability of spare parts
Product consolidation – reduce number of product
Price – reduce price to reduce inventory
Distribution channels – consolidate less profitable channels
Advertising – reduce market expenditure and sell to only niche cus-
tomers
76 Ananda S. Jeeva
Research and design of new product – may continue to use some older
parts and components including refurbished parts
The status of spare parts, components are readily available, but inven-
tory levels declining slowly and increased uncertainty
4.6 Proposed procurement framework

best practice for MRO
This chapter proposes a procurement framework for MRO of industrial

products. Procurement personnel need to create, maintain and update
this procurement framework. It requires an ongoing collaborative
effort with engineering, maintenance and operational staff to create
the framework of best practices. This framework must also be directly
related with the PLC of each of the critical list of machinery, plant and
equipment. This framework must be derived with the collaboration of
maintenance engineering staff.
This chapter suggests the following brief steps:
● Identify and create a critical list of all plant and equipment with
purchase details
● Identify failure details, chronological order of failures
● Identify failure reasons, costs, downtime
● Identify manufacturer’s recommended mean time between failures
● Identify ease or difficulty of sourcing parts, lead time
● Classify all industrial plant and equipment operational life span at
risk
● Classify spare parts and components replacement frequency and
schedule for this critical list
● Classify suppliers into excellent, moderate, mediocre, poor in terms
of pre-agreed service level for each of the plant and equipment on
the critical list
● Create a new inventory risk classification critical list
● Create future requirements list with time schedules of critical spare
parts and components
● Create a performance matrix for each industrial plant and equip-
ment at risk
● Anticipate level of services from critical list of suppliers
● Communicate this information to maintenance and workshop staff
● Seek feedback from maintenance and workshop staff for alternate
strategies
● Update all MRO matrixes in a timely fashion
● Update supplier intelligence knowledge database

● Establish economic rationale for continued operations and replace-
ment
4.7 Risk matrix
Risk matrix is a tool commonly used in assessing risk, based on vari-

ous attributes and depending on the situation. This chapter suggests
the supply risk matrix of probability against consequence to be None,
Acceptable, Moderate, Critical and Catastrophic against Rare, Possible
and Certain. Separate supply risk matrix needs to be developed for
suppliers and; spare parts and components. This risk matrix must be
reviewed ever so often during all stages of the PLC, especially maturity
and decline stages. This would indicate the trend of current manufac-
turer and competitor actions.
As the sales, demand, supply, cost, competitor actions and substitute
products change during the different PLC stages, the risk factors must
be re-evaluated and risk classification re-established. Suppliers must be
classified according to their current and future capability and capacity
to continuously supply spare parts and components in all stages of the
PLC. This risk classification would be enhanced with additional infor-
mation of supplier intelligence of the suppliers’ suppliers. Different
industrial plant and equipment will have different levels of supply
risk. This level of risk depends on a variety of factors such as number
of plant and equipment still in operation, their life span, demand for
MRO, competitive and substitute products, failure rate, inventory lev-
els, readily available parts, opportunity cost of inventory, lead time and
supplier service level.
4.8 Component performance risk classification
From the critical list of plant and equipment, a critical list of components
and sub-assemblies must be derived because not all the components and
sub-assemblies need frequent maintenance, repairs and replacement. A
maintenance schedule is normally provided by the manufacturer for
all plant and equipment. From this schedule the maintenance staff are
able to forecast the exact requirements of components, spare parts and
sub-assemblies including time schedules over the whole operational life
of the plant and equipment. From this schedule procurement personnel
can establish a procurement plan, purchasing plan and sourcing plan as
necessary, and more importantly, a contract negotiation plan.
78 Ananda S. Jeeva
Performance risk matrix would also include failure rates, mean time
between failures, probability of failure according to usage, cost of
repair, downtime and impact to financial bottom line. The how and
why of unexpected failures and its contributing factors would further
help establish a more stable maintenance plan as well as a procurement
strategy.
4.9 Contract and negotiation power
Contract negotiation for the supply of spare parts, components and sub-
assemblies provide additional assurance and certainty to suppliers and
manufacturers of future sales. They are therefore able to plan their sales
and production capacity more accurately and provide greater stability
in negotiating their supply side. Negotiation elements may include serv-
ice level, lead times and costs. Together with the contract negotiation,
customers are further able to increase their negotiating power. With the
additional knowledge gained with supplier intelligence, customers will
be able to negotiate not only price but the critical aspect of continued
supply of parts and components.
Procurement personnel must also consider the implications of Force
majeure when negotiating long term supply or spare parts, components
and sub-assemblies. Mergers and acquisitions of current OEM or their
suppliers may lead to increased risk of supply of raw materials, compo-
nents and sub-assemblies along the upstream side of the supply chain.
Contingency strategies must always be envisioned.
4.10 Alternative strategy
The classification and implementation of best practices for MRO dis-

cussed above provides a basis for establishing alternate procurement
strategies if and when required. These alternate strategies would depend
on current suppliers/manufacturers actions for the short and long
terms. Some of these may be outsourcing the continuation of obsolete
parts and components; or complete termination of the production of
obsolete plant and equipment. Part of evaluating alternate strategies
may include supplier switching costs, variation of costs of parts and
components from new outsourced suppliers, lead times, quality, quan-
tity, proximity of suppliers and service levels. Long term cost benefit
analysis of purchasing new plant and equipment is critical.
References
Brennan, R. and Turnbull, P.W.(1999), ‘Adaptive Behaviour in Buyer–Supplier
Relationships’, Industrial Marketing Management, 28, 481–495.
Cox, A. (1996), ‘Relational Competence and Strategic Procurement Management’,
European Journal of Purchasing and Supply Management, 2(1), 57–70.
Jeeva, A. (2008), Supplier Intelligence in MRO Procurement, 2008 IEEE SOLI
International Conference, Beijing.
Jones, S.R. and Zsidisin, G.A. (2008), ‘Performance Implications of Product Life
Cycle Extension: The Case of the A-10 Aircraft’, Journal of Business Logistics,
29(2), 189–214.
Kotler, P. and Armstrong, G.(2008), Principles of Marketing, 12th edition, Prentice
Hall, Frenchs Forest.
Lysons, K. and Farrington, B.(2006), Purchasing and Supply Chain Management,
7th Edition, Prentice Hall, Essex.
Magnan, G.M., Fawcett, S.E. and Birou, L.M. (1999), ‘Benchmarking
Manufacturing Practice Using the Product Life Cycle’, Benchmarking: An
International Journal, 6(3), 239–253.
Parker, D. and Hartley, K. (2003), ‘Transaction Costs, Relational Contracting
and Public Private Partnerships: A Case Study of UK’, Journal of Purchasing and
Supply Management, 9(3), 97–109.
Seth, J. and Sharma, A. (1997), ‘Supplier Relationships: Emerging Issues and
Challenges’, Industrial Marketing Management, 26, 91–100.
Tassabehji, R. and Moorhouse, A. (2008), ‘The Changing Role of Procurement:
Developing Professional Effectiveness’, Journal of Purchasing and Supply
Management, 14(1), 55–68.
Van Weele, A.J. (2005), Purchasing & Supply Chain Management: Analysis, Strategy,
Planning and Practice, 4th edition, Thomson, London.
Van Weele, A.J. and Roszemeijer, F.A. (1996), ‘Revolution in Purchasing:
Building Competitive Power through Proactive Purchasing’, European Journal
of Purchasing & Supply Management, 2(4), 153–160.
Part III
Financial Perspectives
5
Practical Problems in Mining
Valuations
Wayne Lonergan and Hung Chu
5.1 Introduction
The valuation of mining projects, particularly those in pre-production

stages, is more complex than is generally recognised. This complexity
arises from the need to properly and adequately allow for a multitude
of idiosyncratic factors associated with this type of asset whilst simul-
taneously applying appropriate technical valuation principles. Mining
projects have finite lives and idiosyncratic features. They experience
changes in risk profile as they move through different stages of develop-
ment. Owners of mining projects (particularly those in advanced devel-
opment stages) typically face large initial capital outlays which are close
to certainty outgoings, but are often severely constrained by the lack
of funding required to meet these substantial capital costs. In addition,
even in cases where project finance is available, providers of debt finance
generally require significant upfront cash equity capital over and above
the value of ore reserves as a precondition to lending (in many cases
almost regardless of the quality and value of the ore deposit). Despite
the importance of these idiosyncratic features to the outcome of min-
ing valuations, they have, in the writers’ view, not received adequate
technical consideration and proper treatment in valuation practice.
5.2 Changing risk profile
There are various stages in the life cycle of a mining project, which can
be broadly categorised as early stage exploration, discovery, pre-Banka-
ble Feasibility Study (pre-BFS), BFS, construction and development and
producing mine. The early stage exploration and discovery includes
exploratory drilling. The pre-BFS involves resource delineation, where
83
84 Wayne Lonergan and Hung Chu
more detailed drilling upgrades the prospect to (at least) resource status
and a preliminary feasibility study is conducted to establish whether
or not the project is likely to be economically viable. The BFS stage
involves the application of commercial mining parameters and signifi-
cant independent specialist analysis and the proving up of sufficient
resources to reserve status to justify the necessary investment in pit/
mine design, overburden removal, and expenditure on mining plant
and equipment, infrastructure and processing facilities. The outcome
of the BFS stage is a detailed feasibility study, which is reviewed by
independent geologists and mining engineers. The BFS determines the
appropriate plant size and mining equipment configurations. If the
outcome of the feasibility study is positive, it is, as its name suggests,
submitted to potential lenders for project financing. The construction
and development stage includes the construction of the ore process-
ing plant, power and water facilities, road and rail infrastructure, port
and shipping facilities (in the absence of existing facilities) and the
removal of overburden and the construction of access shafts etc.. The
recognition of the life cycle of a mining project has important implica-
tions for the applicability of the Discounted Cash Flow (DCF) approach
at various stages of the project and the implementation of that val-
uation approach once it has been selected as the primary valuation
approach.
5.2.1 Applicability of the DCF approach

The DCF approach is the theoretically correct approach to valuing
a mining project because it is based on the simple but economically
sound proposition that the value of any asset is the present value of
future cash flows expected to be generated from the asset. Furthermore,
the application of the DCF approach explicitly allows for the finite lives
and relatively large and ‘lumpy’ capital expenditures associated with
mining projects. The application of this theoretically correct approach
in practice to valuing a mining project depends on the availability of a
reliable unbiased forecast of cash flows expected to be generated from
the project being valued. The availability and reliability of such a fore-
cast in turn depends, in particular, on the current development stage
of the project being valued, current and expected future commodity
prices and foreign exchange relativities. Reliable cash flow forecasts may
not be available for those projects which have not yet reached the BFS
stage. However, depending on the nature and location of the deposit it
may still be appropriate to use the DCF method of valuation subject to
appropriate consideration of sensitivity and probability factors and the
Practical Problems in Mining Valuations 85
application of an appropriately higher discount rate and/or allowance

for project timing delays.
The Australian Securities and Investment Commission (ASIC) has
raised concerns against the practice of applying the DCF approach too
early in valuing early stage mining projects.1 However, there is no cor-
rect ‘one size fits all’ solution as to whether or not to apply the DCF
methodology to assess value. For example, a contemporaneous sale of
a nearby deposit may be so ‘comparable’ that it is a more reliable indi-
cation of market value than a DCF valuation (of even a project which
has reached the BFS stage), because in such an ideal setting ‘clean’ mar-
ket evidence of value is readily available and should be utilised. This is
particularly so if the project value is highly sensitive to, for example,
commodity prices, making the DCF valuation inevitably susceptible to
considerable estimation errors. Alternatively, although a project may
not have been sufficiently drilled to reserve status,2 the nature of the
deposit may be such (e.g., large unfaulted coal seam in a geological sta-
ble basin) that the probability of converting resources to reserve sta-
tus may be ‘virtually certain’. In such cases the application of the DCF
method may well be appropriate even in the absence of a BFS.
In the absence of reliable cash flow forecasts, it is naturally necessary
to consider alternative valuation approaches. One of the alternative val-
uation approaches commonly adopted in practice to value early stage
mining projects is the value per a common unit of the principal mineral
contained in ore reserves and/or resources (e.g., $ per ounce or $ per
tonne) implied by recent transactions involving acquisitions of interests
in ‘comparable’ (early stage) mining projects, or observed stock market
values of listed mining companies with interests in ‘comparable’ (early
stage) mining projects. This approach is, in substance, a variant of the
comparable sales approach. Critical to the implementation of any com-
parable sales approach is identifying the right group of ‘comparable’
projects which provide relevant market evidence on value. This poses
significant challenges in valuing early stage mining projects given the
unique nature of most projects. However, for many early stage mining
projects, any valuation guide is likely to be approximate at best and a
properly executed value per unit approach may be the best, or indeed
only, value indicator available.
5.2.2 Implementation of the DCF approach

In cases where the DCF approach can be appropriately adopted, the
value of a mining project is the present value of future cash flows. The
implementation of the DCF approach requires appropriate allowance
for non-systematic and systematic risk. Non-systematic risk (also known

as diversifiable risk or firm-specific risk) refers to an event (positive or
negative) that may affect an individual firm or project. In the context of
mining projects, the discovery of a large ore body, the failure to obtain
necessary consents/permits to commence the mining operation, etc. are
examples of non-systematic risks because these risks apply to an individ-
ual project and are uncorrelated with movements in the broad market.
In theory, these risks can be eliminated if an investor had a diversi-
fied portfolio of assets, rather than a single investment. Consequently,
they are not relevant to the rate of return determined under the Capital
Asset Pricing Model (CAPM). However, they are relevant when consid-
ering the timing and magnitude of probability-weighted or expected
cash flows (i.e., they are reflected in the cash flows). Systematic risk
(also known as market risk or non-diversifiable risk) refers to events
that have an impact (positive or negative) on the broad market and
therefore cannot be eliminated even in a broadly diversified portfolio.
Examples of systematic risk include changes in macroeconomic factors
(e.g., interest rate, tax, commodity prices). Systematic risk depends on
the extent to which the return of a particular investment co-varies with
those of a broad market index. Under the CAPM, a project’s systematic
risk is measured in terms of its beta. The higher the beta, the higher the
systematic risk of the project.
Under the DCF approach, non-systematic risks of a mining project
are usually allowed for in the cash flows rather than the discount rate.
This allowance is made by assigning probabilities to various project-
specific events that may affect the future cash flows of the project to
determine the probability – weighted or expected (unbiased) cash flows
of the project. In the context of mining projects where commencement
of mining operations typically depends on a series of hurdles being
overcome, the probabilities used to calculate probability-weighted or
expected future cash flows are cumulative probabilities. For example,
if Hurdle B has a 75 per cent chance of being met, but can only be
addressed after overcoming Hurdle A, which has a 50 per cent chance
of being overcome, from the onset, the cumulative probability of over-
coming Hurdle B is calculated as 50 per cent (probability of Hurdle
A being overcome) multiplied by 75 per cent (probability of Hurdle B
being overcome), or a 37.5 per cent cumulative probability. To further
demonstrate the principle of cumulative probability in practical mining
valuation, proving that the ore body exists does not necessarily make
it economic. Nor does the combination of these factors make it certain
that regulatory approvals will be granted. The probability of the project
proceeding to the stage where it gets all the necessary approvals is the
cumulative probability of at least all of the above-mentioned events
occurring.
The systematic risk of a project is allowed for in the discount rate,
which is determined using the CAPM. Given the changing risk pro-
file of the project (subject to the necessary hurdles being overcome), it
is difficult, from a conceptual perspective, to justify applying a single
discount rate to all the expected future cash flows. In practice, how-
ever, use of differential discount rates is rare for a number of reasons.
Firstly, computational complexity of the differential rates. Secondly,
lack of objective empirical data on applicable rates. Thirdly, in theory
at least, market discount rates (determined using ‘measured’ betas)
already reflect the combined effects of the differential rates over the
entire project life. Fourthly, at a more practical level, the values of most
mining projects are more sensitive to cash flow-based factors (such as
timing, probability adjustments for various hurdles being overcome,
commodity prices and exchange rates) than to discount rates. Whilst
all of these justifications have some practical merits, it is necessary to
get both the cash flows and the discount rate right if the valuation is to
be technically defensible, even though the valuation outcome is usually
more sensitive to variations in cash flow-based assumptions than to the
discount rate part.
In addition, the use of a single ‘market’ discount rate has a number of
technical problems. Firstly, the single ‘market’ discount rate is typically
derived using either the ‘measured’ beta of the (listed) company own-
ing the project or the ‘measured’ beta of ‘comparable’ companies. Such
‘measured’ beta are not only historic betas (not forward-looking betas),
but also usually portfolio betas (as opposed to individual project betas)
given that the relevant ‘comparable’ companies often hold a portfolio
of projects (which may be at various stages of development and hence
have differing risk profiles). Secondly, given significant changes in the
risk profile of a mining project over its life, the application of a single
discount rate would logically overstate the present value of pre-produc-
tion cash flows and understate the present value of post-production
cash flows. The extent to which such overstatement and understate-
ment offset each other is not transparent. Thirdly, the use of a sin-
gle discount rate produces an anomalous valuation outcome in that
the higher the systematic risk of the project, the higher the discount
rate, the lower the (absolute) present value of the initial upfront capi-
tal costs (i.e., cash outflows), and the higher the project value (other
things being equal).
In recognition of the life cycle of the project, it is theoretically neces-

sary to divide the expected future cash flows into at least two distinct
periods – the pre-production period and the post-production period –
and apply differential discount rates to discount expected future cash
flows occurring in those periods. In practical mining valuations, the
pre-production period can be extended to include the production ramp-
up period and the production period refers to the ‘steady state’ produc-
tion stage. Other things being equal, the beta (hence the discount rate)
for the pre-production period should be higher than the beta (hence
the discount rate) for the post-production period. In fact, the risk profile
of the post-production period resembles the risk profile of a producer
whereas the risk profile of the pre-production period resembles the risk
profile of an advanced explorer about to move into production and
become a producer.3
The cash flow pattern of the pre-production period is distinctively
different from that of the post-production period. In the former, signifi-
cant cash outflows (which are, in many cases, virtually certain outgoings
due to the practical need to at least spend minimal capital costs before
cost overruns) have to be incurred upfront, often over several years,
before positive net cash flows arise from the attainment of ‘steady state’
production. In the latter, the positive cash flows are generally matched
against the negative cash flows and the beta reflects, in particular, the
volatility of the net cash flows due to movements in commodity prices,
foreign exchange movements etc.. Failure to appreciate the implication
of the pattern of cash flows during the pre-production period for the
assessment of beta for that period has resulted in a common pitfall in
practice where the high beta for the pre-production period is justified
as reflecting a significantly higher level of non-systematic risks dur-
ing that period (e.g., poor drilling results, poor metallurgical or chemi-
cal attributes or risk of not getting necessary approvals, permits etc.).
Whilst the high beta for the pre-production period is intuitively, and
often practically, correct, the conventional justification for why this is
so lacks theoretical support because non-systematic risks should theo-
retically have no impact on beta (hence the discount rate) and should
be reflected in the cash flows.
A theoretically preferable explanation of the high beta during the pre-
production period stems from the virtually fixed nature of the substan-
tial upfront infrastructure and mine development costs (before taking
into account the asymmetric adverse effects of cost overruns) occur-
ring in that period. The project owner has to pay the substantial capital
costs upfront before receiving any revenue. This creates an inherent
“development leverage” which increases the (market) risk of the project

in the same way debt increases the volatility of cash flows accruing to
equity holders. The substantial ratio of required upfront capital costs to
the present value of net cash flows makes project values highly sensi-
tive to changes in market conditions. This is further exacerbated by the
indivisibility of many infrastructure investments and the resulting ‘all
or nothing’ nature of the relationship between the substantial cost of
infrastructure (particularly for those greenfield projects located far from
existing transport infrastructure and/or port facilities) and the size of
the reserve/resource base (i.e., either the project goes ahead or it does
not). Therefore, adverse changes in market conditions may result in the
project not going ahead at all (i.e., zero net present value (NPV)). In
simple terms, the high beta during the pre-production period is driven
by the high sensitivity of the NPV of the project in the early stages
to changes in market conditions caused by the amplified effect of the
required upfront substantial capital costs. Technically, a case could be
put that the pre-production beta should fall as the required capital costs
are spent. That is, the fall in pre-production beta is driven by the extent
of the ‘de-leveraging’, not necessarily by how chronologically close the
project is to the commencement of production.
Allowance for the changing risk profile of the project can be under-
taken using a two-stage discounting process, by which post-production
expected cash flows are discounted to the date on which the mining
operation is expected to achieve ‘steady state’ at the assessed post-
production discount rate. In order to allow for the leverage effect of the
substantial upfront capital costs which are yet to be spent, the upfront
(fixed minimum) capital costs are rolled forward and subtracted from
the above-mentioned present value of the post-production cash flows as
at the commencement of ‘steady state’ production. The resulting (future)
NPV is discounted back from the commencement of ‘steady state’ pro-
duction to the valuation date at the significantly higher pre-production
discount rate to reflect the fact that this NPV is highly sensitive to
changes in market conditions (e.g., commodity prices, foreign exchange
relativities). Further allowance for capital cost overruns through the
assignment of even a conservative probability adjustment would sig-
nificantly exacerbate the leverage effect of the significant upfront mini-
mum capital costs on the NPV estimate. The upfront (fixed minimum)
capital costs are rolled forward to the expected date on which ‘steady
state’ production is achieved at a rate close to the risk-free rate to reflect
the fact that they are virtually certain outgoings. Another argument
that can be put forward in relation to the virtual certainty of the fixed
minimum capital costs is that the project owner would theoretically

have an option to abandon the project, thereby avoiding incurring the
full capital costs, if there are significant adverse changes in market con-
ditions. However, in practice this line of argument only applies to mar-
ginal projects and even in this case, pre-committed capital costs may
not be reversed without substantial costs. In reality, if the base case DCF
which typically involves the pre-commitment of the full capital costs
does not result in a positive NPV, it is difficult to conceive that other
optionality factors (such as abandonment, curtailing or delay options)
are likely to result in market participants significantly changing their
views/perception of the value of the project.
5.3 Financing constraints
Big mining companies have significantly reduced their exploration

budgets. Most of the exploration work is now being undertaken by
smaller mining companies. Among the financial reasons is that for the
established miners, annual, and not necessarily recurring, exploration
expenditure tends to get priced as a perpetuity outgoing and reduces
equity value by a large multiple of what is spent annually. This is not
the case for junior explorers.
This industry dynamic has created a group of successful junior min-
ing companies that have advanced exploration through or near to BFS
stage but are constrained by the lack of funding required for mine devel-
opment and production. Whilst finance theories postulate that invest-
ment decisions should be separate from financing decisions and firms
can maximise value by focusing on identifying positive NPV projects,
in practice the difficulties in accessing traditional financing sources
(such as bank financing) represent an important market friction which
has severe adverse impacts on the value of junior mining companies.
Such constraints stem from a number of factors. Firstly, banks tradi-
tionally adopt very stringent policy towards lending to miners with no
historic profit record. This also reflects traditional lenders’ reluctance to
take, in substance, equity risk, even if very high interest rates could be
charged. Secondly, notwithstanding the scarcity of traditional financ-
ing sources to this ‘niche’ market segment, traditional financiers tend
to focus on capital construction costs and debt servicing, rather than
the significant underlying value of the project against which funding
is raised, although, of course, projects on the low end of the cost curve
are preferred. Thirdly, there is a limited number of experienced senior
lenders specialising in the mining sector, let alone the small end of that
sector. The presence of financing constraints for junior mining com-

panies raises several important practical and technical implications for
the valuation of these companies.
5.4 Practical implications
Typically, the market capitalisation of a small junior miner which has

reached the BFS stage is substantially lower than even a very conserva-
tive estimate of the NPV of the project for which the BFS has been com-
pleted and development funding is required. It is apparent that funding
constraints create a significant disconnect between the intrinsic value
of the company and its market capitalisation. In order to unlock the
substantial value embedded in the project, the company needs to raise
some form of capital to advance the project to the production stage. An
apparent option available to the company is to raise equity or quasi-
equity capital via either a rights issue or a private placement. These
traditional capital-raising methods, however, pose several severe com-
mercial disadvantages to the company.
5.4.1 Rights issues

Junior mining companies are usually backed by a small number of rea-
sonably high net worth individual investors, smaller investors with a
high risk tolerance and executive ‘insiders’ who fund the move from
early stage exploration, discovery to the pre-BFS stage. Rights issues,
whereby funds are raised from existing investors, particularly the high
net worth ‘inside financiers’, can be a suitable capital-raising method
for the earlier stages of investment, given the relatively small amount
of funding required. However, the amount of funding required even
for a BFS on a reasonable-sized project, let alone the capital required
for developing the mine and starting production, is substantially larger
than that available from the earlier stage investors. Consequently, rais-
ing equity capital through a rights issue to move the company to BFS
stage and then to production stage requires significantly larger financial
resources. The ‘inside financiers’ are either unable (almost inevitably so
on any major potential project) or unwilling to provide the required
capital and expose their overall investment portfolios to such a signifi-
cant lack of diversification.4 Put differently, upon approaching (often
and certainly after) the completion of the BFS stage, the company has
reached a turning point in its financial growth cycle, where the magni-
tude of its funding needs is beyond the limited financial capability and/
or willingness of the original ‘inside financiers’. In addition, in order
to avoid participating in a significant capital raising via a rights issue,

investors, particularly those who are neither sufficiently informed of
the company (management team, project, etc.) nor financially astute
enough to understand how the funds would be used, tend to sell their
shares in anticipation of the rights issue (which is, in many cases, quite
predictable given the lack of financing alternatives). Such selling pres-
sure (or at least the absence of buying pressure) depresses the share price
of the company prior to the rights issue(s), making it more difficult and
more expensive to raise the funding required and potentially diluting
the existing ownership of the original financial backers of the company
(i.e., ‘inside financiers’). The end result is a ‘vicious circle’ of undervalu-
ation of successful explorers as they approach potential production sta-
tus, increasing the dilution impact of imminent large capital issues, the
demand-supply imbalance of the shares in the lead up to those capital
issues and the difficulty and costs of raising the required capital, which,
in turn, exacerbates the extent of undervaluation.
5.4.2 Private placement

From the junior miner’s perspective, there are several commercial dis-
advantages associated with traditional private placements of equity
capital. Firstly, it is, in most cases, against the commercial interests of
the existing shareholders to raise external equity when the company
is substantially undervalued because this results in severe dilution of
the existing shareholding. Secondly, the dilution of existing share-
holders (unable to maintain their pro rata equity position) is exacer-
bated by the fact that new equity is typically raised at a significant
discount to the already economically deflated share price (compared
to what its fair market value would be in the absence of dilution/stock
overhang). In addition, the greater the degree to which the company is
undervalued and the higher the amount of equity capital raised (rela-
tive to the current market capitalisation of the company), the larger the
extent to which existing ownership is diluted. Thirdly, expensive long-
term equity capital is raised when the company actually needs only
short-term funding (in substance bridging finance) to move from BFS
stage to production stage. Once the company has become a commodity
producer, its funding requirements can generally easily be more than
met by internally generated cash flows (this is particularly so in a high
commodity price environment). In the cases of junior mining compa-
nies, private placements of equity capital can be made to cornerstone
investors. Although the placements are dilutive, the announcements of
these external equity issues are usually associated with positive price
reaction. This is because the cornerstone investors’ participation in the

issue confirms the quality of the underlying mining assets and, inter
alia, increases the probability of the required funding being available
at some point.5
5.4.3 Convertible notes

The extent to which the existing ownership of junior miners is diluted
through significant equity capital raisings could theoretically be miti-
gated by the use of high coupon rate convertible notes, depending on
how the conversion price is set. It is not uncommon at the pre-pro-
duction stage for a conservative estimate of the NPV of the underlying
project to be two or three times the current market capitalisation of
the company that owns it. Consequently, if the conversion price of a
convertible note was set at, say, 30 per cent or 40 per cent higher than
the current (depressed) share price of the company, much less dilution
would occur when the stock was subsequently rerated and the equity
conversion option exercised. However, even if there was a convertible
note issue, the equity conversion option would still normally be exer-
cised (i.e., new equity issued) when the company has become a producer
and is already generating significant cash flows. That is, equity capi-
tal would still be raised when it is not needed, and pre-existing equity
holders would still be diluted. However, this would still be a signifi-
cant improvement compared to what generally occurs if equity capital
is raised via rights issues or private placements. Despite such a relative
improvement, it is interesting to note that convertible note issues are
very rare for emerging miners (let alone other financial instruments
with more flexible conversion terms, repurchase rights, etc.).
5.4.4 Sale of partial interest/farm-in

This financing option typically involves a junior mining company sell-
ing out a partial interest or allowing farm-in by a major mining house.
However, the lack of funding alternatives generally means that farm-in/
sales occur at prices which still do not reflect the full value of the under-
lying project. Consequently, this alternative is still suboptimal.
5.4.5 Control premium

The use of expensive long-term equity capital by a junior mining com-
pany to move from BFS stage to production stage creates a situation
where additional value (representing the differential between current
market capitalisation and the NPV of the underlying project) can be
unlocked, but at a substantial cost to the existing owners of the company
in the form of either severe lack of diversification (in the case of a rights
issue) or virtually perpetual significant dilution of existing ownership
(in the case of a private placement).
Substantial value can be unlocked if/when the cash-strapped junior
miner is taken over by a cashed-up bidder. Depending on the size of the
underlying project, the cashed-up bidder can be a major producer who
is seeking growth options through acquisitions or a growing mid-tier
producer who is seeking growth options and/or commodity diversifica-
tion through acquisitions. The cashed-up bidder can also be a major
commodity trading house or a potential end user of the commodity
who is seeking security of raw material supplies. For the established
miners which generate significant cash flows from their existing estab-
lished operations, acquiring successful explorers about to move into
production facilitates optimising their value creation. Such acquisitions
not only reduce the adverse valuation implications of exploration costs
but also enable established miners to profit significantly by acquiring
emerging producers relatively cheaply and resolving the stock over-
hang/dilution problems and the consequent excessive value dilution of
emerging producers which they are otherwise unable to avoid.
For emerging producers, the (otherwise) unlockable value (to them)
represents the ‘pure’ value of control, as distinct from the value of
potential synergies that can be generated in a traditional merger/takeo-
ver. This is because the ‘pure’ value of control can be derived without
the need to combine the physical operations of two entities. The sub-
stantial value can be unlocked simply by the injection of cash from the
cashed-up bidder to resolve the financing constraints faced by the tar-
get and move the underlying project into production. This is in contrast
to cases where synergies are created from, for example, the combination
of two existing producing mining companies whose mining operations
are (say) adjacent to each other or from the combination of two indus-
trial companies whose distribution networks overlap.
Conceptually, there are two ways of assessing the ‘pure’ control pre-
mium payable by the bidder to the target. One is as a share of the ‘pure’
value of control or total unlockable value (to the target) and the other
is as a share of the ‘pure’ value of control net of the appropriate costs
(including opportunity costs) (to the bidder) of unlocking the unlock-
able value. The target (i.e., the emerging producers) tends to prefer the
former approach in assessing/expecting what the size of the control pre-
mium should be, whereas the bidders tends to prefer the latter approach
because it is based on the economic residual unlockable value (to them)
which they may be willing or forced (in the presence of competition)
to share with the target. The apparent divergence in the views of the
emerging producers and the bidders means that the control premium
payable in takeover offers for successful junior mining companies has
three unique drivers. First is the nature of the ‘pure’ value of control
(i.e., the otherwise unlockable value gap in the hands of the emerging
producer). Second is the large size of this ‘pure’ value of control or total
unlockable value gap and third is the ability of the bidding company to
minimise the amount it pays away to obtain the ‘pure’ value of control
(because often the target shareholders have little realistic opportunity
to ensure they receive it anyway).
At a theoretical level, one view is that virtually all of the unlockable
value should be paid away to the target shareholder because competi-
tion between potential cashed-up bidders (of which, in theory, there are
many) should cause this to occur (potential cashed-up bidders cannot
generally extract major unique synergies from the takeover). At a prac-
tical level, however, the control premium actually paid away generally
represents a much lower share of the (otherwise) unlockable value (to
the target) than would theoretically (and traditionally) be considered ‘as
fair’. At its most basic level this is because the bidder should be entitled
to a financial benefit for acting as a liquidity provider. There are also
several other reasons why this is so.
Firstly, there are, in practice, generally only a limited number of inter-
ested bidders, resulting in an insufficient level of competition to acquire
the emerging producer. The limited number of interested bidders can be
attributed to the non-homogeneous and non-traded nature of mining
assets, as opposed to standardised financial assets (such as listed shares)
which are regularly traded. Secondly, most mining acquisitions occur
during periods of high commodity prices. This economic cycle effect
means there are few, if any, buyers during commodity price downturns.
Thirdly, the non-homogeneous nature of mining assets (as opposed to
traded financial assets) also requires potential bidders to incur signifi-
cantly higher transaction costs and take an extended period of time to
conduct due diligence. Paying away all or a significantly large propor-
tion of unlockable value means that the successful bidder would gener-
ate no return or an inadequate return on their significant due diligence
time and costs. Fourthly, the potential bidders may have differing views
as to the true value of the underlying project and the size of the unlock-
able value as well as the uncertainty associated with its measurement.
This is particularly so for early stage (pre-BFS) mining projects given
the significant valuation uncertainty associated with such projects.
Fifthly, the successful bidder still has to bear the risk of unlocking the
(otherwise) unlockable value. Finally, as stated earlier, it is economi-

cally rational for fully informed potential bidders to exploit the value
gap created by the much more commercially disadvantageous next best
alternative available to the target (i.e., a highly dilutive capital raising to
meet the required capital costs).
The actual share of the (otherwise) unlockable value paid away to the
target in the form of the control premium is, of course, highly case-spe-
cific. However, given the substantial extent to which the market capital-
isation of the target junior miner is below even a conservative estimate
of the value of the underlying project, the control premium paid for tar-
get junior miners (as a percentage of the pre-bid share price of the tar-
get6) should typically be very substantial. Another way to think about
the impact of the takeover on the value of the target junior miner is that
in the absence of the takeover, the share price of the company reflects
the NPV of the underlying project discounted by the probability of the
required financing not being secured at all and the substantial dilution-
ary value effect on existing shareholders in the event that the required
funding is secured through a traditional equity raising. The arrival of
the takeover unlocks significant value by ensuring the required fund-
ing is available and by eliminating the need to undertake the highly
dilutive equity raisings (at a significant discount to the already under-
stated pre-bid price of the target’s shares). However, in the absence of
cashed-up bidders, significant dilution seems to be an unavoidable cost
if further value is to be unlocked by moving to producer status.
5.5 Technical implications
The widely accepted definition of market value is:
The price that would be negotiated in an open and unrestricted mar-

ket between a knowledgeable willing but not anxious buyer (WBNAB),
and a knowledgeable, willing but not anxious seller (WBNAS) acting
at arm’s length within a reasonable time frame.
The market value of an asset is also determined on the basis that the
asset is put to its highest and best use. Consequently, market value is
a hypothetical or theoretical price in nature. In the case of a mining
project which has reached the BFS stage and whose BFS produces a posi-
tive outcome, the adoption of the ‘highest and best use’ principle theo-
retically implies that the market value of the asset should be determined
on the assumption of the availability of funding required to develop
the project and bring it into production because this is the highest and
best use to which the asset should be put. A strict acceptance of the
market value definition and ‘the highest and best use’ basis on which
the market value is measured can lead a valuer to reason that the hypo-
thetical WBNAB that is fully informed of the highest and best use of
the asset is cashed up and should have the capacity to meet the funding
requirement to bring the underlying project into production without
the highly dilutive capital raising. Consequently, as the argument goes,
the market value, which is the price the hypothetical WBNAB pays for
the asset (even at the time the financing uncertainty has not yet been
resolved), should reflect the above-mentioned position. In other words,
the assessment of market value seems to assume away the significant
financing and dilution risk which the owner of the asset is actually
facing.
In order to resolve the apparent disconnect between the way the
‘theoretical’ market value would be measured on a highest and best
use basis and the obvious significant impacts of financing and dilu-
tion constraints on value in practice, it is important to recognise the
relationship between market value and liquidity. The market value defi-
nition which is widely used in practice and which underpins most judi-
cial findings has been in existence for over 100 years dating back to the
Spencer v The Commonwealth (1907) case. In comparison, the concept
of liquidity and its impact on asset value have been widely recognised
and reasonably documented in academic literature only over the last
20 years or so.7 Consequently, in a mining valuation context the long-
established market value definition may be susceptible to the (incor-
rect) interpretation that the hypothetical WBNAB and the hypothetical
WBNAS always arrive at the same time, whereas the fact that buyers and
sellers for an asset do not always arrive at the same time underpins the
importance and value of liquidity.
The appropriate way to reconcile this apparently conceptual mis-
match is to recognise that a fully informed WBNAB and a fully informed
WBNAS are aware of the importance and value of liquidity and factor
it into the negotiated price (i.e., market value) of the asset. In the case
of an advanced developing mining asset, the owner of the asset (i.e., a
junior mining company) typically faces severe restrictions in its ability
to convert the asset into cash either through outright sale of the asset
(due to the non-traded and non-homogenous nature of the asset) or by
‘monetising’ the asset by bringing it into production (due to the severe
financing and dilution constraints). Thus, the hypothetical WBNAB in
this case is not only a normal purchaser of the asset8 but it also acts as
a liquidity provider for the hypothetical WBNAS. It naturally follows

that the negotiated price for the asset should reflect a liquidity discount
which allows the hypothetical WBNAB to earn an additional return
(over the nominal CAPM rate of return9) for the provision of liquidity
or investing in an asset which lacks liquidity.
In the DCF framework, this can be allowed for by adding a liquidity
premium to the base cost of equity derived using the CAPM. Because
there is no equivalent of the CAPM to accurately measure the required
rate of return for liquidity (or lack thereof) as a component of risk, the
assessment of the liquidity premium is highly subjective, case-specific
and can be cyclical in the case of development mining assets. A conven-
tionally useful starting point for assessing the liquidity premium is the
observable premium (over and above the base CAPM rate of return) at
which various cohorts of listed companies established in terms of size
are traded, although a subtle difference is that the empirical evidence
on small company risk premium is based on the trading of listed minor-
ity interests, whereas the liquidity premium in the context of mining
valuations refers to the underlying mining asset with a consequential
flow through impact on the equity value of the entity owning the
asset. Proper understanding of and appropriate allowance for liquidity
in assessing the market value of a mining asset would ensure that the
market value of the asset is assessed on ‘the highest and best use’ basis
(i.e., to be brought into production) and, at the same time, allows the
hypothetical WBNAB to receive an appropriate return for the provision
of liquidity and the resolution of financing and dilution risk. Proper
allowance for liquidity also has important implications for assessing the
size of the unlockable value (to the potential bidders). Not allowing for
or inadequately allowing for the liquidity premium (which is added to
the base CAPM rate of return) in a DCF valuation will result in an over-
statement of the NPV of the underlying project, which, in turn, over-
states the size of the unlockable value and the extent to which a control
premium can be, and is likely to be, paid.
5.6 Conclusions
While use of differential discount rates for the different stages of min-
ing project development is rare in practice, it is theoretically appealing
and is worthy of serious consideration. The consideration and adop-
tion of differential discount rates in DCF valuations of mining projects
would contribute greatly to putting more science into practical min-
ing valuations. The shares of many emerging producers are materially
undervalued due to dilution/stock overhang and, in substance, financ-

ing risk. The established miners with access to significant, internally
generated cash flows or competitively sourced external capital are able
to unlock substantial value by reducing their exploration budget and
acquiring successful explorers at the pre-BFS/pre-production stage. As a
result, the premium for control payable for successful explorers should
be much higher than normal premiums due to this additional value.
Whether this actually occurs depends on the specific facts of each case.
The appropriate assessment of the extent to which a control premium
is likely to be paid for successful explorers requires proper appreciation
of the liquidity concept, which has, in the writers’ view, not generally
received proper recognition and appropriate treatment in a mining val-
uation context.
Notes
1. ‘ASIC Issues Alert On Valuation’, The Australian Financial Review, 19 October
2010.
2. As defined by the JORC Code.
3. The importance of using prospective beta rather than historic beta of emerg-
ing producers is self-evident.
4. At a practical level, many early stage investors – who may have been investors
for five or ten years – become ‘stale’ or disillusioned with the long timescale
to investment return.
5. This does not necessarily increase the probability of further dilution not
occurring in subsequent rounds of financing.
6. This excludes the impact of any potential pre-bid price run-up due to antici-
pation of the impending takeover bid.
7. Liquidity refers to how quickly an asset can be converted to cash without
the asset’s owner incurring substantial transaction costs or price concession.
Liquidity is valuable to investors because the lack of liquidity causes inves-
tors to miss opportunities to allocate capital to assets with higher return.
8. Like a purchaser of a small parcel of BHP shares on the stock exchange. In
such a case the seller of the parcel of shares does not even know who the
actual purchaser of those shares may be because there are so many potential
buyers.
9. The standard version of CAPM does not allow for circumstances where the
cost of equity capital has to establish for investments that lack liquidity.
6
The Tax Accounting Interface
in the Mining Industry in the
Context of IFRS
Les Nethercott
6.1 Introduction
The mining industry is characterised by high risk and uncertain return

on capital. Furthermore, there is usually a long time period in determin-
ing the viability of any project and obtaining positive cash flows from
exploration activities.1 This chapter examines the accounting and tax
issues arising from the treatment of exploration and evaluation costs.
Where such costs are capitalised and carried forward as an asset, the
chapter considers the subsequent impairment of these assets.
An analysis of the accounting treatment of such expenditure is
particularly appropriate with the adoption of International Financial
Reporting Standards (IFRS) and the issue of the accounting standards
AASB 6 ‘Exploration for and Evaluation of Mineral Resources’, AASB 136
‘Impairment of Assets’ and AASB 138 ‘Intangible Assets’.2
These standards not only impact on the accounting treatment of
exploration and evaluation expenditure, they give rise to differences in
accounting and taxable income. Consequently, this chapter examines
how these expenditures should be treated under IFRS. It also considers the
issue when differences in accounting and taxable income arise and how
any timing differences should be treated under AASB 112 ‘Income Taxes’3
and whether any deferred tax asset or liability should be recognised.
6.2 The nature of the mining industry
The mining industry is unique in terms of some of its operating

characteristics.
100
Tax Accounting Interface in the Mining Industry 101
Firstly, any exploration usually requires a large amount of expendi-

ture to be incurred in the pre-production stage.
Secondly, there is a small likelihood that early exploration activities
will lead to further exploration and evaluation of any activity.
Thirdly, where such exploration activity reveals the possibility of a
commercial deposit there is usually a very long gestation time between
initial exploration, evaluation, development of the mine and subse-
quent production.
Fourthly, where commercial production results from any successful
outcome of an exploration programme, there is quite often a significant
disproportion to the expenditure incurred and the revenue streams
that result.
Fifthly, the vagaries of the global economy. From an economic per-
spective there is always the risk that changing global prices for minerals
may affect the commercial viability of a commercial mining operation.
In view of these difficulties, the issue arises as to how pre-produc-
tion expenditure, particularly exploration and evaluation expenditure,
should be accounted for. While pre-production expenditure may be
varied in nature, it may be of an intangible or tangible nature.
Where physical assets are generated from such expenditure, it will
often be in the form of plant and equipment or buildings. In this respect
the accounting standard AASB 116, ‘Property Plant and Equipment’, will
apply. However, it is not the intention of this chapter to deal with the
pre-production expenditures where they give rise to plant and equip-
ment or buildings. Instead, the focus is on pre-production expenditure
of an intangible nature that may give rise to intangible assets.
As a result it is necessary to examine the relevant accounting stand-
ards that deal with these issues.
Prior to the introduction of IFRS in 2005, the relevant accounting
standard dealing with Extractive Industries was AASB 1022, ‘Accounting
for the Extractive Industries’.4 This standard was much broader than the
new IFRS standard AASB 6. The main differences are that AASB 1022
also dealt with the:
● Treatment of development, construction and restoration costs

● Amortisation of those costs
● Treatment of inventories
● Revenue recognition
While the treatment of exploration and evaluation expenditures under

AASB 6 are essentially the same as those contained in AASB 1022 there is a
102 Les Nethercott
need to turn to other accounting standards after the introduction of IFRS

in 2005 to address the issue of how pre-production expenditure should
be accounted for. This raises the issue of how the expenditure should be
accounted for when it is incurred, and also how it should be accounted for
if the expenditure is carried forward as an asset into a subsequent period.
Consequently, it is necessary to examine the provisions of AASB 6 in
more detail to determine how exploration and evaluation expenditure
should be accounted for.
6.3 AASB 6 and the treatment of exploration and

evaluation expenditures
An important aspect of AASB 6 is contained in para 7 of the stand-

ard.5 This paragraph contains additions to the IFRS standard by indicat-
ing how exploration and evaluation expenditures should be treated in
Australia.
Para 7.1 states that:
For each area of interest expenditures incurred in the exploration for

and evaluation of mineral resources shall be:
(a) Expensed as incurred; or

(b) Partially or fully capitalised and recognised as an explora-
tion and evaluation asset if the requirements of para 7.2 are
satisfied.
Furthermore, the paragraph states that such a decision must be made

for each area of interest.
(The area of interest is defined in para 7.3 as an individual geologi-
cal area whereby the presence of a mineral deposit or an oil or natu-
ral gas field is considered favourable or has been proven to exist)
Para 7.2 states that:
An exploration and evaluation asset shall only be recognised in

relation to each area of interest if the following conditions are
satisfied.
(a) The rights to tenure of the area of interest are current; and
(b) at least one of the following conditions are met:
(i) the exploration and evaluation expenditures are expected to
be recouped through successful development and exploita-
tion of the area of interest, or alternatively by sale; and
(ii) exploration and activities in the area of interest have not

reached the stage which permits a reasonable assessment
of the existence or otherwise of economically recover-
able reserves and active and significant operations are
continuing.
In determining how exploration and evaluation expenditure should be

treated a number of methods have been suggested.6 These are the:
● Expense method
● Full cost method
● Successful efforts (or area of interest method)
Under the full cost method, all exploration and evaluation expenditure
is carried forward whether it is successful or otherwise. This is based
on a macroperspective that treats individual exploration expenditures
as part of a wide exploration activity within the entity. This is also
based on the view that it is necessary to undertake a wide-reaching
exploration programme in order to find a commercial deposit. While
potentially unsuccessful, it is a necessary part of a strategy to locate a
commercial mining deposit.
The expense method takes a conservative view. Given that most
exploration activity is likely to be unsuccessful the method adopts a
policy of treating all such expenditure as an expense when incurred. It
can be argued that both methods are deficient.
The full cost method capitalises exploration and evaluation expendi-
ture whether it is successful or not. In the case of the exploration
expenditure being unsuccessful it means the expenditure is capitalised
in the balance sheet and the income statement does not reflect the
unsuccessful outcome at the time of the unsuccessful exploration activ-
ity. This provides misleading information to investors.
The expense method adopts an opposite and conservative perspec-
tive by expensing all such expenditures. However, it means that in the
case of successful exploration and evaluation expenditure, the income
statement records as an expense expenditure which has given rise to an
asset in the form of a viable mineral deposit. Furthermore, the balance
sheet does not record or recognise the creation of an asset represented
by the expenditure which has been undertaken in the exploration and
evaluation programme.
The successful efforts method allows exploration and evaluation
expenditures to be carried forward in relation to an area of interest until
104 Les Nethercott
the exploration is determined to be successful or otherwise. Where it

proves to be successful, it is capitalised to be offset against the revenues
that will accrue from the development and commercial production of
the area. However, where it is determined the exploration is not success-
ful, the expenditure is expensed.
The new standard AASB 6 essentially provides entities with a choice
between the successful efforts method and the expense method by
letting entities decide to either expense exploration and evaluation
expenditure as incurred or carry it forward subject to the conditions
outlined above.
The standard AASB 6 indicates that once a decision has been made to
recognise the expenditure as an asset, the exploration and evaluation
costs should be measured at cost. The standard further indicates that
the following expenditures would come within the scope of the recog-
nition criteria as to what might be recognised as an asset. These are:
● Acquisition of rights to explore

● Topographical, geological, geochemical and geophysical studies
● Exploratory drilling
● Trenching
● Sampling
● Activities associated with the determination of the technical and
commercial feasibility of the resource
However, in the context of the ‘Framework for the Preparation and

Presentation of Financial statements’7 (Accounting Framework), it may
be argued that where exploration expenditures and evaluation expen-
ditures are carried forward as an asset pursuant to AASB 6, they do not
meet the definition of an asset.
In the Accounting Framework, assets are defined as:
The future economic benefit embodied in an asset is the potential to

contribute directly or indirectly to the flow of cash and cash equiva-
lents to the entity.8
In this respect the Accounting Framework states that an item meets the
definition of an element if:
(a) It is probable that any future economic benefit associated with the
item will flow to the entity; and
(b) The item has a cost or value that can be measured reliably.9
It is suggested that where entities choose to carry forward exploration

and evaluation expenditure as an asset it is not likely to meet the defi-
nition of an asset as outlined in the Accounting Framework. This is
especially the case where an exploration programme is in the early
or formative stages. A characteristic of the mining industry is the fact
that there is a long gestation time between the initial stages of explora-
tion and the ultimate determination of the presence of a commercial
deposit which would indicate future economic benefits which can be
determined and measured reliably. It is more likely that as the explora-
tion programme matures and further exploratory work and evaluation
is undertaken, it may be possible to justify the capitalisation of such
expenditure and may meet the definition of an asset.
6.4 Measurement after recognition: the Interface of

AASB 136 and AASB 138
When expenditure on exploration and evaluation has been recog-

nised as an asset, AASB 6 allows entities to choose either the cost or the
revaluation model to measure such assets. However, where the expendi-
ture gives rise to property plant or equipment, it must meet the require-
ments of AASB 116 ‘Property Plant and Equipment’ or in the case of
intangible assets AASB 138 ‘Intangible Assets’. In the case of exploration
and evaluation expenditure activities, most of the expenditure will not
be in the form of plant or equipment but is more likely to be represented
by an intangible asset as outlined above.
Consequently, where the expenditure gives rise to an intangible asset
then the provisions of AASB 138 are applicable. The standard states that
when any expenditure is carried forward, the measurement of the asset
may be based on either the cost or the revaluation model.10 It is neces-
sary to examine the provisions of AASB 138 to see how this choice of
model applies to exploration and evaluation expenditure.
The standard AASB 138 defines an intangible asset as:
An identifiable non monetary asset without physical substance.11
However, in order to distinguish intangible assets from goodwill, the

standard indicates that it must meet the identifiably criterion. This
occurs when the asset:
(a) is separable, that is, is capable of being separated or divided from

the entity and sold, transferred, licensed, rented or exchanged,
106 Les Nethercott
either individually or together with a related contract, asset or

liability; or
(b) arises from contractual or other legal rights, regardless of whether
those rights are transferable or separable from the entity or from
other rights and obligations.12
As noted earlier, the characteristics of exploration activities and the kind

of expenditures that give rise to them are unique to the mining indus-
try. Certainly, from a recognition perspective, having regard to AASB
138, it seems incongruous to argue that such expenditures meet the
definition of an asset let alone the requirements of identifiably. When
an analysis is made of early exploration activities which are prelimi-
nary in nature, such as exploratory drilling or trenching and sampling,
it is difficult to view them as an intangible asset which comes within
the criteria outlined above. It is also difficult to envisage such expendi-
ture as capable of being separated or divided from the entity or even
exchanged to other parties. Furthermore, having regard to the other
requirement of para 12(b) of AASB 138, it may be difficult to determine
whether the exploration and evaluation expenditures arise from con-
tractual or other legal rights. It may be argued that the lease right of
tenement, which gives the right to explore a prospective area, might
be regarded as an asset in respect of exploration activities and related
expenditure. However, it is suggested that such a lease right is a differ-
ent asset. It is different in nature to the generation of an intangible asset
established by an exploration programme as a result of exploration and
evaluation activities.
Where it is established that there is an identifiable intangible asset
arising from exploration activities, AASB 138 requires that the expendi-
ture should also meet certain recognition criteria. On this matter AASB
138 states that:
An intangible asset shall be recognised if and only if:
(a) it is probable that the expected future economic benefits that

are attributable to the asset will flow to the entity; and
(b) the cost of the asset can be measured reliably.13
The standard recognises the difficulty of such a task by stating that the
entity shall assess the probability of expected future economic benefits
using reasonable and supportable assumptions that represent manage-
ment’s best estimate of the set of economic conditions that will exist over
the useful life of the asset. While such a proposition or view may be fine
in theory, it is suggested that the main characteristic of any exploration

expenditure and evaluation expenditure is the uncertainty especially in
terms of predicting whether it will be successful, or what the future cash
flows might be or whether the costs incurred will be recovered.
As indicated above, where an entity recognises exploration and evalu-
ation expenditures as an asset, AASB 6 allows entities a choice to use the
cost model or revaluation model as its accounting policy.14
However, where the cost model is used, entities are required to
recognise any losses by way of impairment. Consequently, to deter-
mine whether there is any impairment, the provisions of AASB 136
‘Impairment of Assets’ are important.15 An impairment loss is defined
in the standard as:
The amount by which the carrying amount of an asset or a cash gen-

erating unit exceeds its recoverable amount.16
While the carrying amount is reflected by the expenditures incurred

on exploration and evaluation activities the recoverable amount of the
asset is more difficult to determine. It is defined as:
The higher of the fair value less costs to sell and its value in use.17
Such a definition raises issues as to what ‘value in use’ means or what

the ‘fair value less costs to sell’ of the asset is. In this respect, the stand-
ard indicates that fair value less costs to sell is the amount which may
be obtained from the sale of an asset or cash generating unit in an arm’s
length transaction between knowledgeable willing parties, less costs of
disposal. However, value in use is defined as the present value of the
future cash flows expected to be derived from the asset or cash generat-
ing unit.
It would seem that the concept of recoverable value as discussed
above raises a number of conceptual and practical difficulties in ana-
lysing whether there has been any impairment of any exploration and
evaluation expenditures which have been carried forward as an asset
within the provisions of AASB 6 and AASB 138.
Firstly, in determining the value in use of an asset, represented by
exploration and evaluation expenditure, it is most likely that the present
value of cash flows will not be capable of determination in an objective
manner, as it is dependent on substantial evaluative work being com-
pleted and a reliable assessment being made of the presence of a com-
mercial deposit and the generation of future cash flows.
108 Les Nethercott
Secondly, in determining what the recoverable value might be in rela-

tion to such expenditure, this also raises the question as to what is the
fair value (less costs to sell) of the expenditure carried forward. Given
the uncertainty involving mining activities, especially in the pre-pro-
duction and evaluative stages, the assessment of fair value of the asset
may be extremely difficult. The assumption made in the determination
of fair value is that there is the sale of an asset in an arm’s length trans-
action between knowledgeable willing parties. It is suggested that in the
case of an asset represented by exploration and evaluation expenditure
that such an outcome is not likely. This is because the entity undertak-
ing the exploration may not wish to sell any of the exploration pro-
grammes as represented by the expenditure carried forward. Nor is it
likely that the entity would be willing to make a full disclosure of the
geological outcomes of such a programme to another entity in order to
facilitate a sale. More importantly, the entity may not be a willing seller.
There is also the issue of whether the costs incurred on exploration
activities are separable and divisible from the entity.
An alternative way to determine the recoverable amount of the asset is
to determine the value in use of the exploration and evaluation expend-
iture. However, AASB 136 outlines a number of factors that should be
considered in determining the value in use of an asset. They are:
● An estimate of the cash flows the entity expects to derive from the
asset
● The time value of money, represented by the risk-free rate of interest
● The price to reflect the uncertainty inherent in the asset
● Other factors such as illiquidity
The nature of the mining industry and especially those related to explo-
ration programmes are such that each of these factors outlined above is
difficult to assess and quantify.
Firstly, the ability of an entity to determine the future cash flows aris-
ing from an exploration programme is a most difficult task.
Secondly, possible variations in the amount or timing of such flows
are again difficult to predict. Such variations may be more predictable
as the evaluation and later stages related to development and produc-
tion occur.
Thirdly, while the risk-free rate of interest may be determined, the
assessment of what might be appropriate to reflect the uncertainty is
difficult. Such an assessment could reflect uncertainty on a macro or
global scale (such as reflected in the Global Financial Crisis) or those
peculiar to the mining industry or the firm (as reflected by changing

risk assessment of the mining industry or the firm).
Once an asset has been recognised in respect of exploration expendi-
ture and is carried forward in the balance sheet, AASB 136 requires that
the carrying value of the asset is reviewed to determine whether any
impairment has occurred. On this issue, AASB 136 requires:
An entity to assess at each reporting date whether there is any indica-

tion that an asset may be impaired. If any such indication exists the
entity shall estimate the recoverable amount of the asset.18
While AASB 136 requires a determination to be made as to whether

there is an impairment of any exploration and evaluation expenditure,
it is suggested that the determination of any impairment by reference to
the recoverable amount of the asset is an uncertain and difficult task.
As the nature of the exploration programme becomes more determi-
native of a favourable outcome, it may be argued that the assessment of
the asset’s recoverable amount may be possible. However, it should be
remembered that the provisions of AASB 6, under the cost model, allow
all expenditures on exploration to be carried forward until a determina-
tion of an outcome is possible. This is possible notwithstanding the fact
that the exploration and evaluation stage may take up to five to seven
years or even longer for many exploration programmes. Consequently,
where an early explorer undertakes an initial exploration programme, it
may decide to carry exploration expenditure forward as an asset under
the choice given in AASB 6.
One of the reasons for such a course of action is that small entities
and initial explorers are reluctant to expense such expenditure in the
early stages of exploration and evaluation. The reluctant expensing
of such expenditures would potentially result in a loss being reported
from such activities. Moreover, a secondary impact would occur with
the non-recognition of an asset in the balance sheet and the related
diminution of equity and shareholders’ funds.
Given the definition of an asset in the Accounting Framework, it
seems a strange outcome that the provisions of AASB 6 and AASB 138
should allow for recognition of exploration and evaluation expenditure
as an asset. Furthermore, given the requirements of AASB 136 in relation
to the impairment of such an asset, it seems that the objective deter-
mination of any impairment raises issues concerning the recoverable
amount of the asset due to the fact it is difficult to assess and quantify.
Nevertheless, where any impairment loss occurs, AASB 138 requires a
110 Les Nethercott
write-down of the asset to its recoverable value. Such impairment is an

impairment loss which should be recognised in the profit and loss.
Another important aspect of AASB 136 is the provision relating to
the reversal of an impairment loss. The standard states that an entity
shall assess at each reporting date whether there is any indication that
an impairment loss recognised in prior periods for an asset other than
goodwill may no longer exist or may have decreased. Furthermore, the
standard states that an impairment loss recognised in prior periods shall
be reversed if there has been a change in the estimates used to determine
the assets’ recoverable amount Where this occurs, the standard indicates
that the entity shall estimate the recoverable amount of the asset and
the carrying amount of the asset should be increased to its recoverable
amount.19 In comparison with the provisions of AASB 122, this is a sub-
stantial change and may, as a result, allow a prior period adjustment.
An illustration of this would be reflected by the comparison of two
entities A and B who had spent $10 million on comparable exploration
programmes. Entity A had adopted a conservative view and expensed
all of its exploration and evaluation expenditure. As a result, no asset
is carried forward and the provisions of AASB 136 do not apply as there
is no impairment to be considered. However, Entity B decides to carry
forward the $10 million as an asset. In the programme’s early stages, it
determines an impairment of $5 million is appropriate and writes down
the asset to reflect this.
In later years both entities discover that their exploration programmes
have been successful. Entity B that had carried forward expenditure on
an exploration programme would be able to reverse the impairment loss
as if no impairment had occurred. However, Entity A would not be able
to undertake such a reversal because none of the expenditure had been
carried forward and recognised as an intangible asset subject to AASB
138. If such an asset had been recognised the provisions of AASB 136
would be able to be applied to reverse any earlier write-down.
This is indeed a strange outcome and does not reflect the reality of
the situation. Two entities in comparable situations would reflect sub-
stantially different outcomes as reflected by their profit and loss and
their balance sheets.20
6.5 A Tax perspective
While the above analysis has considered the main accounting stand-
ards relating to the issue of how exploration costs should be accounted
for, there is a different outcome when tax is considered. In this respect it
is important to recognise that the interface between what is appropriate

for taxation purposes is substantially different from that of accounting.
This issue of the tax interface between accounting and tax has been a
contentious issue for many years and has been considered by a number
of authors.21
However, from a taxation perspective, a key provision that deter-
mines how exploration and evaluation expenditure should be treated is
S 8–1 of the Income Tax Assessment Act 1997 (ITAA 97). This section deals
with allowable deductions (which is offset against assessable income to
derive taxable income (see s 4–1 ITAA 97).
Section 8–1(1) of the ITAA 97 states that:
You can deduct from your assessable income any loss or outgoing to
the extent that:
(a) it is incurred in gaining or producing your assessable income;
or
(b) it is necessarily incurred in carrying on a business for the pur-
pose of gaining or producing your assessable income.
(These are known as the positive limbs.)
Section 8–1(2) states that:
You cannot deduct a loss or outgoing under this section to the extent
that
(a) it is a loss or outgoing of capital, or of a capital nature.
(This is known as a negative limb of the section.)
In the case of mining entities that incur expenditure on exploration

and evaluation programmes, the provisions of S 8–1 are most important
from a tax perspective in determining whether the expenditure is an
allowable deduction. Unlike the provisions of AASB 6, the provisions of
S 8–1 ITAA 97 do not give the taxpayer a choice of whether to expense
or capitalise such expenditure.
In order to determine whether exploration and evaluation expen-
ditures are an allowable deduction the expenditures must meet either
of the positive limbs.22 Under the first positive limb, the decision in
Amalgamated Zinc indicates that it is necessary to determine whether
the expenditure is incidental and relevant to the gaining of income.23
This is often referred to as the ‘nexus test’ which means that the expend-
iture must also have the essential character of an income-producing
112 Les Nethercott
expense. As a result it must be able to determine whether the expendi-

ture can be linked to the production of assessable income immediately
or in the foreseeable future. The longer the lapse of time between the
outgoing and the expected production of income, the more likely it will
be concluded that the nexus test is not met. This view was expressed in
Amalgamated Zinc when it was observed that:
The outgoings must be an expenditure which has an effect in gain-

ing or producing income.24
In terms of determining whether the outgoing is incidental and rele-

vant to the gaining of income it was observed in the decision of Charles
Moore that:
What matters is their connection with the operations which more

directly gain or produce the assessable income.25
In the case of mining entities engaged in exploration and evalu-
ation activities, it is likely that such expenditures will not meet the
requirements of the first positive limb of S 8–1(1). This is because the
expenditures are too remote from the gaining of future income and
there is considerable uncertainty as to whether any income will be
produced. Perhaps the conditions might be met where exploration
and evaluation activities are incurred as part of an ongoing explora-
tion program of an entity which has already commenced business
and where commercial production has begun, or is likely to begin,
resulting in the production of income. The case of Softwood Pulp
and Paper26 would support this conclusion. This case related to the
deductibility of expenditure incurred by the taxpayer in undertaking
a feasibility study to determine whether a pulp paper mill was wor-
thy of development. The Court concluded that the feasibility study
was too early and remote from the production of income. It could
not be sustained that the expenditure was incidental and relevant
to the gaining of income as it was too early to determine whether
assessable income would arise from the venture.
Where an entity is a fledgling explorer with no other activities, it is most

likely that the requirements of the first positive limb will not be met.
However, with an established mining operation, an entity may undertake
further exploration and evaluation expenditure to delineate the actual
reserves and commercial viability of the area of interest. In this situation
the requirements of the first positive limb of S 8–1 would be met.
Where the conditions of the first positive limb are not satisfied it is
possible that the expenditure on exploration and evaluation may come
within the scope of the second positive limb of S 8–1. While the second
positive limb is more liberal than the first limb insofar as the nexus
test is not applied, the second positive limb is broader and covers the
situation where the production of income is more problematic and may
be more uncertain. However, for such expenditure to be an allowable
deduction under the second positive limb it is necessary that the:
● Expenditure is necessarily incurred and the

● Entity is carrying on business
In determining whether expenditure is necessarily incurred, the Courts

have observed that:
A strict dictionary meaning of necessarily should not be applied. The

Courts have indicated that the term should be interpreted as
No more than is clearly appropriate or adapted for.27
Therefore, where expenditure is incurred as part of an ongoing explora-

tion programme to further develop or establish an existing business, it
would be an allowable deduction.
However, the entity needs to be able to demonstrate that it has com-

menced business. As indicated earlier, where exploration and eval-
uation expenditures are incurred in determining the feasibility of
an exploration site it may be argued that such expenditures are a
preliminary activity to the establishment of a business and do not
satisfy the second positive limb.28
The outcome would be different in the case of an established busi-
ness. Where as part of an ongoing exploration program a business
conducts a number of exploration programs in a number of geo-
logical areas to determine whether an area is worthy of commercial
development it is most likely the provisions of S 8–1 in relation to
the requirement that the entity is carrying on a business would be
met.29
Where the expenditures on exploration and evaluation expen-
ditures satisfy the positive limb it is still necessary to determine
whether the expenditures are of a capital nature. Where expenditures
are of a capital nature, the negative limb of s 8–1 would disallow the
expenditure on exploration and development expenditure.30
114 Les Nethercott
The leading case which examines this issue is the decision in Sun
Newspapers.31 In this case the taxpayer paid 86,500 pounds to a rival
newspaper not to publish a newspaper within 300 miles of Sydney. The
Court held that the outgoing was of a capital nature because it related
to the profit-making structure of the firm. In this respect the Court
observed that:
The distinction between expenditure and outgoings on revenue

account and on capital account corresponds with the distinction
between the ... business entity, structure, or organization set up or
established for the earning of profit and ... the process by which such
an outlay, the difference between the outlay and returns represent-
ing profit or loss.32
In view of this test, it is most likely that where a mining entity is

undertaking an initial exploration and evaluation programme it
would not overcome the negative limb relating to the capital nature
of the outgoings. Consequently, the expenditures would not be an
allowable deduction under S 8–1. However, as noted earlier, in the
situation where a mining entity has an ongoing exploration pro-
gramme which is reflective of a larger exploration activity as part of
an established business operation, it is likely the negative limb would
not apply.
While an entity may not be able to claim a deduction for explora-
tion and evaluation expenditure because it is of a capital nature, the
expenditure may be an allowable deduction under S 40–880 ITAA 97.
This section was introduced to allow a deduction for what is known as
‘black hole expenditure’. Essentially the section allows a deduction over
five years for certain capital expenditure which would not be an allow-
able deduction.
In order for the provisions to apply it is necessary that the
expenditure
● is not an allowable deduction under another provision and

● the expenditure is not denied by some other provision and
● the business is carried on for a taxable purpose.
In particular the definition of a taxable purpose refers to the purpose of

exploration and prospecting activities. In this respect the section would
allow a deduction for expenditure which is incurred before the business
commences.
6.6 The interface of accounting and tax
From the above discussion it can be seen that in determining how

expenditures on exploration and evaluation activities are treated, the
requirements of the ITAA 97 are substantially different from the provi-
sions contained in the relevant accounting standards under IFRS.
While the provisions of AASB 6 provide entities with a choice of
expensing exploration and evaluation expenditures or carrying them
forward (where certain conditions are met), the ITAA 97 provisions do
not provide a choice to the taxpayer. In order to be an allowable deduc-
tion, the legislative requirements must be met.
Consequently, it is possible that different entities will have different
accounting and taxable outcomes because of the different manner in
which exploration and evaluation activities are treated.
At one level an entity engaged in an initial exploration programme
may choose to capitalise exploration and evaluation expenditures under
the provisions of AASB 6. However, as it is most likely that the provi-
sions of S 8–1 ITAA 97 would not be satisfied the expenditure would not
be an allowable deduction. Nevertheless, the expenditure may come
within the provisions of s 40–880 which would allow the expenditure
to be deducted over five years.
At another level an entity which has an established business operation
with a wide-ranging exploration programme may choose to expense all
of its exploration and evaluation expenditures under AASB 6. Another
possibility is that it may expense the early exploration expenditure and
capitalise the expenditure relating to the evaluation activities under
AASB 6.
Where a divergence between accounting and taxable income arises
from the treatment of such expenditure it is necessary to examine the
impact of AASB 112 ‘Income Taxes’ on the matter.
In the Objective part of the Standard, AASB 112 states that:
It is inherent in the recognition of an asset or liability that the report-

ing entity expects to recover or settle the carrying amount of that
asset, or liability. If it is probable that recovery or settlement of that
carrying amount will make future payments larger (smaller) than
they would be if such settlement were to have no tax consequences,
this standard requires an entity to recognise a deferred tax liability
(or deferred tax asset).
Consequently, where there is a divergence between accounting income

as determined by the application of IFRS standards and taxable income
116 Les Nethercott
due to timing differences in the treatment of exploration and evalua-

tion expenditures, the standard requires that a deferred tax liability or
deferred tax asset is recognised.
In the definition part of AASB 112,33 a deferred tax asset is defined
as the amount of income tax recoverable in future periods in respect
of deductible temporary differences. Deferred tax liabilities are the
amounts of income taxes payable in future periods in respect of taxable
temporary differences. An example of a deferred tax asset would arise
where the entity had written off exploration and evaluation expendi-
tures for accounting purposes but not for tax purposes. Conversely, a
deferred tax liability would arise where the entity had written off the
exploration and evaluation expenditure for tax purposes but not for
accounting purposes.
In the context of the Accounting Framework, it is arguable that nei-
ther a deferred tax asset nor liability should be recognised where there
are timing differences caused by the different tax treatment of explo-
ration and evaluation expenditures. This is because the Accounting
Framework states that:
The future economic benefit embodied in an asset is the potential to

contribute directly or indirectly to the flow of cash and cash equiva-
lents to the entity.34
However, in the case of a deferred tax asset arising from the treatment
of exploration and evaluation (i.e., where the expenditure has expensed
for accounting purposes but capitalised for tax purposes), it is argua-
ble that an asset does not exist. This is because the future economic
benefits cannot be predicted or measured with any certainty until the
entity is able to determine that the exploration site will be commercial
in nature.
Conversely, in the case of a deferred tax liability (i.e., where the explo-
ration and evaluation expenditure has been capitalised for accounting
purposes but written off for tax purposes), it may be argued that a liabil-
ity does not exist. In the Accounting Framework, an important charac-
teristic of a liability is that there is a present obligation by the entity.35
In this case there is no present liability as the presence of the liability
is dependent on future events which may not occur. Furthermore, the
presence of a liability is dependent on future taxable income being pro-
duced which can be measured reliably. From an Australian Tax Office
perspective, a tax liability does not exist.
It is suggested that the uncertainty associated with any exploration

and evaluation programme is such that it is not likely to give rise to
any deferred tax asset or deferred tax liability. An exception might
arise where the exploration, or evaluation, activities are a part of an
established mining operation with an established business which has
income and a cash flow to justify the presence of future benefits in the
form of an asset.
Nevertheless, where such expenditures are carried forward and recog-
nised as an asset pursuant to the provisions of AASB 138, it should also
be recognised that such assets are subject to the provisions of AASB 136
on the impairment of assets. Consequently, a regular review to deter-
mine whether there is any impairment must be made. In turn this may
impact upon any deferred tax asset and liability which has been previ-
ously recognised.
It may be thought that the issue of the tax accounting interface and
the recognition of any deferred tax asset or liability is of little conse-
quence. However, on this matter it has been stated that accountants and
taxpayers need to recognise that:
There are a number of accounting standards that presently impact

upon taxation law and are formally recognised in tax law.36
The adoption of IFRS, and in particular the new standards as discussed

above, has impacted not only on the accounting treatment of explora-
tion and evaluation expenditure but has, in turn, impacted on the dif-
ference between accounting and taxable income and the recognition of
assets and liabilities.
In the past, Courts have been reluctant to recognise accounting prin-
ciples and concepts in the determination of taxable income.37 On this
issue it may be argued that there are three possible outcomes on the
accounting tax divergence in the measurement of income. These are:
● Tax laws should be amended to accounting standards

● Accounting standards should conform to tax laws
● Existing tax laws and accounting standards should be replaced and a
new hybrid set of laws developed38
However, with the move by Australia to adopt IFRS, it essentially means

that there is no flexibility to amend accounting standards to converge
towards tax law. Furthermore, there seems to be reluctance by the
118 Les Nethercott
legislature or the Courts to converge tax law with accounting standards

and principles. The outcome is to produce a difference between the two
measurements of income and the resulting deferred tax asset (or liabil-
ity) where timing differences arise.
6.7 The consequences of IFRS for the mining industry
From the above discussion it can be seen that the new IFRS accounting
standards raise a number of issues concerning the accounting treatment
of exploration and evaluation expenditures. In particular, there is the
issue of whether to expense such expenditure as incurred or to carry it
forward until a decision can be made as to whether the expenditure will
be recoverable by the future cash flows attributable to the exploration.
Where the latter choice is made, this essentially means that an asset will
be recognised. The difficulty with this outcome is that it is hard to estab-
lish or justify the presence of an asset. This is because the exploration
activities and expenditure related to it does not meet the definition of
an accounting asset, within the context of the Accounting Framework,
but also because there is considerable uncertainty as to whether there
will be a successful outcome from the exploration activity.
From a tax point of view, the determination of whether exploration
expenditures are an allowable deduction, or may be recognised as an
asset, is dependent on tax law which has different principles. As a result
there is not likely to be any congruence between the accounting meas-
ure of income and that of taxable income.
Where such differences occur due to the presence of timing differ-
ences AASB 112 requires the recognition of a deferred asset or a liability.
However, as indicated earlier, it may be argued that such a liability or
asset should not be recognised due to the fact the asset or liability is
based on future events which are uncertain.
In the case of an established mining operation which has a posi-
tive cash flow and earnings, it may be possible to argue that a liability
may exist. However, from a tax point of view, this is not the case. From
an Accounting Framework perspective, it would be difficult to argue
that there is a deferred asset or a deferred liability. In the case of a new
explorer, the argument that a deferred asset or liability does not exist is
much stronger.
As a result it may be argued that the accounting tax interface raises
a number of conceptual and practical difficulties in determining how
exploration and evaluation expenditure should be treated. In an ideal
world, it would be desirable to have congruence between measures of

accounting and taxable income. This is not likely for the reasons cov-
ered earlier in this chapter.
Consequently this produces accounting and tax outcomes which may
produce divergent results in the recognition of assets, and liabilities,
which are questionable in nature.
From an investor point of view it may be argued that this outcome
is inconsistent with the definition of assets and liabilities in the
Accounting Framework. It may also be argued that such an outcome
does not produce accounting results which are consistent with the
objective of financial reporting, that is, to provide information about
the financial position and performance and cash flows of an entity that
is useful to a wide range of users to make economic decisions.39
This is because under the new IFRS standards, different choices are
available to entities as to how exploration and evaluation expenditures
may be treated. Depending upon which choice is made, different income
consequences arise and different balance sheet outcomes result.
6.8 Conclusion
The adoption of IFRS has raised a number of accounting issues for enti-
ties engaged in the mining industry, especially concerning the treat-
ment of exploration and evaluation expenditures. This produces a result
where entities are given a choice of how to account for exploration and
evaluation expenditures prior to production. As a result, the account-
ing for these expenditures may produce different asset and expense
outcomes.
From a tax perspective, where there is a divergence between taxable
and accounting income due to the different treatment of exploration
and evaluation expenditure, this raises the possibility that a deferred
asset or liability should be recognised for accounting purposes when
there is no asset or liability strictly at law.
The outcome of this divergence is the recognition of assets and liabili-
ties which are questionable in nature and the production of financial
statements that may be misleading and not reflective of the entity’s
financial position.
In view of the move to adopt IFRS it would seem that any congruence
between accounting and taxable concepts of income is remote. In the
case of the mining industry the outcome is to increase the complexity
of financial reporting and as a result the tax interface.
120 Les Nethercott
Notes
1. Henderson, S. and Pierson, G. (2010), Issues in Financial Accounting, Pearson
Prentice Hall, Chapter 22, 2010.
2. Financial and Reporting Handbook (2010), Wiley, and R Picker et al. (2006),
Australian Accounting Standards, John Wiley and Sons Australia Ltd.
3. See Financial and Reporting Handbook (2010), Wiley.
4. Financial and Reporting Handbook (2005), Wiley.
5. AASB 6, para 7.
6. Henderson, S. and Pierson, G. (2010), Issues in Financial Accounting, Pearson
Prentice Hall, chapter 22.
7. See ‘Framework for the Preparation and Presentation of Financial Statements’
in the Financial and Reporting Handbook (2010), Wiley.
8. ‘Framework for the Preparation and Presentation of Financial Statements’,
para 83.
para 83.
10. AASB 138, para 12.
11. AASB 138, para 8.
12. AASB 138, para 12.
13. AASB 138, para 21.
14. AASB 6, para 12.
15. Nethercott, L. and Anamourlis, T. (2009), ‘Impairment of Assets: A Tax
Accounting Interface’, Journal of Law and Financial Management, 8(1), pp.
14–19
16. AASB 136, para 6.
17. AASB 136, para 6.
18. AASB 136, para 9.
19. AASB 136, paras 110 and 114.
20. AASB 101, ‘Presentation of Financial Statements’ refers to a requirement to
provide a ‘Statement of Comprehensive Income’, that is, a profit and loss
statement and a requirement to provide a ‘Statement of Financial Position’,
that is, a balance sheet.
21. See Nethercott, L. and Hanlon, D. (Spring 2005), ‘The Taxation Consequences
of Adopting International Financial Reporting Standards in Australia’, Asian
Pacific Journal of Taxation, 9(1), pp. 34–49.
De Zilva, A. (2003), ‘The Alignment of Tax and Financial Accounting
Rules: Is It Feasible?’ Australian Tax Forum, 18, pp. 264–284.
Freedman, J. (2004), ‘Aligning Taxable Profits and Accounting Profits:
Accounting Standards, Legislators and Judges’, eJournal of Tax Research, 2(1),
pp. 71–79.
DÁscenzo, M. and England, D., The Tax and Accounting Interface: 2003
Proceedings of 15th Australian Tax Teachers Conference, University of
Wollongong.
22. See Woellner, Barkcoczy, Murphy, Evans and Pinto (2010), Australian Tax
Law, CCH, 567–605.
23. See Amalgamated Zinc (de Bavay’s) Ltd v FCT (1935) 54 CLR 295; Herald and
Weekly Times Ltd v FCT( (1932) 48 CLR 113.
24. Amalgamated Zinc (de Bavay’s) Ltd v FCT (1935) 54 CLR 295 at 303.
25. Charles Moore & Co (WA) Pty Ltd v FCT (1956) 95CLR 344.
26. Softwood Pulp and Paper 76 ATC 4439.
27. Ronpibon Tin NL v FCT (1949) 78 CLR 47; also see FCT v Snowden and Wilson
Pty Ltd (1958) 99 CLR 431.
28. Softwood Pulp and Paper v FCT 76 ATC 4439.
29. Travelodge Papua New Guinea v Chief Collector of Taxes 85 ATC 4432.
30. See Woellner, Barkcoczy, Murphy, Evans and Pinto (2010), Australian Tax
Law, CCH, 606–619.
31. Sun Newspapers Ltd and Associated Newspapers Ltd v FCT (1938) 61 CLR 337.
32. Sun Newspapers Ltd and Associated Newspapers Ltd v FCT (1938) 61 CLR 337,
359.
33. AASB 112, para 5.
para 53.
para 60.
36. Nethercott, L. (2005), ‘Consolidations: An Accounting Tax Interface’, The
Tax Specialist, 8(3), 152.
37. See C of T v Executor Trustee and Agency Company of South Australia (1938) 63
CLR 108.
38. De Zilva, A. (2003), ‘The Alignment of Tax and Financial Accounting Rules:
Is It Feasible?’ Australian Tax Forum, 18, 265.
Hill, G. (Feb 2003), ‘The Interface between Tax Law and Accounting Concepts
and Practice as seen by the Courts’, 15th Annual Australasian Tax Teachers
Association Conference, Faculty of Law, University of Wollongong.
para 12.
7
Carbon Tax: Economic Impact
on the Latrobe Valley
Mereana Barrett, Svetlana Maslyuk and Daniel Pambudi
7.1 Introduction
Australia’s greenhouse gas (GHG) emissions per capita are presently

among the highest compared to other developed nations. Currently
Australia contributes 1.5 per cent of global GHG emissions (Garnaut,
2008). The electricity sector in Australia together with agriculture
bears the largest proportion of the carbon dioxide (CO2) emissions,
while brown coal’s share in Australian total GHG emissions is 15 per
cent. In contrast to black coal mining, brown coal emissions are not
fugitive, so the bulk of emissions associated with the brown coal
are related to its use. Although 58 per cent of Australian power gen-
eration capacity is coal-fired, at present Australian power generation
is dominated by coal with approximately 81 per cent of the total
electricity generated produced by brown and black coal generators
(Nelson, et al. 2010). Our Ecological Footprint (a measure of how
much land and water area a human population requires to produce
the resource it consumes and to absorb its wastes, using prevailing
technology) is 7.8 global hectares per capita (Living Planet Report,
2008), well above the sustainable global level of 2 global hectares per
capita. This is three times larger than the resources that our country
can regenerate in the course of one year. In response to the climate
change challenge, the Labour government proposed the following
climate change strategy:
● Reduction of Australia’s GHG emissions by 5 per cent below 2000

levels by 2020 irrespective of other countries’ actions or by 15–20 per
cent depending on the scale of global action (Australian Government
Climate Change Plan, 2011).
122
Carbon Tax: Economic Impact on the Latrobe Valley 123
● The long-term target is to reduce Australia’s GHG emissions by 80

per cent below 2000 levels by 2050 (Australian Government Climate
Change Plan, 2011).
Australia has a long record in setting environmental policies. For

example, the first National Greenhouse Response Strategy (NGRS) was
released in 1992 as a strategic tool for Australia’s long-term commit-
ment to climate change. This policy was adopted after the Australian
government ratified the United Nations Framework Convention on
Climate Change (UNFCCC) and largely affected Australia’s actions
and policies with respect to the environment and the GHG emis-
sions prior Australia’s ratification of the Kyoto Protocol (KP). In 1998
Australia launched the National Greenhouse Strategy (NGS), which
stressed the need for an integrated approach to climate change by all
levels of Commonwealth, state and local governments, which pro-
moted industry and community participation in addressing climate
change (Barrett et al., 2009).
In December 2007, the newly elected Labour government signed the
KP, an international agreement on climate change, which sets legally
binding targets in reducing GHG emissions. It was ratified in early March
2008. The primary achievement of the KP is the commitment of 38
Annex I countries, of which Australia is now a member, to reduce GHG
emissions 5 per cent below 1990 country-specific levels over the period
2008–12 (Dagoumas et al., 2006). The KP considered six major GHGs
including carbon dioxide, methane, nitrous oxide, perfluorocarbons,
hydrofluorocarbons and sulphur hexafluoride (CO2, CH4, N2O, PFC,
HFC and SF6). To achieve this target, the KP has established three mar-
ket based-mechanisms including Emissions Trading (article 17 of KP),
Joint Implementation (article 6) and Clean Development Mechanism
(article 12). Although the particulars of the Emissions Trading were not
established in the Protocol, this idea has gained momentum through
introduction of the mandatory Emissions Trading Scheme (ETS) in the
European Union (EU-ETS), voluntary ETSs in Japan, Switzerland and
New Zealand, Chinese 3+4+1 trial emissions reduction schemes and by
establishing regional emissions trading initiatives such as the Regional
Greenhouse Gas Initiative (RGGI). The latter is the first mandatory mar-
ket-based solution for the reduction in the GHG in the United States.
The current debate on climate change and global warming suggests an
increasing trend for establishing voluntary and mandatory regional and
national ETS, particularly by the developed nations such as China and
India, and linking of the existing schemes.
124 Mereana Barrett, Svetlana Maslyuk and Daniel Pambudi
In an effort to launch emissions trading as suggested by the KP, the

government issued the Green Paper in July 2008, outlining its pro-
posals for a mandatory multi-sector national ETS – called the Carbon
Pollution Reduction Scheme (CPRS). These initial proposals were very
ambitious, suggesting no free initial allocation of permits to carbon
polluters. Emissions trading is not new to Australia. The first volun-
tary emissions trading system in Australia was the New South Wales
(NSW) Greenhouse Gas Abatement Scheme, which operated at the
state level over the period 1997–2002 and covered the electricity sec-
tor. In 2003, the New South Wales government introduced the manda-
tory Greenhouse Gas Reduction Scheme, covering the electricity sector
only (NSW Department of Water and Energy, 2008). The scheme will
remain operational until the launch of the national ETS. Although the
Australian government had initially planned to introduce the CPRS in
2010, the global financial crisis led to the government deciding to delay
the introduction of the Scheme before it was finally rejected.
On 24 February 2011, Prime Minister Julia Gillard announced a new
framework to establish a fixed price on carbon and reduce GHG emis-
sions. The framework included a proposal to implement a transitional
carbon tax from 1 July 2012 (Leslie, 2011) and ETS from 2015. The tax,
which will be payable by approximately the country’s 500 biggest pol-
luters, aims to achieve a reduction in Australia’s GHG emissions of 120
million tonnes by 2020 (Australian Government Climate Change Plan
2011). Sectors excluded from the scheme are agriculture, decommis-
sioned mines, forestry, legacy waste, emissions from synthetic gases
and Scope 2 emissions from electricity. With the introduction of the
national ETS, carbon price will be determined by the carbon market
subject to a price ceiling. However, this price will become fully flexible
only after 1 July 2018.
The purpose of this chapter is to analyse the economic and social
impact of carbon tax on the Australian Latrobe Valley, which is the base
for the majority of coal-fired electricity generation plants supplying elec-
tricity to the state of Victoria. The proposed tax will be producer-based
tax. Over the course of three years, the tax will be Australia’s primary
policy tool to drive reductions in emissions of GHG. In this chapter we
use the Computable General Equilibrium (CGE) methodology which
proved to be extremely useful in the analysis of climate policy impacts.
There are several advantages of this methodology. Firstly, it ‘allows for
sectoral output adjustments in response to higher production costs,
which may be induced by climate policies’ (Schumacher and Sands,
2007, p. 800). Secondly, it allows the analysis of interactions between
several production sectors in the economy and the examination of a

combined response to changes in the relative prices of these sectors.
Following Schumacher and Sands (2007, p. 800), ‘handling both sec-
tors within a common framework avoids double counting of emissions
reductions’. Thirdly, it allows for estimating changes in welfare which
provides a good measure of the overall effect of comparing several cli-
mate change policies (Rivers and Jaccard, 2006).
The chapter is structured as follows. Section 7.2 provides an over-
view of the Latrobe Valley. Section 7.3 provides a brief overview of the
carbon tax and other environmental policy instruments. Data and
methodology are described in Section 7.4, modelling results and main
policy implications are given in Section 7.5 and Section 7.6 concludes
the chapter.
7.2 Latrobe Valley overview
Latrobe Valley is located approximately two hours east of Melbourne,

the capital of Victoria. The region is defined within the boundaries of
the Latrobe City. Its population is approximately 75,000 people mainly
residing in Moe, Morwell and Traralgon. In 2006, the total labour force
in the Valley was estimated to be 66,707 (DEEWR, 2012). Employment
in the Latrobe City is heavily dependent on the income earned in coal
mining and electricity generation because for every ten jobs in the elec-
tricity sector, an additional eight jobs can be sustained (Latrobe City,
2010). Based on ABS 2006 Census data, although only 11 per cent of
jobs are in electricity generation and coal mining, this sector has rela-
tively high wages (Latrobe City, 2010).
Within the Gippsland Basin, the Latrobe Valley contains 53,000 mil-
lion tonnes of ‘economic’ coal (GHD, 2005, p. 38). At the current rate
of annual production of approximately 65 million tonnes, it will take
over 800 years for coal reserves to reach depletion. In fact, only 5,000
metric tonnes (Mt) of coal have been mined in the last 80 years (Latrobe
Valley 2100 Coal Resources, 2005, p. 38). There are three operating
open cut coal mines (see Table 7.1) in the Latrobe Valley (Loy Yang,
Hazelwood and Yallourn). The cost of coal extraction in the Valley is
quite low (Nichol and Moore, 2007). Brown coal produced in the Valley
has very low ash and sulphur content and is used mostly by power sta-
tions to generate electricity, and also by the briquette plant. Due to the
absence of the adjacent coal processing plant which could process and
prepare coal for export, all mining operations are currently servicing
the Australian domestic market only. Brown coal has very high water
Table 7.1 Operating mines at the Latrobe Valley
Coal seam
thickness Overburden
Mine Mine area (metres) depth (metres) Mining technique
Loy Yang 800 Ha 180 5–24 Bucket wheel

dredgers
Hazelwood 761 Ha 100 18 Bucket wheel
dredgers
Yallourn 1625 Ha 100 18 Oversized bulldozers
for coal and
dredgers for
overburden
Source: Table is based on PowerWorks: Industry Overview. Available online at: http://www.
powerworks.com.au/information/industry-overview.
content, making it a not very efficient source of electricity produc-

tion, which leads to higher CO2 emissions than in the case of black
coal. The Hazelwood mine produces 19 million tonnes of coal a year
(supplied to Energy Brix power station), the Loy Yang mine produces
approximately 30 million tonnes of coal a year (supplied to Loy Yang A
and B power stations) and the Yallourn mine produces approximately
18 million tonnes of coal a year (supplied to TRUenergy’s Yallourn W
power station).
Electricity generation in the Latrobe Valley is through five coal-fired
generation plants (Energy Brix, Yallourn W, Hazelwood and Loy Yang
A and B), which collectively produce over 90 per cent of Victorian elec-
tricity. The privatisation of the power industry heralded in a period of
economic recession. From 1986 to 2001, unemployment rates soared
from a low of 6 per cent up to 16 per cent (ABS, 2001). The impact of
restructuring efforts saw unemployment numbers within the Electrcity
Supply Industry (ESI) fall from 9,859 in 1989 to just 1,790 in 2001. The
Latrobe Valley’s population plummeted from 79,450 in 1991 to 73,439
in 2001, equating to a net loss of around 9 per cent of its total popula-
tion (Birrell, 2001). A large portion of ESI workers accepting the volun-
tary departure packages left the region in search of future employment
(Kazakevitch et al., 1997). Numerous local supporting businesses from
Morwell, Moe and the smaller surrounding townships dependent upon
the ESI for trade closed. Also, land and property values spiralled down-
wards between 1989 and 1997.
Table 7.2 shows the resident population in the Latrobe Valley after
the industry underwent major restructuring in the 1990s. If during
Table 7.2 Estimated resident population in the Latrobe Valley, the state of Victoria
and Australia
2003 2004 2005 2006 2007 2008 2009
Latrobe 70,459 70,709 71,112 72,003 73,083 74,165 75,259

Valley
Total 4,923,485 4,981,467 5,048,602 5,126,540 5,221,310 5,326,978 5,443,228
Victoria
Total 20,011,882 20,252,132 20,544,064 20,873,663 21,263,271 21,730,585 22,165,460
Australia
Source: ABS, 3218.0 – Regional Population Growth, Australia, 2008–09, retrieved from http://
www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPage/3218.02008–09?OpenDocument and ABS,
3101.0 – Australian Demographic Statistics, retrieved from http://www.abs.gov.au/ausstats/
abs@.nsf/mf/3101.0.
2001–04, resident population was fluctuating around 70,500 people,

from 2004 it has been steadily growing.
Based on Table 7.3 it can be seen that an increase in the resident
population in the Valley corresponded to a decrease in unemployment.
However, unemployment in the Valley was above the average Victorian
unemployment, while labour force participation rates were lower.
Table 7.4 compares average salaries and wage incomes between
Latrobe Valley, Victoria and Australia and reveals that from 2003 to
2008 the average income earned by the workers in the Valley was below
the Victorian and Australian average. Therefore, any government policy
including a carbon tax on producers is more likely to have a profound
effect on the population of the Valley in terms of their well-being and
unemployment.
More recently, based on the ABS 2006 Census, the top three employ-
ers in the region included Public and Community Services; Retailing,
Wholesaling and Transport and Manufacturing (respectively, 32 per
cent, 18 per cent and 7 per cent of the workforce, ABS, 2006). In 2008,
electricity generation was responsible for 21 per cent of the Gross
Regional Product (GRP) in the Valley (Latrobe City, 2010). Major indus-
tries in the Latrobe Valley include agriculture (particularly beef and cat-
tle industries), the Australian Paper Pulp and Paper Manufacturing Mill
at Maryvale, Monash University and the Central Gippsland Institute
TAFE, the Australian Securities Commission’s National Information
Processing Centre and Victoria’s five major power generators (Latrobe
City, 2010)
Electricity generation in the Latrobe Valley dates back to the 1920s
and was mostly controlled by the State Electricity Commission of
Table 7.3 Labour force participation in Latrobe Valley and Victoria
Latrobe Valley Victoria
1991 1996 2001 2006 1991 1996 2001 2006
Employed full time 18,930 15,915 15,617 16,960 1249626 1,285,053 1,354,647 1,445,460
Employed part time 7,292 7,846 9,121 10,136 466133 556,422 663,221 682,604
Employed not stated 1,376 515 795 755 94277 43,405 64,348 146,383
Total employed 27,598 24,276 25,533 27,851 1810036 1,884,880 2,082,216 2,274,447
Total unemployed 4,291 4,644 3,541 2,584 247,132 196,189 151,859 130,158
Unemployment rate (%) 8.16 9.16 6.90 4.83 7.47 5.72 4.14 3.27
Total labour force 31,890 28,920 29,074 30,435 2057168 2,081,069 2,234,075 2,404,605
Labour force 60.63 57.03 56.61 56.92 62.17 60.69 60.90 60.39
participation rate (%)
Total not in labour force 19,421 20,548 20,374 19,964 1173309 1,269,348 1,277,942 1,330,370
Not stated 1,290 1,238 1,908 3,072 78667 78,358 156,367 247,061
Total working age 52,601 50,706 51,356 53,471 3309144 3,428,775 3,668,384 3,982,036
population
Source: ABS, Census of Population and Housing, 2006, 2001, 1996, and 1991. Available online at: http://www.abs.gov.au/websitedbs/d3310114.nsf/
Home/census.
Table 7.4 Average salary and wage income
2003–04 2004–05 2005–06 2006–07 2007–08
Latrobe Valley 35,761 36,872 38,938 40,797 42,851

Total Victoria 36,882 38,421 39,861 41,260 42,782
Total Australia 36,889 38,607 40,276 42,081 43,921
Source: based on the ABS (2010) ‘Wage and Salary Earner Statistics for Small Areas, Time
Series, 2003–04 to 2007–08’. Available online at: http://www.abs.gov.au/ausstats/abs@.nsf/
mf/5673.0.55.003.
Victoria (SECV) (Barrett et al., 2009). Following Owen (2009), until the
mid-1990s generation, transmission, distribution and electricity retail-
ing were undertaken within a single, vertically integrated, monop-
oly business. These huge monopoly businesses operated not only in
Victoria but also in Tasmania and South Australia. In the 1990s, the
electricity industry in Victoria was privatised mainly due to the vast
financial crisis and large level of outstanding debt of the state govern-
ment. Privatisation also corresponded to severe economic recession.
The industry underwent a major restructuring with the objective of
unbundling these four functions into separate businesses (Barrett et al.,
2009). Electricity generation was horizontally privatised ending up in
five electricity generation plants controlled by the private domestic and
international corporations. Table 7.5 contains comparison of the power
plants currently operating in the Valley. Overall, electricity generation
plants in the Valley use outdated technology requiring large amounts of
water and are unsustainable in the future due to large amounts of GHGs
produced. According to the Australian Electricity Generation Report
(2009), of the power stations emitting the most GHG emissions in
Australia in 2009, the top three were Victorian Loy Yang A, Hazelwood
and Yallourn W.
7.3 Carbon tax as environmental policy to reduce

GHG emissions: an overview
There are several policy tools that governments can use to achieve reduc-
tion in the GHG emissions. These include intensity-based approaches
(e.g., setting a baseline limit on emissions above/below which compa-
nies will be penalised/subsidised), a flat tax on emissions, creating a
market for emissions (e.g., ETS) and a hybrid approach (e.g., combination
of a tax and ETS, which, for example, was introduced in Switzerland)
(Jones et al., 2007).. Any approach to cut the GHG emissions and put
Table 7.5 Electricity generators in the Latrobe Valley
Electricity Date of start Capacity Emissions Emissions

generator Location Owner of operation (MWh) (Mmt CO2-e) intensity
Yallourn W Yallourn TRUenergy 1921 1,480 15.00 1.29

Hazelwood Morwell International 1964 1,675 16.25 1.37
Power Mitsui
Loy Yang A Traralgon Great Energy 1982 2,210 18.81 1.10
Alliance
Corporation
Loy Yang B Traralgon International 1993 1,026 9.80 1.15
Power Mitsui
Energy Brix Morwell Energy Brix 1949 170 1.59 1.26
Australia
Corporation
Source: Based on the electricity generators websites. Great Energy Alliance Corporation
includes Australian Gas Light Company (AGL), the Tokyo Electric Power Company (TEPCO),
Transfield Services Ltd and superannuation funds MTAA Super, state-wide Superannuation
Trust and Westscheme (the Age, 2006). Emissions and emissions intensity data is taken
from Australian Electricity Generation Report (2009). Emissions are in million tonnes
of carbon dioxide equivalent (MmtCO2 -e) and emission intensity is in tonnes of carbon
dioxide equivalent per Megawatt hour (tCO2 -e/MWh).
a price on carbon will have substantial short-term and long-term eco-

nomic impact (Jones et al., 2007; Pizer, 2002).
Of these approaches, carbon tax and the ETS are the most commonly
used across the globe. The main advantage of carbon tax is that is offers
certainty to economic agents through fixed and predictable carbon
price. Price certainty not only helps businesses and households in their
decision-making, but it also makes it easier for government to set fiscal
and monetary policies (Frebairn, 2010). In addition, carbon taxes are
a relatively simple market-based incentive to reduce GHG and govern-
ment does not need to take discretionary decisions about who is allowed
to emit (Garnaut, 2008; Humphreys, 2007). By contrast, the advantage
of the ETS, that carbon tax might fail to deliver, is that it provides more
certainty in terms of environmental outcomes but at the expense of
volatile carbon price (Green, 2008). However, in the current absence of
global emissions trading and the industry preference for stable carbon
price, the government’s proposal to introduce carbon pricing with fixed
price and then transition to a market-based pricing system could be a
good option (Jotzo, 2011). Table 7.6 discusses the advantages and disad-
vantages of carbon taxes.
Environmental taxes have been widely used in Europe since the
1990s. For example, in Denmark, both producers and households are
taxed per tonne of CO2 emitted. Similar taxes also exist in Sweden,
Table 7.6 Advantages and disadvantages of carbon taxes
Advantages Disadvantages
Environmental taxes on carbon

1 Provide stable price signals Are not effective in uncertain
conditions when the response to a
tax on emissions is not known
2 Create a permanent, stable, If set too high, activities that are
incentive to adopt a least-cost particularly sensitive to the
way of reducing GHG emissions tax may relocate to an overseas
and continued technological location that does not have such
innovation imposts
3 Can be implemented quickly, are Depending on how the tax is
simple and could have wide applied, it may lock a firm into
coverage a particular emissions reduction
method in order to reduce the tax
imposed, rather than reduce the
environmental harm occurring
4 Are a revenue source for the The level at which the tax is set to
government produce the best outcomes cannot
be known in advance
Source: Adapted from Nielson (2010, p. 9).
Norway, the Netherlands, Denmark, Finland, Austria, Germany and

Italy. More recently developing countries started introducing environ-
mental policies. For example, in July 2010 India introduced a nation-
wide carbon tax of 50 rupees per metric tonne of CO2 emitted on coal
produced domestically and imported (Ministry of Environment and
Forests, 2010). The tax is part of India’s policy instruments to achieve
a reduction of CO2 emissions by 25 million tonnes per year by 2014–15
(Ministry of Environment and Forests, 2010).
In order to achieve Australia-wide reduction of emissions and at the
same time to contribute to the global goal of reducing GHG emissions,
the Australian government has initially proposed an introduction of
the CPRS – a mandatory Australia-wide multi-sector ETS covering
all six Kyoto gases. The main objective of the CPRS was ‘to reduce
Australia’s GHG emissions by transitioning economy away from the
production and consumption of goods and services, that are GHG
intensive’ (Lambie, 2010, p. 204). Australian CPRS was designed as
the mandatory national multi-sector multi-gas cap-and-trade system.
This ETS design is most commonly used to reduce pollution from the
electricity generating plants as compared to hybrid and baseline-and-
credit designs (Linn, 2010;, Buckley et al., 2005). Following Bohringer
et al. (2003, p. 295), ‘The beauty of a cap-and-trade system is that

no central planner information on specific abatement possibilities is
required in order to achieve the cost-effective outcome; the market
will work it out – which is the quintessence of market-based regula-
tion.’ The additional advantage of such design is that it allows achiev-
ing emissions reduction at minimum costs by equalising the marginal
abatement costs across emitters (Lambie, 2010; Betz and Owen, 2010;
Betz et al. 2010; Baumol and Oates, 1988). However, the design of the
CPRS was too ambitious; it was planned to cover many sectors of the
economy (e.g., transport, agriculture and emissions-intensive, trade-
exposed industries) which raised the question of potential carbon
leakage and a necessity to implement compensation arrangements to
the affected industries.
The Australian government has recently announced an alterna-
tive climate change reaction plan, which will be introduced to the
Parliament at the spring 2011 session. In this plan, carbon tax is set
to be implemented on 1 July 2012, after which it will switch to a cap-
and-trade national ETS from 1 July 2015. According to the Australian
Government Climate Change Plan 2011, in the first year of opera-
tion tax is fixed at $23 per tonne of CO2 emitted, while in the second
and third years it is set at $24.15 and $25.40, respectively. The rise in
carbon price is attributed to a projected inflation rate of 2.5 per cent
(the midpoint of the Reserve Bank of Australia’s target range). Over
the three years of carbon tax, the government plans to raise $27.3 bil-
lion in revenue. The government will spend 50 per cent of the revenue
generated from the tax compensating households for higher living
costs which are passed on to consumers by polluting companies. Since
it is a producer-based tax, another 40 per cent of carbon tax revenue
will be used as assistance for Australian companies, which can pur-
chase permits (up to the number of their emissions for the compliance
year) from the government at the fixed price (Australian Government
Climate Change Plan 2011). These permits have to be surrendered in a
respective year of vintage and cannot be carried on for future compli-
ance years. Assistance will also be in the form of freely allocated car-
bon permits and cash payments up to $5.5 billion (nominal $) over the
next six years. The bulk of these assistance measures will be received
by the electricity generators with an emissions intensity of above 1.0
tCO2 -e/MWh or National Electricity Market Average of 0.86 tCO2 -e/
MWh (Australian Government Climate Change Plan, 2011), which
means that all Latrobe Valley power stations are eligible for govern-
ment assistance.
7.4 Data and methodology
The CGE models have become the standard tools of analysis of the
economy-wide impacts of environmental policies such as introduc-
tion of the ETS and carbon taxes on the resources allocation and the
well-being of the market participants (Weyant, 1999). This approach
provides a consistent and comprehensive framework for studying price-
dependent interactions between the energy system and the rest of the
economy (Bohringer et al., 2009, p. 51).
In this chapter, the Australian ‘The Enormous Regional Model’
(TERM) and the CGE Model were used for analysing the impact of
the introduction of the CPRS on the Latrobe Valley and deriving esti-
mates. It is a ‘bottom-up’ CGE model of Australia, which treats each
region of a country as a separate economy (Horridge et al., 2005) and
is developed by the Monash University Centre of Policy Studies. The
advantages of this model include its ability to deal with highly disag-
gregated regional data and analyse the impacts of shocks that may be
region-specific (Horridge et al., 2005). The original TERM model was
modified to reflect regional specifics of Gippsland regional and the
Latrobe Valley. It contains 19 sectors of the economy, 56 bottom-up
regions, and 1,337 subregions across Australia. Production, consump-
tion and investment decisions in the TERM are modelled under the
assumption of competitive markets and a given production technol-
ogy used by the producers. Producers are assumed to maximise profits
and choose inputs in order to minimise costs of production, while
consumers are maximising utility subject to their respective budget
constraints.
The main characteristics of the TERM used in this chapter include:
1. there is complete labour migration between different 19 industrial

sectors as well as 56 regions,
2. rates of return (ROR) on capital are exogenous and capital for each
regional industry is assumed to have elastic supply in the long run,
3. foreign currency prices of imports are treated as exogenous,
4. other exogenous variables in the study include production tax rates,
technological coefficients, and price and quantity shift variables,
5. because in each region, nominal household consumption moves in
proportion to the nominal income, in order to operate in after-tax
terms we have excluded income tax from the regional income,
6. real government consumption is assumed to be exogenous,
7. the Australian dollar/US dollar exchange rate is fixed as numeraire.
The modelling is done using the General Equilibrium Modelling

PACKage (GEMPACK) developed by the Monash University’s Centre
of Policy Studies and Impact Project. For technical details behind the
model, please refer to the TERM model documentation available at
www.monash.edu.au/policy/term.htm.
In this chapter, similar to the Australian Treasury modelling
(Australian Treasury, 2011) which analysed a range of tax between $20
to $30, as an instrument to reduce carbon emissions from coal mining
and electricity generation, we analysed an increase of production tax
by 5 per cent and 15 per cent on the mining and electricity genera-
tion. Since Latrobe Valley generators supply more than 90 per cent of
electricity in Victoria, this tax is expected to affect the supply curves
for coal mining and electricity generation and also impact the employ-
ment in the Latrobe Valley, as well as the price of electricity (and hence
the inflation and the cost of living).
7.5 Modelling results
Simulation results of the 5 per cent and 15 per cent on production tax
scenarios are given in Table 7.7, which contains results of a shock on
macroeconomic variables for Latrobe Valley and the Australian nation
in general. These results are compared to the business-as-usual scenario
in which no carbon tax was introduced. Results are given in percentage
changes.
On the expenditure side of GDP, an increase in the production tax
by 5 per cent (15 per cent) leads to a 2.75 per cent (8.25 per cent) fall
in real household expenditures and 7.67 per cent (23.01 per cent) fall
in real investment. Since domestic demand is expected to drop, import
volumes would also contract by 4.61 per cent (13.83 per cent).
However, a tax increase also leads to an increase in GDP price index by
a moderate 0.73 per cent (2.18 per cent). Other price indexes including
consumer price index (CPI), government price index and investment
prices fall by less than 1 per cent, respectively. The government price
index mainly falls due to the fact that local governments in Australia
primarily use government services, which are a labour-intensive sector.
So when local wages fall, so does the output price and the government
price index.
On the income side of GDP, introduction of a tax leads to a moderate
fall in aggregate employment levels (1.36 per cent and 4.08 per, cent
respectively) and a large fall in aggregate capital stock (7.59 per cent and
22.76 per cent, respectively). Overall, real regional GDP shrinks by either
Table 7.7 Carbon tax impact on brown coal mining and electricity generation:
simulation results
5% simulation 15 % simulation
Latrobe Latrobe
Main Macroeconomic Valley Australia Valley Australia
Variables (1) (2) (3) (4)
Real household expenditure –2.75 –0.03 –8.25 –0.10

Real investment expenditure –7.67 –0.10 –23.01 –0.30
Export volume –8.92 0.03 –26.77 0.08
Import volume used –4.61 –0.04 –13.83 –0.13
Real GDP –4.70 –0.03 –14.11 –0.08
Aggregate employment –1.36 0.00 –4.08 0.00
Average real wage –1.40 –0.04 –4.20 –0.12
Aggregate capital stock –7.59 –0.07 –22.76 –0.21
Price GDP 0.73 –0.05 2.18 –0.15
Consumer price index –0.23 –0.05 –0.69 –0.14
Export price index 2.23 –0.01 6.69 –0.02
Nominal household –2.98 –0.08 –8.94 –0.24
expenditure
Nominal GDP –3.98 –0.08 –11.93 –0.24
Source: Monash University and Authors Calculations.
approximately 4 per cent or 12 per cent. Increase in the production tax

also implies a lowering of real wages in the region. If there was no labour
mobility between regions in Australia, the employment in the Valley
would slightly decrease in response to lower real wages with either tax.
Both employment and real wages are expected to decrease in the region
approximately in the same proportion. Since both employment and
wages fell in Gippsland and the Latrobe Valley, and both capital and
price on capital fell, household income would have fallen as well.
National results are similar to Gippsland results although they are
somewhat smaller. One reason is that national results are no more than
the sum of the corresponding regional results. On the expenditure side,
both 5 per cent and 15 per cent tax led to a shrinking of the national real
household expenditures by less than 1 per cent (0.03 per cent and 0.10
per cent, respectively), mainly as a result of a reduction of Gippsland
household expenditure. Real investment expenditure also fell due to a
fall in aggregate capital stock. Due to the assumption of fixed regional
gross growth rates of capital, investment will follow capital growth.
While Gippsland GDP price index (GDPPI) inflated, national GDPPI
deflated by 0.05 per cent (0.15 per cent) due to input–output interac-
tion across industries and regions.
7.6 Discussions and policy implications
The goal of the carbon tax is to achieve a reduction in Australia’s emis-

sions through establishing a stable price for carbon and a creation of
incentives for producers of the GHG. This price is likely to be substantial
and raise costs in those industries and regions which are both directly
and indirectly involved in production of emissions of all six gases under
the KP, including coal mining and electricity generation. The introduc-
tion of the carbon tax and in the longer-term emissions trading will
not only increase the costs economy-wide, but it will also represent
large structural change in the economy. The survival in this new car-
bon economy will depend on the company’s ability to understand and
manage its carbon exposure, generate offsets, improve energy efficiency
and find new investment opportunities in cleaner technologies.
In this chapter we analysed the immediate impact of the proposed
carbon tax on the region, where economic and social well-being is
vastly dependent on mining and electricity generation industries. The
simulation results indicate that with the carbon tax in place, real GDP,
real consumption and employment levels in the Latrobe Valley and in
Australia overall would fall. This is because, firstly, a tax has the poten-
tial to reduce economic efficiency. Secondly, it will put a strain on real
investment expenditures in the Valley, which will further reduce pro-
ducer’s revenues and hence lead to additional reduction in investment.
Our study has shown that the magnitude of the tax is important: a
larger tax is likely to bring a larger fall in regional GDP.
The modelling results presented here are somewhat contradictory to
the Commonwealth Treasury carbon tax modelling results, which pro-
poses that an introduction of a tax in the range of $20 to $30 will lead
to future growth in national income and employment. In this study we
examined the immediate impact of the introduction of the tax and did
not forecast future long-term outcomes.
There are some limitations of our study. For example, in this study we
did not incorporate the exact amounts of compensation that each elec-
tricity generator in the Latrobe Valley is expected to receive each year
and over the lifetime of a tax. As stated earlier, in the terms of the pro-
posed assistance to electricity generators, government is proposing free
permits and cash allowances. Several studies have advocated the need
for such assistance under the carbon tax. For example, ACIL Tasman
(2011), ROAM (2008) and MMA (2008) have indicated significant losses
for the National Electricity Market generators ($11.0, $17.5 and $0.1 bil-
lion, respectively) after the introduction of carbon price.
In addition, the current level of technology is assumed to be fixed in

the study; we did not consider technological innovation, improvements
in energy efficiency, carbon capture and storage (CCS) that can become
available in future. In addition, there are a number of factors outside the
model including demand and prices for Australian exports, exchange
rates, global economic and political situation, major industrial partners,
global climate change negotiations and other factors. Finally, we did
not estimate how efficient carbon tax is likely to be in achieving its goal
of reducing GHG emissions.
It should also be noted that introduction of a carbon price as the only
measure to combat climate change and reduce Australian GHG emis-
sions is not likely to bring long-term substantial economic and envi-
ronmental benefits. As stated earlier, the advantage of the carbon tax
is price certainty, but it is uncertain a priori whether the tax will bring
a reduction in total emissions. Therefore, the Australian government
should consider a more complex climate change response policy, com-
prising a carbon tax as well as measures to improve energy efficiency,
the development and use of carbon neutral technologies and adaptation
to climate change. Following plans to introduce an ETS in the future, the
government should carefully address such design issues as ETS coverage,
initial permit allocations and improved assistance packages to affected
industries and individuals. In any case, comprehensive economic mod-
elling of all policies to reduce Australia’s GHG emissions is necessary.
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Arrangements for the NSW Greenhouse Gas Reduction Scheme – Consultation
paper’, available online at http://www.trade.nsw.gov.au/energy/sustainable/
greenhouse-gas/reduction-scheme/sustain_greenhouse_gas_consultation_
paper_nsw_ggas_reduction_scheme.pdf (accessed 12 October 2010).
Nichol, M. and Moore, T. (2007), ‘Regional Resources: Mining – Economic
Impacts for the Latrobe Valley Coalfields (VIC)’, La Trobe University and the
Minerals Council of Australia, available at <http://www.minerals.org.au/__
data/assets/pdf_file/0016/12328/Economic_Impacts_for_the_Latrobe_Valley_
Coalfields_-_Final.pdf> (accessed 10 October 2010).
Pizer, W.A. (2002), ‘Combining Price and Quantity Controls to Mitigate Global
Climate Change’, Journal of Public Economics, 85(3), 409–434.
Rivers, N. and Jaccard, M. (2006), ‘Useful Models for Simulating Policies to
Induce Technological Change,’ Energy Policy, 34(15), 2038–2047.
Schumacher, K. and Sands, R.D. (2007), ‘Where Are the Industrial Technologies
in Energy-Economy Models? An Innovative CGE Approach for Steel Production
in Germany’, Energy Economics, 29(4), 799–825.
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www.theage.com.au/articles/2006/07/31/1154198043099.html> (accessed 13
October 2010).
Weyant, J.P. (1999), Energy and Environmental Policy Modeling, Kluwer Academic
Press, Boston, USA.
Part IV
Disclosure Perspectives
8
Permissive and Uninformative
Reporting of Clean-Up Costs
R. G. Walker
8.1 Introduction
An issues paper produced by the International Accounting Standards

Committee (IASC) observed that prior to the early 1970s, ‘future
removal and restoration costs were typically ignored in the extractive
industries’ (IASC 2000, paragraph 8.18).
Changes in practice may have been prompted by initiatives of the
Australian accounting profession. In 1976 the then Australian Society
of Accountants (now CPA Australia) and the Institute of Chartered
Accountants in Australia issued a pioneering accounting standard, DS 12
(1976) ‘Accounting for the Extractive Industries’. The standard noted that
‘it is frequently a condition of a permit to engage in extractive operations,
that the area covered by the permit be restored after cessation of opera-
tions’ and that it ‘may be policy of the entity involved in the operations
to carry out such restoration even if there is no legal obligation to do so’
(paragraph 39). DS 12 (1976) then established the following requirements
for the establishment of provisions in relation to restoration obligations:
Where there is an obligation or intention to restore an area of inter-

est, and the costs of restoration are expected to be material, provision
should be made for such costs as follows:
(a) The cost of restoration work necessitated by exploration, evalu-
ation or development activities prior to commencement of pro-
duction should be provided for at the time of such activities and
form part of the cost of the respective phase of operations.
(b) The cost of restoration work necessitated by any activities after
the commencement of production should be provided for dur-
ing production and be treated as a cost of production.
143
144 R. G. Walker
(c) In determining the amount to be provided in any one period,

the balance of the provision for restoration costs (after charg-
ing against it actual costs incurred to date) should be reassessed
in the light of expected further costs (paragraph 40).
Note that these rules required the establishment of provisions for site
restoration, but did not specify how the dollar amount of those pro-
visions should be calculated. They also contemplated the inclusion of
future expenditure on mine closure and site clean-up as part of the ‘his-
toric’ cost of the development phase of a mining operation.
It might be recalled that in the 1970s, liabilities (including provi-
sions) were customarily valued at their face amount. It would be some
time before there were any Australian Accounting Standards prescrib-
ing the use of present values – arguably the first to appear was AAS
17 ‘Accounting for Leases’ in 1984. Indeed, even for long-term mon-
etary liabilities, local accounting standards did not prescribe the use of
present values for several years after that. The impetus for change was
the Accounting Guidance Release AAG 10, ‘Measurement of Monetary
Assets and Liabilities’ (April 1988), a publication that surprised many
readers when it asserted that it was ‘generally accepted’ that non-cur-
rent monetary items should be measured at ‘present values’. Prior to
1988, few (if any) companies had measured monetary items at present
values.
It may also be recalled that at this time, the accounting profession
had yet to issue a ‘conceptual framework’ articulating definitions of
key concepts such as ‘asset’ or ‘liability’. The profession’s Statement of
Accounting Concepts’ ‘Definition and Recognition of the Elements of
Financial Statements’ (SAC 4) did not appear until 1992.
DS 12 was newly numbered AAS 7 ‘Accounting for the Extractive
Industries’ (1977), a relabelled series of profession-sponsored account-
ing standards. In 1989 similar standards became regulations in terms
of the Corporations Law with the release by the Australian Accounting
Standards Board (AASB) 1022 ‘Accounting for the Extractive Industries’,
albeit with some modifications. Whereas DS 12 and AAS 7 had required
the establishment of provisions when there was an obligation or intention
to restore ‘an area of interest’, AASB 1022 changed this to ‘where there is
an expectation that an area of interest will be restored’ (emphasis added).
One can speculate that the change, while subtle, could be interpreted
as relieving miners from establishing provisions if state governments
did not enforce licensing conditions for site restoration. Certainly there
were suggestions that, in some cases, state governments were more
Reporting of Clean-Up Costs 145
concerned in promoting economic development than in requiring

operators to spend money tidying up old mine sites. In any case, the
mining licences were said to be fairly vague about the standard of ‘res-
toration’ required. In truth, the promise of ‘restoration’ to the original
condition of a mine site was impractical, as ground disturbance often
made it impossible to bring a site back to a pristine state of biological
diversity. ‘Remediation’ may be a better descriptor.
Conventional ideas about the valuation of assets at ‘historical cost’ were
taken to mean the sums expended in acquiring an asset and bringing it
to a condition ready for use. For manufacturing businesses, that meant
that an item of (say) property, plant and equipment would initially be
recorded at its purchase price, plus the costs of delivery and installation.
For a mining firm, the costs of successful exploration and evaluation
activities, together with costs incurred in bringing a site to a condition
where mining activities could commence, could thus be capitalised.1 But
DS 12 went further, and allowed capitalisation to include not only costs
actually incurred but also expected costs, that is, estimates of the costs of
removing equipment and cleaning up a site on mine closure.
Arguably this accounting treatment of asset valuation – the addition
of historic and expected future costs – was unique to the mining indus-
try. That is not to say that ‘expected costs’ were entirely ignored in
standards for other industries. For plant and equipment, for example,
the depreciation base was historical cost less the expected proceeds of
salvage or scrap. But it appears that no other industry took into account
expected future costs as part of the cost base of a non-current asset.
This unusual accounting treatment for regarding a mining project as
an ‘asset’ was coupled with what (with the benefit of hindsight) appears
to be a rather unusual interpretation of the quantification of a ‘liabil-
ity’. Hindsight comes from knowledge of later-published definitions of
the concept of ‘liability’ for accounting purposes. To quote from the
(now withdrawn) SAC 4, ‘Definition and Recognition of the Elements of
Financial Statements’ (1992), liabilities are ‘future sacrifices of economic
benefits’ that an entity is ‘presently obliged to make’ as a result of past
transactions or other past events. In these terms, if a miner strips away
topsoil and rock in order to access a coal seam in an open-cut mine, the
stripping activities would have created a form of obligation to engage in
some level of site remediation – and usually this would have been estab-
lished as a condition of the mining licence. Moreover, given accounting
practices in the 1970s and 1980s, which did not contemplate the use
of present value calculations, that liability would be the gross amount
potentially incurred in site restoration.
146 R. G. Walker
In other words, miners’ balance sheets theoretically should have shown

the liability at its full amount from the time when, for example, strip-
ping of the overburden in an open-cut mine had been undertaken.
In practice, many (if not most) miners avoided showing a liability for
site restoration on their early balance sheets after the start of production
by establishing ‘provisions’ which increased over the expected period
of mine production. To take a simple example: if restoration costs were
expected to total $1 million at the expiration of its economic life of 10
years, a provision account would be built up by a series of entries of
$100,000 per annum, coupled with an annual expense of $100,000.
While listed mining companies were subject to some detailed report-
ing rules by the stock exchanges, notably for interim reporting, some
changes in Australian statutory disclosure requirements imposed addi-
tional reporting obligations – obligations that were largely ignored, for
a time.
The first of these was a requirement in a 1985 revised Schedule 7
to the Companies Act and Codes for financial reports to include a
Statement of Accounting Policies as Note 1 to the accounts. (Later this
requirement was incorporated in an ‘approved accounting standard’
ASRB 1001 ‘Accounting Policies – Disclosure’ issued by the Accounting
Standards Review Board in 1985.) A second requirement in Schedule 7
was for the disclosure of financial commitments that were ‘not included’
in balance sheets (excluding commitments for the supply of invento-
ries), together with information about when those commitments fell
due (paragraph 22). This disclosure rule was introduced at a time when
the profession had yet to issue statements specifying the definition of
‘liability’. The intention was to ensure disclosure of information about
present financial commitments regardless of whether preparers consid-
ered that they did not meet the definition of liability (for a review of the
history of this requirement, see Walker, 2008).
During the 1990s, many miners conspicuously failed to comply
with the requirements of Australian corporation laws and account-
ing standards for disclosure of accounting policies in relation to the
establishment of provisions. Leading miners simply reported that they
had established a ‘provision’ for site restoration – without explaining
whether that provision reflected the overall cost meeting licence condi-
tions, or the present value of that expected future cost, or represented
a creeping ‘accrual’ intended to accumulate to the expected future cost
over the economic life of a mine. Nor was it clear whether the provi-
sions covered all mine projects undertaken by those companies. That
was a clear failure to explain accounting policies. Further, despite the
‘belt and braces’ approach in the legislation, they failed to disclose the
dollar value of commitments for mine restoration.
External complaints prompted the ASC to issue a media release
headed ‘Mining Companies: Disclosure of Exploration Expenditure
Commitments’ (ASC Information Release 95/16). This explained that in
the course of the ASC’s surveillance programme, it had been noted that
a number of companies had provided notes to the accounts in very gen-
eral terms without quoting actual dollar amounts or providing details
of the timing of commitments. The ASC held the view
that the quantum and timing of exploration expenditure commit-

ments by mining and exploration companies must be provided not-
withstanding the possibility of their renegotiation at some future
date.
The ASC considers this is required for companies to comply with
sub-clause 22(2) of Schedule 5 to the Corporations Regulations. If
appropriate, the possibility of renegotiation of these commitments
should also be disclosed.
The accounting profession’s Urgent Issues Group (UIG) entered the

debate in 1995. While the UIG supposedly provided authoritative inter-
pretations of accounting standards, it provided a weak analysis. UIG
Abstract 4 ‘Disclosure of Accounting Policies for Restoration Obligations
in the Extractive Industries’ required separate disclosure of the amount
of restoration obligations recognised as a liability. It also required dis-
closure of the accounting method adopted in determining the liability
for restoration. But it did not prescribe or recommend any specific valu-
ation method, let alone refer to the treatments that would be consist-
ent with the recently issued Statement of Accounting Concepts SAC 4
(1992) – that is, recognition of a ‘liability’ – even though until 1993,
compliance with SAC was supposedly mandatory for members of the
profession.2 While the UIG proposed disclosure of whether restora-
tion costs had been discounted to present values or not, and whether
costs were based on current or anticipated technology, it was also not-
ing – and effectively endorsing – a wide range of possible accounting
treatments.
Subsequent changes in accounting standards (and regulatory enforce-
ment) might be supposed to have strengthened requirements for the
recognition of a ‘liability’ for clean-up costs. AASB 1034 ‘Financial
report presentation and disclosures’ (1996) dealt with ‘commitments’
not recognised as liabilities, but limited disclosures to expenditure
148 R. G. Walker
commitments contracted for as at the reporting date (other than com-

mitments for the supply of inventories) which had not been recognised
as liabilities. In 2004 AASB 137, ‘Provisions, contingent liabilities and
contingent assets’ reversed the previous narrowing of requirements to
establish provisions only for contractual obligations, by extending its
application to encompass ‘constructive obligations’.
But changes in standards have simultaneously enabled avoidance of
immediate recognition of the amount of provisions for site restoration
as an immediate expense, and permitted the capitalisation of future
expected outlays site restoration as part of the development cost of
a mine. The 1999 revised version of AASB 1034 required disclosure
of ‘the accounting policy for restoration costs relating to non-current
assets’ – thus effectively endorsing the accounting option of treating
provisions for restoration costs as giving rise to a corresponding asset
item.
Subsequently, UIG Abstract 4 was superseded by AASB 137 ‘Provisions,
Contingent Liabilities and Contingent Assets’ (2004), which addressed
measurement issues. It stated that ‘where the effect of the time value of
money is material, the amount of a provision shall be the present value
of the expenditures expected to be required to settle the obligation’
(paragraph 45).
It appears that the stance taken by the Australian Securities
Commission in 1995 prompted miners to look more closely at the man-
ner in which provisions for site restoration were established. Rather than
incrementally increasing a provision over the life of a mine (and show-
ing a corresponding expense representing the increase in the accrued
liability) the industry started recognising the full amount of the pro-
jected rehabilitation expenditure, but discounted to present values. At
the same time, companies may have looked more closely at the option
of capitalising and then amortising expected restoration costs. In hind-
sight, that practice can be seen to have always been contemplated by DS
12 (1976) and reiterated in AAS 7 (1977) and AASB 1022 (1989) in the
following passage (emphasis added):
The cost of restoration work necessitated by exploration, evaluation

or development activities prior to commencement of production
should be provided for at the time of such activities and form part of
the cost of the respective phase(s) of operations
Plainly the language used in these standards was less than explicit, per-
haps deliberately so.
8.2 IASC review of reporting options
In 2000 the IASC produced an ‘issues paper’ on financial reporting by

the extractive industries, but this did not lead to an industry-specific
standard. Rather, relevant standards were primarily contained in IAS
16 ‘Property, Plant and Equipment’ and IAS 37 ‘Provisions, Contingent
Liabilities and Contingent Assets’ (which in Australia were duly trans-
lated into AASB series standards). Subsequently in 2010 the IASC issued
a further ‘issues paper’ dealing specifically with ‘stripping costs’ in sur-
face mines.
The 2000 issues paper had surprisingly little to say about the account-
ing treatment of provisions for site restoration – only a few lines distrib-
uted throughout a paper of more than 400 pages. Even less attention
was given to the possible corresponding capitalisation of the amount of
those provisions.
Indeed, one might be forgiven in thinking that this was either an
oversight or a deliberate attempt to avoid drawing attention to a report-
ing option that was not available to other industries.
The issues paper noted that IAS 37 ‘neither prohibits nor requires
capitalisation of the debit arising when a provision is recognised’
(paragraph 8.3) yet provided an example of a provision being estab-
lished once an oil rig had been constructed. ‘The debit arising from
the provision becomes part of the depreciable cost of the oil rig’ (idem).
The paper repeated these observations and provided an attempted
justification:
The removal and restoration costs must be incurred for the enter-
prise to obtain any future economic benefits from the rig itself, that
is, they are necessary to prepare (sic) the asset for its intended use
(paragraph 8.14).
Mark the curious use of the word ‘prepare’. The fact that an oil rig, upon
installation, was sufficiently ‘prepared’ to commence production was
disregarded. So too was any discussion of the conventional concept of
historic cost as encompassing those costs incurred to bring an item of
equipment ‘ready for use’. The only support presented for the contention
that removal and restoration costs were part of the (historic) cost of an
asset was the invocation of the authority of a statement issued by a UK
committee representing the industry. Yet Statement of Recommended
Practice (Oil Industry Accounting Committee, 2001) had made a some-
what different assertion:
150 R. G. Walker
The future cost of decommissioning an installation ... should be

regarded as part of the total investment to gain access to future eco-
nomic benefit. Thus a ‘decommissioning asset’ should be established
and should be included as part of the overall cost pool or field cost
centre (paragraph 64, emphasis added).
But perhaps a clearer explanation of the reasons for the IASC to accept
and propose adoption of this stance was given in the course of a review
of the main options for treating an offsetting charge when a provision
for restoration costs was recorded. The identified options were:
(a) capitalise and subsequently depreciate the costs;

(b) record the debit amount as a deferred expense to be charged against
income as related reserves are produced;
(c) charge to expense the entire amount at the time the provision is
made;
(d) record the entire amount of the debit as a separate asset and to
charge the entire amount of the asset, including subsequent adjust-
ments to the provision, to expenses when the removal and restora-
tion occurs, with no depreciation taken during the production of
the related reserves (see IASC 2000, paragraph 8.15).
In reviewing these options, the IASC paper invoked the notion of

expected economic benefits (a key element of the definition of ‘asset’
in the IASC’s Framework document) in order to dismiss item (d) on the
ground that ‘the need for the removal and restoration does not create
any additional future benefits’. But it did not offer the same comment
about item (a), to which the same argument could have equally been
applied. Item (b) was described as a procedure recommended ‘by some
who maintain that the estimated future provision is not a part of the
asset’s cost in the way that equipment costs or the costs to construct a
facility are part of the asset’s depreciable base’ (paragraph 8, 15). The
IASC paper neglected to mention that those who held this view were
probably those who recalled past authoritative definitions of the con-
cept of historical cost and its application to asset valuation.
Item (c) – charging to expense the entire amount at the time the provi-
sion is made –was entirely consistent with the IASC’s Framework document,
and other profession-sponsored definitions of key accounting concepts.
There was a liability, in the form of an obligation to sacrifice cash (or other
economic benefits) in the future. When clean-up and decommissioning
work was undertaken after mine closure, it would not generate economic
benefits thereafter. But the IASC avoided any such discussion. Pursuing
the illustration of an oil rig (though the discussion was also relevant to
mine sites and mine equipment), the paper noted that
whether or not the rig is operated commercially, the removal and

restoration must take place and therefore the requirement to remove
the rig and restore the seabed do not provide future economic ben-
efits. (paragraph 8.15)
But it rejected immediately treating these costs as expenses, with the

following explanation:
There appears to be little, if any, support for this approach from

within the extractive industries. (idem)
In other words, the IASC’s interpretations were not based on the

consistent application of a conceptual framework, but by industry
preferences.
The same approach was evident in the 2010 issues paper on stripping
costs. The overall thrust of the draft interpretation was to allow cer-
tain costs incurred after mine production had commenced to be capi-
talised rather than expensed. Thereafter, the capitalised costs incurred
in accessing an ore body would be depreciated or amortised over the
production period for that part of the ore body made accessible by the
stripping activity, using a ‘units of production’ method.
On this occasion, the IASC related its discussion of expensing versus
capitalising the costs of extending an open-cut mine to the definition
of ‘asset’ in the Framework document, that is, ‘a resource controlled by
an entity as a result of past events and from which future economic
benefits are expected to flow to the entity’. It then asserted that strip-
ping activity ‘creates a benefit’ – improved access to the ore to be mined
(paragraph 7).
One could equally argue that many items conventionally recognised
as ‘expenses’ create some kinds of benefit. Sweeping a factory floor,
cleaning windows and removing garbage all creates a benefit in the
form of improved working conditions for employees. But could, say, dust
removal constitute a ‘resource’? The whole discussion involved stretch-
ing conventional interpretations of the definitions in the Framework
document.
While the proposals in the IASC’s 2010 issues paper would allow post-
production expenditures to be capitalised (and then amortised) rather
152 R. G. Walker
than immediately expensed, they would also introduce a range of addi-

tional potential treatments. For example, in the case of strip mining,
where rehabilitation work may be undertaken progressively rather than
at the conclusion of mining activities, preparers would have some discre-
tion in determining whether work undertaken in a given year was asso-
ciated with pre-production exploration (in which case outlays would be
charged against a previously established provision), subsequent efforts
to expand the scale of a mine (indicating further capitalisation), or
whether the work was associated with current year’s production (and
hence, it would be expensed).
Industry practice involved a curious and arguably inappropriate
accounting treatment – that of treating the future costs of site reha-
bilitation after mine development as an ‘asset’. The proposals in the
IASC’s stripping costs paper extended the application of that treatment
to disturbance created in the course of subsequent operating activities,
where in the judgement of preparers, such disturbance was intended to
expand the scale of mining operations.
Such treatments are not available to other industries. For example,
chemical manufacturers must treat provisions for remediating envi-
ronmental damage as giving rise to an expense. Yet the IASC’s own
Framework document stresses the need for financial statements to be
comparable between different enterprises:
The measurement and display of the financial effect of like trans-

actions and other events must be carried out in a consistent way
throughout an enterprise and over time for that enterprise and in a
consistent way for different enterprises. (as cited IASC, 2010, para-
graph 1.12)
Overall, the IASC’s approach would superficially legitimise an account-

ing treatment enabling operators to manage earnings by selective appli-
cation of a number of reporting options, thereby enhancing reported
profitability.
There are certainly other areas/elements of contemporary practice
that warrant debate. One source of concern is the use of discounting to
calculate the present value of provisions for site restoration (and corre-
spondingly the amount capitalised). Over time, the use of discounting
means that the reported value of the liability is increased. Industry prac-
tice is to treat this as giving rise to a corresponding ‘finance expense’ –
rather than an increase in the capitalised value of planned remediation
work (or as ‘remediation expense’). Tax considerations influence prac-

tices in this area.
A related issue concerns the choice of discount rates, and this lends itself
to diversity in reported results. It was noted that the 2010 annual reports
of Australian-listed mining companies disclosed the discount rate being
used – though there were exceptions (e.g., Iluka Resources reported use of a
pre-tax nominal discount rate of 6 per cent). Other miners explained that
they used current market assessments and the risks specific to the liabil-
ity (Newcrest), a rate appropriate for the asset location (Alumina) or rates
specific to the country in which the operation is located (BHP Billiton).
While current accounting standards do not prescribe a rate, arguably a
risk-free rate is appropriate for the valuation of liabilities (see Jones and
Walker, 2003). The use of a higher rate – because of the risks associated
with increases in costs of performing remediation work – would have the
absurd effect of reducing the value of the reported provision.
8.3 Disclosures – restoration costs per site
Neither Australian accounting standards nor international standards

have required any details to be reported about the sites involved or the
standard of site restoration to be undertaken.
In practice, disclosures regarding provisions for clean-up costs have
generally provided statements about the establishment of provisions
based on expected future outlays, but have used vague language when
describing how provisions were calculated in respect of sites in differ-
ent countries. For example, some miners indicate they will meet ‘any
obligations’ for site restoration, possible because certain countries may
not impose a legal obligation on miners to remediate sites. Companies
known to be operating in different countries appear to have crafted
notes that avoid acknowledging that different standards of rehabilita-
tion may have been assumed.
The notes recently reported in some annual reports are too lengthy to
reproduce in their entirety. But the following extracts may indicate the
flavour of these disclosures:
The mining, extraction and processing activities of the Group nor-

mally give rise to obligations for site closure and rehabilitation ... The
extent of work required and the associated costs are dependent on
the requirements of relevant authorities and the Group’s environ-
mental policies. (BHP Billiton, 2010 annual report)
154 R. G. Walker
The timing of recognition and quantification of the liability

required the application of judgment to existing facts and circum-
stances, which can be subject to change. (Rio Tinto, 2010 Annual
Report)
On the other hand, what does not get reported may be more signifi-
cant. The activities of Lihir Gold were the subject of claims about the
deleterious effects of its practice of dumping mine waste materials into
the ocean. Yet its statement of accounting policies referred to ‘restora-
tion and rehabilitation to be undertaken after mine closure’ as includ-
ing ‘the removal of residual material and the remediation of disturbed
areas’ (2009, p. 62) – without reference to its policy of ‘Deep Sea Tailings
Disposal’.3
It seems noteworthy that many miners claim to be concerned about
the environment and to recognise their social responsibilities. Yet the
annual reports of multinational miners typically fail to identify what
provisions have been established for site restoration in different coun-
tries. There are of course some exceptions:
In the United States, Iluka closed its Florida/Georgia operations and

commenced rehabilitation activities in 2006. Reclamation in Georgia
was completed in 2010 and the company fulfilled its environmen-
tal obligations with regulators. Reclamation and remediation of the
Florida mien and processing sites is continuing with approximately
100 hectares rehabilitated during the year. (Iluka Resources, 2010
annual report)
MacArthur Coal referred to ‘completion and evaluation of 50 hectares

of rehabilitation at Coppabella and Moorevale mines’ and reported
coming-year targets for areas of rehabilitation.
Yet even this report failed to indicate the scale (and potential cost) of
the task remaining, and the standard of rehabilitation that was being
targeted.
It may be contended that disclosure of rehabilitation standards and
practices on a site-by-site, or country-by-country basis, would be unduly
expensive and burdensome. However, many miners provide detailed
information about known and probable reserves at different sites. So it
would not be unduly demanding for accounting standards to require
comparable explanations and disaggregation of data regarding recog-
nised provisions for clean-up costs.
8.4 Final comments
Investors and other stakeholders in mining companies understand that

money is spent initially on the development of a mine in the expecta-
tion of financial returns at a later date. Accounting treatments devel-
oped by (and for) the industry – involving as they do, the capitalisation
of mine development expenditure – largely obscures that fact. While
staff of the USA’s Securities and Exchange Commission have taken the
position that capitalisation of exploration costs ‘should be expensed as
incurred during the exploration stage under US GAAP’ (IASC, 2000,
p. 383), other jurisdictions permitting capitalisation and expensing
remain unpopular within the mining industry.
The little-debated practice of capitalising projected future expendi-
ture on mine site rehabilitation – before any money has been spent or
work has been undertaken – only contributes further to the use of prac-
tices that are hard to associate with economic realities.
While the IASC is considering the development of an international
standard for the industry, there is no shortage of expressions of self-
interest. Consider the following curious comment by a former secretary
of the Australian Accounting Standards Board (who was the commis-
sioned author of a submission by major Australian companies to the
AASB when it was considering a response to the IASC 2000 paper):
There is no point in the development of a so-called international

standard that only a few countries, such as Australia, adopt. That
could potentially do more harm than good to Australian miners,
as requiring Australian miners to comply with more stringent rules
while overseas competitors are allowed to continue to use current
rules could place Australian miners at a competitive disadvantage.
(Micallef, 2001)
But one would expect that miners would be competing on the price
of extracted materials, not on how their financial statements reported
profits.
On the other hand, if balance sheets failed to show all of a mining
company’s financial commitments, there is a risk that miners might
exploit natural resources, abandon mine sites, and leave taxpayers with
the bill for clean-up costs. If Australian miners were operating in foreign
countries, then it might be considered in their interests not to high-
light a failure to provide for site restoration since that would be leaving
156 R. G. Walker
clean-up costs to foreign governments. These are, of course, specula-

tions – but they are somewhat supported by a brief scan of the disclo-
sures in the annual reports of companies engaged in mining activities
in a range of jurisdictions.
Alternatively, the IASC’s views may have had regard to the possibil-
ity that accounting standards could influence tax treatments in differ-
ent countries – and the expectation that miners would readily accept
accounting treatments that enabled them to ‘expense’ future restoration
costs while a mine was generating positive cash flows. Within Australia,
a prior survey of the minding industry revealed concerns that local tax
legislation at that time did not allow deductions for restoration expenses
until mine closure, when a mining venture company would no longer
be earning assessable income (Gowland, 1995). There is a risk that a
country’s tax policies may influence the timing and extent of rehabili-
tation work and hence drive suboptimal environmental outcomes.
Notes
1. Some argue that expenditure on mining exploration is not in itself an ‘asset’.
Indeed, in the 1930s the U Securities and Exchange Commission took strong
action against mining companies that wrote up the value of mine sites and
associated infrastructure (see Walker, 1992); as noted below, SEC staff report-
edly continue to hold the view that expenditure on mine exploration is not
in itself an ‘asset’.
2. From 1990, compliance with Statements of Accounting Concepts in general
purpose financial reports was said to be mandatory, in terms of ethical rules
of the accounting profession, as contained in Miscellaneous Professional
Statement APS 1 ‘Conformity with Statements of Accounting Concepts and
Accounting Standards’ (1990) issued jointly by the Australian Society of
Certified Practising Accountants and the Institute of Chartered Accountants
in Australia. This stance was somewhat relaxed in 1992, when a revised ver-
sion of APS 1 stated that ‘application of the concepts set out in Statements
of Accounting Concepts is mandatory except where there is incompatibility
between an Accounting Standard and a Statement of Accounting Concepts,
in which case the Accounting Standard prevails’ and ‘application of the
standards set out in Accounting Standards is mandatory’. The professional
bodies’ stance towards compliance with Statements of Accounting Concepts
was further relaxed in 1993 when a revised version of APS 1 described
Statements of Accounting Concepts as being a ‘source of guidance’ (rather
than mandatory).
3. The former chairman of Lihir Gold Limited responded to a television report
on these practices by explaining inter alia that information about the impact
of these practices on the marine environment was made available to the pub-
lic by the company, the Papua New Guinea Government and independent
agencies. ‘The risk assessment and engineering studies showed that marine
disposal was the best option available for the project on grounds of environ-
mental impact and risk.’
References
Australian Accounting Research Foundation (April 1998), Accounting Guidance
Release AAG 1: Measurement of Monetary Assets and Liabilities.
Australian Accounting Research Foundation (1995), Urgent Issues Group, UIG
Abstract 4: Disclosure of Accounting Policies for Restoration Obligations in the
Extractive Industries.
Australian Accounting Standards Board (1985), ASRB 1001: Accounting Policies –
Disclosure.
Australian Accounting Standards Board (1989), AASB 1022: Accounting for the
Extractive Industries.
(Australian Accounting Standards Board (2004), AASB 137: Provisions, Contingent
Liabilities and Contingent Assets.
Australian Society of Accountants and The Institute of Chartered Accountants
in Australia (1976), DS 12: Accounting for the Extractive Industries.
in Australia (1977), AAS 7: Accounting for the Extractive Industries.
in Australia (1992), Statement of Accounting Concepts SAC 4: Definition and
Recognition of the Elements of Financial Statements.
Australian Securities Commission, ASC Information Release 95/16 (9 June 1995),
‘Mining Companies: Disclosure of Exploration Expenditure Commitments’.
Gowland, D. (1995), ‘The Mining Industry in Australia and the Environment’,
QUT Accounting Research Journal, 7(1), 37–42.
International Accounting Standards Committee (2000), Extractive Industries – An
Issues Paper.
International Accounting Standards Committee (2010), Draft Interpretation
DI/2010/1: Stripping Costs in the Production Phase of a Surface Mine’.
Jones, S. and Walker, R.G. (2003), ‘Measurement: A Way Forward’, Abacus, 39(3),
356–374.
Micaleff, F. (2001), ‘A Black Hole – Financial Reporting for Extractive Industries
is a Minefield’, Australian CPA, 71(11), 72–73.
Oil Industry Accounting Committee (January 2000, revised June 2001), Statement
of Recommended Practice (SORP) on Accounting for Oil and Gas Exploration,
Development, Production and Decommissioning Activities.
Walker, R.G. (1992), ‘The SEC’s Ban of Upward Asset Revaluations and the
Disclosure of Current Values’, Abacus, 28(1), 3–35.
Walker, R.G. (2008), ‘Disclosure of Financial Commitments’, Australian
Accounting Review, 18(2), 161–172.
9
Capital Management Determinants
of Financial Instrument Disclosures
in the Extractive Industries:
Evidence from Australian Firms
Grantley Taylor and Greg Tower
9.1 Introduction
The extractive mining, oil and gas industries are of major global eco-
nomic importance. Given the capital-intensive nature of the extractive
industry, resource firms commonly seek access to domestic and interna-
tional financial markets to fund the acquisition of assets or entities or
to provide working capital for current operations and new project devel-
opments. In such a situation, it is expected that capital management
considerations will have a bearing on the financial disclosure policy
decisions of extractive resource firms through the potential impact on
a company’s cash flow, payment of dividends, capacity to service debt
and meet financial covenant constraints, maintenance or improvement
of credit ratings, exposure to risk and to retain flexibility to pursue
attractive investment opportunities including acquisitions. Resource
firms may utilise specific financial instruments to achieve a target capi-
tal structure and cost of capital and thus to optimise financial returns
to stakeholders (Botosan, 1991).
The use of and complexity of financial instruments has increased
markedly over the past decade in line with financing arrangements
to ameliorate a firm’s business risks (Nguyen and Faff, 2002; Nguyen
and Faff, 2003; Benson and Oliver 2004). For example, average daily
turnover in Australian over-the-counter derivatives activity increased
from US$3.8 billion in April 1995 to US$17.6 billion in April 2004.1
Australian extractive resource (mining, and oil and gas) firms routinely
engage in activities that involve complex, often poorly understood
158
Grantley Taylor and Greg Tower 159
financial instruments. These resource companies and their financial

institutions develop a wide variety of innovative instruments for use by
companies seeking to mitigate risks (Berkman, Bradbury, Hancock and
Innes, 2002; Chalmers and Godfrey, 2004).
The nature and use of financial instruments is expected to have
a profound impact on the financial reporting of companies in the
mining and petroleum sub-industries (Ernst and Young, 2005). For
instance, particular financial instruments such as derivatives have
the potential to introduce significant volatility to earnings, impact
on reported profits, debt covenants, balance sheet ratios, net assets,
dividend policy and hedge accounting with consequent income tax
impacts (Honey, 2004). How the impact is communicated and under-
stood by individual investors, fund managers, financial intermediar-
ies, auditors and regulatory bodies is thought to have a bearing on the
company’s ability to undertake capital management initiatives such
as capital raisings (Leyden, Mason and Croft, 2004; Ernst and Young,
2005).
Currently, substantial resources are devoted to the disclosure of infor-
mation within annual reports and other media without any clear indi-
cation of matching benefits passing to either the users or producers of
these annual reports (Stocken and Verrecchia, 2004). Financial instru-
ment disclosures (FIDs) are important to companies, stakeholders and
information intermediaries (Hancock, 1994; Benson and Oliver, 2004).
Research can advance an understanding of the link between the extent
and quality of disclosures and the risks, cost of capital and the ability
to raise finance.
This chapter assesses FIDs within the annual reports of Australian-
listed extractive mining and petroleum resource firms and in doing
so addresses the research question: What are the capital management
determinants of reported FID? The concept of capital management is
composed of these key elements: (a) capital raising; (b) takeovers and
mergers; and (c) existence of international operations. Additionally, this
chapter assesses whether overseas listing (OVLIST) status is an impor-
tant determinant of disclosures.
This chapter is structured as follows: Section 9.2 outlines the research
questions and significance of the study. Section 9.3 covers the theo-
retical position of the chapter and hypothesis development and Section
9.4 discusses the research approach, construction of the dependent and
independent variables and choice of control variables. Section 9.5 high-
lights the key results of the empirical analysis while Section 9.6 offers
concluding remarks for the chapter.
160 Capital Management Determinants
9.2 Significance of the study
Chalmers and Godfrey (2000) investigated the diversity in hedge

accounting policy choices and hedge accounting disclosure, recogni-
tion and measurement practices of Australian firms. They found that
firms were significantly lacking in disclosures of their hedge accounting
policies and net fair value methodology including important assump-
tions relating to determination of net fair value of derivative financial
instruments under Australian Accounting Standards Board (AASB) 1033
Presentation and Disclosure of Financial Instruments (AASB, 1999). Many
of the disclosures relating to derivative instrument information were
vague and clearly failed in terms of contributing to the overall under-
standability, comparability and consistency of the body of information
within the annual report. Chalmers and Godfrey (2000) concluded that
the disclosure requirements in respect to hedge accounting under AASB
1033 were too general and that more specific disclosure requirements
were required.
Chalmers (2001) found that Australian listed firms’ disclosures of
derivative instrument activity increased during the period 1992 to 1998.
In 1995, coinciding with the issue of professional body recommenda-
tions and accounting Exposure Draft 65: Presentation and Disclosure of
Financial Instruments (ED65), the number of firms making voluntary
disclosures within annual reports increased significantly. On balance,
she found that disclosure of derivative information lacked completeness
relative to disclosures recommended in ED65.
Using a sample of 199 firms that were listed on the Australian Securities
Exchange (ASX) as a top 500 company over the study period, Chalmers
and Godfrey (2004) found that the change in the value of the volun-
tary reporting disclosure index for derivative financial instruments was
statistically significant for the 1993–94, 1994–1995 and 1995–96 report-
ing periods. The presence of professional scrutiny, proxied by affilia-
tion to The Group of 100 (G100) and Australian Society of Corporate
Treasurers (ASCT), was associated with increased voluntary derivative
FIDs within annual reports consistent with theory. Larger firms and oil
and gas firms exhibited higher voluntary disclosures. Firm leverage, as
measured by total liabilities divided by total assets, was significantly
positively associated with firm disclosures only in 1996. Overall, their
results demonstrate that in a regulated environment, firms voluntarily
disclosed more derivative instrument information as greater pressure
was exerted for firms to increase transparency of financial reporting
and to comply with professional norms and institutional pressures.
Lopes and Rodrigues (2006) found that disclosures of financial

instrument information by 55 Portuguese companies were poor and is
indicative of a high degree of non-compliance with IAS 32 disclosure
requirements. In a majority of cases, even if financial instrument infor-
mation was disclosed, it was too general in nature and not particularly
useful or comparable to users of those companies’ annual reports.
The research findings of Chalmers and Godfrey (2000) in respect
to derivative financial instrument disclosures mandated under AASB
1033 in Australia demonstrated a high degree of non-compliance with
this standard. Even if derivative instrument information was disclosed
pursuant with AASB 1033 requirements, it tended to be too brief,
vague or general in nature to represent useful, reliable and compara-
ble information to the various users of annual financial reports and
would unlikely assist them in making informed economic decisions.
Chalmers and Godfrey (2004) demonstrated that firms voluntarily dis-
closed more derivative instrument information as greater pressure was
exerted through compliance with professional norms and by institu-
tions. Further, Chalmers and Godfrey (2004) noted that the dramatic
increase in the use of derivatives had caused growing concern to corpo-
rate regulators and accounting standard setters globally. Chalmers and
Godfrey (2004) attributed much of this concern to highly publicised
losses that corporations have suffered as a result of positions taken in
derivative financial instruments. For instance, there have been several
prominent Australian cases where mining companies have gone into
administration and/or liquidation as a direct consequence of misman-
agement of their hedging activities. In August 2004, Sons of Gwalia Ltd,
an Australian gold mining company, went into administration follow-
ing a downgrade in gold resources and reserves ultimately leading to its
inability to meet hedge-book commitments. Sons of Gwalia Limited’s
hedge book was $350 million ‘out of the money’ on a mark-to-market
basis on 30 June 2004). Also, in June 2006, Croesus Mining NL, an
Australian gold mining company, went into administration following
the inability of the company to reach agreement with a counterparty
to restructure hedging commitments following a downgrade in gold
resources and reserves at the firm’s Norseman operations.
Collapses of the nature of Sons of Gwalia Ltd and Croesus Mining
Ltd often occur very quickly much to the surprise of shareholders. This
raises the question whether firm management have adequately commu-
nicated relevant information to stakeholders, in particular shareholders,
concerning the mechanics of hedging arrangements, associated risks
and consequences. In these cases, potentially important information
relating to hedge restructuring, the engagement of counterparties and

unrealised loss positions may not have been fully disclosed to various
stakeholder groups.
Capital market considerations such as the cost of capital, availabil-
ity and choice of external financing and analyst following are impor-
tant drivers of management’s voluntary disclosure practices (Healy and
Palepu, 2001). Botosan (1997) and Nikolaev and Lent (2005) found firms
can achieve lower costs of capital through voluntarily increasing disclo-
sures of credible information. Similarly, a positive association between
firms seeking to obtain external financing and earnings forecast disclo-
sures were found by Frankel, McNichols and Wilson (1995). They con-
cluded firm management provide forecast disclosures to increase the
flow of information to capital market participants and that manage-
ment consider these disclosures to be value relevant. There are capital
management implications arising from a firm’s financial instrument
management, strategy, policies and procedures. Disclosure of the sig-
nificant financial risks that give rise to unrealised losses of hedging
instruments at fair value forces management to examine this impact on
the achievement of business objectives. Clear communication allows
the board of directors to examine the potential impact of these risks on
the ability to raise further capital or continue as a going concern.
9.3 Hypotheses development to better understand

differences in reporting
The motivation to disclose financial instrument information is

explained by using agency theory arguments which posit that many
determinants of disclosure patterns are driven by economic considera-
tions (Watts and Zimmerman, 1990). Agency theory provides a concep-
tual framework for examining FIDs in the annual reports of Australian
listed resource firms. Jensen and Meckling (1976) postulated that the
separation of firm ownership and control provides management with
incentives to serve their personal interests at the expense of shareholder
interests. An inevitable consequence of the separation of ownership
and control is that management (agents) acquires information about
the performance of the firm that is superior to that acquired by share-
holders (principals). Agents may engage in activities that enhance their
own personal utility or welfare by taking advantage of the fact that
the bulk of their decision-making and use of superior knowledge is not
observable to principals. Agents use their discretion regarding when to
disclose information depending on how this impacts on the wealth of

not only themselves, but all contracting parties to the firm (Watts and
Zimmerman, 1990). Extant literature (Welker, 1995; Douglas, 2003;
Monem, 2003; Liang, 2004; Cheng and Warfield, 2005) cites agency
theory to explain managerial disclosure decision-making in the area of
capital management. Management’s disclosure decisions affect credibil-
ity with investors and other stakeholders (Mercer, 2005).
A firm’s capital management policy is a key factor that can determine
financial risk management disclosure practices. The concept of capital
management has several key elements including the capital raisings,
takeovers and mergers and existence of international operations. Healy
and Palepu (2001) identified six capital market hypotheses why firm
management would voluntarily disclose information.2
Financial institutions often require resource companies to implement
sufficient hedging to cover repayments of project financing with these
conditions being stipulated in debt covenants. Companies that raise
capital are likely to be more motivated to disclose information con-
cerning financial risk management practices. For example, Jenson and
Meckling (1976) propose that more highly leveraged firms incur more
monitoring costs and seek to reduce these costs by disclosing more
information within annual reports.
It is argued that capital raisings induce the company to disclose more
information in relation to financial risk management particularly since
resource firms will regularly seek access to capital markets and may use
or issue financial instruments as a consequence. Provision of account-
ing disclosures and reports are identified as an agency cost (Jensen and
Meckling, 1976) that managers are willing to accept to enable them to
better raise capital. Firms that raise capital are expected to disclose more
extensive financial instrument information. The incentive is that a
decrease in information asymmetry or enhancement of financial trans-
parency will serve to reduce negative perceptions relating to riskiness
and in turn lower the cost of capital as the firm will be more competi-
tive in obtaining financing. Nikolaev and Lent (2005), for example, pro-
vide strong empirical support for the negative causal relation between
the quality of information disclosed by a firm and its cost of capital
after taking into consideration unobservable firm-specific factors such
as costs of disclosure and management reputation that are also corre-
lated with the cost of capital. Clearly, information asymmetry between
the various stakeholders of the firm can be mitigated by disclosure strat-
egies linked to the capital structure and strategies of the firm.
Disclosure practices may vary with takeover or merger activities.

Brennan (1999), for example, examined disclosure of profit forecasts by
target companies during takeover bids for listed UK companies between
1988 and 1992. Disclosures were found to be associated with the type
of bid with greater disclosures made during contested bids. Although
Brennan (1999) examined disclosures made in takeover documents,
similar reasons for disclosures in the annual reports of firms engaged in
takeover or merger activity may apply. Takeovers and mergers amongst
mining or petroleum companies are often achieved through use of spe-
cific financial instruments such as interest rate swaps or equity swaps.3
A consequence of these events is that hedge contracts are restructured,
novated or closed out. Acquisition of financial instrument assets and
liabilities at fair value further necessitates recording gains and losses
in the income statement or in equity. Consequently, it is expected that
FIDs will increase in line with corporate takeover and merger activity.
Companies with operations in foreign jurisdictions will have
additional policies and procedures for complying with legal opera-
tional requirements of the jurisdiction in which the firm operates.
Multinational firms that have operations in Australia and overseas
are exposed to a complex legal, operational, financial and regula-
tory environment that generates a range of risks, additional manage-
rial decision-making and associated monitoring activities (Bushman,
Chen, Engel and Smith, 2004). Malone et al. (1993) examined the
extent of financial information disclosures by oil and gas firms with
purely domestic operations and compared these with material foreign
operations. They suggested that firms with overseas operations are sub-
ject to additional reporting requirements levied by the foreign gov-
ernment of the country in which the firm was operating and/or the
overseas stock exchange on which the firm was trading. Examples of
these additional reporting requirements may include companies with
foreign exchange transactions (i.e., companies with multinational
operations). Companies with extensive hedging programmes, holding
a large number of derivatives or with operations across a number of
jurisdictions are expected to disclose more information concerning
financial instruments in their annual reports in line with an increase
in information required by both the company and its shareholders.
Australian firms with international operations are still likely to have
to address a wider set of investor needs than domestically operating
firms. For example, Watts and Zimmerman (1990) argued that there
are incentives in the international market for capital to meet levels of
disclosure expected by international investors. Provision of accounting

disclosures and reports has been identified as an agency cost (Jensen
and Meckling, 1976) that entrepreneurs are willing to accept to enable
them to raise capital (Healy and Palepu, 2001). Clearly, information
asymmetry between managers and shareholders can be mitigated by
disclosure strategies in the international context. Companies with
multi-jurisdictional operations are expected to disclose more informa-
tion concerning financial instruments.
To formally test the association between the extent of financial
instrument disclosures and capital management exposure and impacts
to the firm, the following hypothesis is constructed:
H1: All else being equal, there is a positive association between capi-
tal management exposure and the extent of financial instrument
disclosures by Australian resource firms.
OVLIST status may also have an important influence on disclosure

practices because of regulatory differences across jurisdictions and asso-
ciated differences in disclosure requirements and shareholder scrutiny.
Ahmed and Courtis (1999), for example, analysed associations between
corporate characteristics and disclosures within annual reports using
disclosure studies between 1968 and 1997. They found that listing sta-
tus was significantly and positively associated with disclosure levels.
Riahi-Belkaoui (2001) hypothesised that disclosure should be positively
associated with multinationality for two reasons. The first reason was
the requirement to raise capital at the lowest possible cost. This places
pressure on firms to voluntarily disclose more information. The second
reason was that firms with multiple listing status are more likely to
be subject to greater scrutiny from a diverse shareholder set, thereby
increasing monitoring costs. Monitoring costs can be reduced through
greater disclosure in annual reports. Lang, Raedy and Wilson (2006)
found that the US cross-listed firms subject to potential US Security and
Exchange Commission enforcement substantially increased annual
report disclosures. To formally test the association between the extent
of FIDs and OVLIST status of the firm, the following hypothesis is
constructed:
H2: All else being equal, there is a positive association between those
firms that are listed in more than one jurisdiction and the extent of
financial instrument disclosures by Australian resource firms.
9.4 Research method
9.4.1 Dependent variable

Hypotheses testing uses data from the annual reports of 111 Australian
listed resource firms that constitute the population of resource firms
engaged in production or extractive activities at any time over a four-
year longitudinal timeframe encompassing the 2002 to 2006 years. Data
with respect to FID disclosures are obtained from the annual reports for
the three financial years prior to the International Financial Reporting
Standards’ (IFRS’) adoption and one-year post-IFRS adoption (i.e., post
1 January 2005).
The extent of FID is measured using the FID Index (FIDI) comprising
120 FID items (57 mandatory and 63 discretionary). For each FIDI item
disclosed by a firm in its annual report a dichotomous score of one [1]
is assigned, otherwise a score of zero [0]. A FIDI score is computed for
all years by summing all information items disclosed divided by the
maximum number of items that could be disclosed. The FIDI score is
mathematically represented as follows:
Total number of items disclosed

FIDI jt = (9.1)
Maximum number of items
where
FIDIjt = financial instrument disclosure index in year t for firm j.
Mandatory FID items include information relating to their use and
significance, risk and risk management activities, derivative and hedge
accounting, significant accounting policies and methods, terms and con-
ditions, fair value accounting and financing arrangements. Collectively
these items were used to calculate the mandatory FIDI (mandFIDI) in the
same manner as for equation 1. Discretionary FID items, derived from
extant accounting literature, include information relating to changes
in accounting standards that deal with financial instruments, financial
ratios, additional hedge accounting information including information
relating to hedge documentation, effectiveness and designation criteria,
hedge restructuring and compliance with financial covenants, financ-
ing arrangements, structured financial instruments and financial risk
management activities, in particular credit risk. Collectively, these
items are used to calculate the discretionary FIDI (discFIDI) in the same
manner as for equation 9.1.
9.4.2 Independent variables

The independent variables for our chapter are denoted by capital man-
agement score (CMS) and overseas listing (OVLIST) of the firm. To create
a proxy measure to capture the strength of a firm’s capital manage-

ment exposure, a value of one is assigned to the following three condi-
tions: (a) the firm undertook capital raising activities during the current
financial year (i.e., undertook new equity, hybrid or debt financing);
(b) the firm was involved in corporate takeovers and mergers during a
financial year and (c) the firm has international operations. All three
items are weighted equally. A firm can receive a CMS score ranging
from 0 to 3 depending on the number of conditions satisfied. The CMS,
measured as a percentage, is treated as a continuous variable in the sta-
tistical analysis. OVLIST is measured as a dichotomous variable in our
study. A score of 1 is given to a firm that is listed on both the ASX and
an overseas stock exchange during the sample year, or 0 otherwise.
9.4.3 Control variables

Aside from the dependent and independent variables, the study also
includes the standard control variables of firm size (SIZE), leverage
(LEV), sub-industry (SUBIND), shareholder concentration (TOP20) and
return on assets (ROA) in the statistical analysis. The size of the firm is
measured as the natural logarithm of total assets to reduce the impact
of skewed data in the statistical analysis. Firm leverage or debt to equity
ratio is measured as the square root of total liabilities divided by total
equity. Sub-industry refers to mining or the oil and gas sub-industries.
Shareholder concentration is measured by the proportion of the ordi-
nary share capital owned by the top 20 shareholders of the firm at
financial year-end.
9.4.4 Pooled regression results

To test the association between the dependent variable (FIDI) and
the independent variables (CMS, OVLIST) and control variables (Size,
Leverage, Sub-Industry, Top20 and ROA), the following base ordinary
least squares (OLS) regression model is estimated.
The pooled regression results for each of total (FIDI), mandatory
(mandFIDI) or discretionary (discFIDI) disclosures are shown as Table
9.1. The multiple regression model supports the predictions of a posi-
tive association between the capital management structure of sample
firms (as measured by the CMS) and all financial risk management dis-
closures. The results are further supported by regressions performed on
panel data (results not shown for brevity) with a statistically significant
and positive association between FIDI and CMS being recorded in years
1 (pre-IFRS) and year 4 (post-IFRS). Hypothesis 1 is supported. Contrary
to expectations, there is a significant and negative association between
firms with overseas stock exchange listing or listings and the extent of
Table 9.1 Pooled multiple regression results
FIDI mandFIDI discFIDI

coefficients t-statistic P-value coefficients t-statistic P-value coefficients t-statistic P-value
Intercept –36.571 –6.916 0.000* –1.017 –0.185 0.853 –68.739 –11.469 0.000
CMS 0.064 3.652 0.000* 0.057 3.166 0.002* 0.069 3.508 0.001*
OVLIST –3.581 –3.518 0.000* –4.332 –4.089 0.000* –2.902 –2.515 0.012**
SIZE 3.730 12.108 0.000* 2.594 8.092 0.000* 4.759 13.627 0.000*
LEV 2.374 10.517 0.000* 2.571 10.944 0.000* 2.196 8.585 0.000*
SUBIND 0.282 0.246 0.806 0.505 0.423 0.673 0.081 0.063 0.950
TOP20 0.024 0.966 0.334 –0.005 –0.191 0.848 0.050 1.783 0.075***
ROA 0.050 2.413 0.016** 0.080 3.696 0.000* 0.023 0.986 0.325
Yr2–Yr1 –12.120 –9.563 0.000* –10.419 –7.901 0.000* –13.658 –9.508 0.000*
Yr3–Yr2 –10.677 –8.647 0.000* –9.029 –7.027 0.000* –12.169 –8.694 0.000*
Yr4–Yr3 –7.823 –6.311 0.000* –6.813 –5.282 0.000* –8.737 –6.218 0.000*
Model summary Adjusted R square 0.684 Adjusted R square 0.592 Adjusted R square 0.688
Observations 427 Observations 427 Observations 427
F-statistic 94.272 F-statistic 63.387 F-statistic 96.157
Significance 0.000* Significance 0.000* Significance 0.000*
FIDs. Hypothesis 2 is not supported by the results. Firm size and lever-
age are control variables consistently positively associated with FIDI.
Shareholder concentration is significantly positively associated with
discFIDI only. ROA is a positive and significant predictor variable of
total FIDs and mandatory disclosures over the study period. In respect
of mandatory and voluntary FIDs, the same variables are generally sig-
nificant. The predictive adjusted r-squared range is 68.4 per cent for
total disclosure, 59.2 per cent for mandatory disclosure and 68.8 per
cent for voluntary disclosure. These are measures concerning how well
the model explains differences in disclosure across various companies.
The regression equation (model 9.1) is stated as:
FIDIjt = αj + β1 CMSjt + β2 OVLISTjt + β3 SIZEjt + β4 LEVjt + β5 TOP20jt +

β 6 SUBINDjt + β7 ROA jt + β 8 Yearjt + εj
where Dependent Variables: FIDIjt = Financial Instrument Disclosure
Index for firm j in year t; Independent Variables: CMSjt = capital man-
agement score for firm j in year t; (maximum 3 variables); OVLISTjt =
firm j listed on an overseas stock exchange as well as on the ASX
(Yes = 1, No = 0); Control Variables: SIZEjt = natural log of total assets
for firm j in year t; LEVjt = square root of debt/debt + equity ratio (total
liabilities/total equity + total liabilities) for firm j in year t; TOP20jt =
top 20 shareholder concentration for firm j in year t; SUBINDjt = firm
j engaged in mining in year t (1 = yes, no = 0); ROA jt = return on assets
for firm j in year t; αj = intercept; β = estimated coefficient for each
item or category; εj = error term. Associations *, ** and *** are statisti-
cally significant at the 1%, 5% and 10% levels, respectively.
9.5 Conclusions
Healy and Palepu (2001) state that contracts between the firm and
its creditors (debt contracts) and contracts between management and
shareholders (compensation contracts) and political and legal issues
such as management’s concern regarding taxation, reputation and regu-
lation drive managements motives for making financial disclosure deci-
sions. Capital management strategies and events are important factors
affecting decisions by managers on financial reporting and disclosure
of financial instrument information.
Using a sample of 111 Australian listed resource firms, a significant
positive association is found between firm capital management struc-
ture and FIDs over the four-year study period. Hypothesis 1 is supported
by these results. Disclosure in relation to financial instruments may
have been undertaken for commercial reasons by increasing certainty

and information flow to capital markets or to reassure investors of expo-
sure to risk, particularly in relation to key capital management activi-
ties and events. One of the key drivers of this association appears to be
merger and acquisition activity. Firms engaged in merger and acquisi-
tion activity may utilise specific financial instruments such as deriva-
tives (e.g., equity swaps or interest rate swaps) as part of the scheme
of consolidation, require additional financing (debt or equity), may
necessitate restructuring of financial instruments which in turn may
expose the firm to new and different levels of financial risks. Firm man-
agement would also be acutely aware that the firm is exposed to addi-
tional capital market scrutiny during the course of this type of activity.
Consequently, takeover and merger activity may account for observed
associations. In contrast, firms with multiple exchange listings are
characterised by less extensive financial risk management disclosures.
Foreign listing is not necessarily an important driver of disclosure
policy as the overall financial instrument use and management pro-
gramme of these resource companies focuses on the unpredictability of
commodity prices, interest rates and foreign exchanges which can be
managed independently of listing status. Hypothesis 2 is not supported
by the results.
Firm size and leverage are additional predictor variables of FIDs. Prior
research (e.g., Ahmed and Courtis, 1999; Watson et al. 2002) has gener-
ally shown that larger companies tend to disclose more information.
Watson et al. (2002) cite that smaller companies will incur higher costs
for voluntarily disclosing information, in terms of the cost of collect-
ing and disclosing data and information and also due to potential costs
relating to loss of competitive edge with the release of proprietary infor-
mation. Larger firms will generally have greater resources and financial
expertise that will assist in ensuring that financial instrument is dis-
closed adequately to stakeholders. Financial institutions often require
resource companies to implement sufficient hedging to cover repay-
ments of project financing with these conditions being stipulated in
debt covenants (Berkman et al., 2002). Firms with more debt in their
capital structure are likely to be more motivated to disclose information
concerning financial instruments, in particular derivative and hedge
accounting information (Berkman et al., 2002). Jenson and Meckling
(1976) and Watson et al. (2002) posit that more highly leveraged firms
incur more monitoring costs and will seek to reduce these costs by dis-
closing more information within annual reports. ROA is another signifi-
cant and positive predictor variable of extent of FIDs. Accounting-based
ratios such as ROA are often used as a measure of default risk where
lower ROA values reflect greater default risk (Ashbaugh-Skaife et al.
2006). A firm’s disclosure policy may vary according to ROA as a high
level of default risk may necessitate restructuring of loan agreements,
a review of credit rating status and further capital raisings and use of
financial instruments. Malone et al. (1993) and Watson et al. (2002)
suggest that firm management might be willing to disclose more infor-
mation with higher earnings to support management compensation
contracts and to assure investors of the profitability of the firm. Higher
costs of disclosure are also justified with higher levels of earnings. Sub-
industry and shareholder concentration were generally not predictor
variables of FIDs.
Overall, this chapter provides a wealth of empirical insights to explain
the extent of FIDs by Australian listed extractive resource companies.
There are clear positive relationships between the extent of disclosure
and the amount of capital management initiatives, firm size, profit
and the level of firm borrowings. These findings contribute to a bet-
ter understanding of the extent, trends and rationale behind resource
firms’ FID practices in Australia.
Notes
1. www.rba.gov.au, media release survey of foreign exchange and OTC deriva-
tive turnover, 29 September 2004.
2. The first is the capital markets transactions hypothesis where voluntary
disclosure of information is made by management who anticipate mak-
ing capital market transactions to reduce information asymmetry and to
reduce the cost of external financing. The second is the corporate control
contest hypothesis where information is voluntarily disclosed to increase
firm valuation and to explain poor earnings performance. The third is the
stock compensation hypothesis where information is voluntarily disclosed
by recipients of stock compensation to reduce the likelihood of insider trad-
ing allegations, to correct any perceived undervaluation of the firm and to
reduce contracting costs between the firm and its management. The fourth
is the litigation cost hypothesis where management has the incentive to
disclose bad news to reduce the likelihood of legal action for inadequate or
untimely disclosures. The fifth is the management talent signalling hypoth-
esis where talented managers may voluntarily disclose information such as
earnings forecasts to signal to investors as early as possible that manage-
ment can anticipate future changes in the firm’s economic environment.
The sixth is the proprietary cost hypothesis where disclosures might be con-
strained if information is deemed to provide competitor firms with propri-
etary information.
3. Examples include the takeover of WMC Resources by BHP Billiton and the
takeover of Portman by Cleveland-Cliffs.
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10
Transnational Corruption and
Conflict Minerals
David Chaikin
10.1 Introduction
The global mining business faces a series of interrelated financial crime

risks, including transnational corruption, organised crime (OC) and
conflict minerals. These legal and reputational risks have become more
important because of the new international standards governing cor-
porate behaviour and the rising expectations of governments, investors
and civil society.
The size of the corruption problem is first examined through the
lens of country or geographical risk. The annual corruption indexes
issued by Transparency International (TI) are surveyed for the purpose
of determining their significance for mining countries. The unique fea-
tures of the mining industry are then analysed from a corruption pre-
vention perspective. Junior mining companies face higher corruption
risks in developing and transient resource-rich countries and these may
be undetected if a multinational mining company does not carry out
adequate due diligence when buying out juniors.
Transnational corruption has become an important policy agenda item
for governments. The major international initiatives combating corrup-
tion are the United Nations Convention against Corruption (UNCAC)
and the Organisation for Economic Cooperation and Development
(OECD) Convention on Combating Bribery of Foreign Public Officials
in International Business Transactions (Foreign Bribery Convention)
which have been implemented by nearly all countries where mining
companies are headquartered.
National enforcement of transnational anti-corruption laws is no
longer confined to the United States, and there is active anti-foreign
bribery enforcement by countries such as Germany, Switzerland and the
174
Transnational Corruption and Conflict Minerals 175
United Kingdom. A more aggressive campaign against foreign corrup-

tion has been launched by the US Securities and Exchange Commission
(SEC) and the Department of Justice, leading many companies to sub-
stantially revise their internal compliance procedures.
One strategy to prevent corruption in the mining industry is to
require increased transparency in payments made by corporations
to host governments. A critical assessment is made of the Extractive
Industries Transparency Initiative (EITI) which has established a global
framework for verification and publication of payments made by oil, gas
and mineral companies to governments. This has been complemented
by national initiatives on transparency of resource revenue payments.
The illicit mining, smuggling and trafficking of precious minerals has
been a long-standing challenge to mining companies. The Kimberley
Process (KP) which applies to 99.8 per cent of the global production of
rough diamonds has imposed extensive obligations on its members to
certify that shipments of rough diamonds are ‘conflict free’. An analy-
sis of the effectiveness of the KP is then given. The weaknesses of the
KP explain in part the reason for new US corporate securities laws on
conflict minerals.
10.2 Corruption in the global mining industry
The World Bank estimates that more than $1 trillion of bribes are paid
annually which is then laundered ‘both domestically and increasingly
in the international financial system’ (Chaikin and Sharman 2007, p.
3). However, any calculation of the extent of corruption in the min-
ing industry or any other sector of a country’s economy is inherently
subjective: corruption is a difficult activity to accurately ascertain due
to its (necessarily) secret nature. There are a number of useful proxies
of the corruption problem such as the the Global Financial Integrity
Report (2011) which issue ‘scorecards on national level anti-corruption
institutions in over 100 countries’. There are also the annual indexes
of corruption produced by TI, which is the leading Non-Governmental
Organisation (NGO) devoted to combating corruption. All these indexes
and the accompanying qualitative information produced by these
organisations should be used by corporations in determining their cor-
ruption risks when investing in specific countries.
This chapter concentrates on the TI indexes because they have become
extremely influential in moulding public opinion throughout its 100
national chapters. The oldest index (from 1995) is TI’s Corruption
Perceptions Index (CPI), which measures perceptions of demand-level
176 David Chaikin
public sector corruption in various countries by using surveys and assess-

ments and data from 13 sources including the Economist Intelligence
Unit. Although the methodology of the CPI has been questioned
(Uslaner 2005; Uslaner 2008, pp. 11–13), it is generally viewed as a reli-
able estimate of the perceived levels of corruption in each country.
The 2010 CPI ranks 178 countries in relation to the perceived cor-
ruption in the public sector. It scores countries on a scale from 10 to
1, with countries obtaining higher values perceived to be ‘clean’ or
less corrupt and countries ranked lowest perceived as highly corrupt.
Nearly three quarters of the 178 countries analysed in 2010 obtained
a score below 5, which indicates ‘a serious corruption problem’
(Transparency International, 2010). Among the leading mining coun-
tries, the OECD countries are generally ranked highest, perceived to
be ‘clean’ (Sweden and Finland are ranked 9.2) or less corrupt (Canada,
Australia, Germany, Chile and the United States are ranked between
7.1 and 8.9). Poland, Turkey and Mexico are ranked below 5.3, indicat-
ing a significant corruption problem. The mining countries in Africa
score poorly, ranked below 5.8 in the CPI, with the majority ranked
below 3.0. The mining countries in Asia fare similarly, ranked below
3.5 in the CPI. South American mining countries are also ranked
below 3.7. Post-Soviet mining countries are ranked between 2.9 and
1.6. These statistical indexes suggest that corruption is prevalent in
many mining countries.
There is also TI’s Bribe Payers Index (BPI) that aims to ‘expose the
degree to which companies of the leading exporting nations are likely
to engage in bribery when doing business abroad’ (Transparency
International 2008). While the BPI attempts to capture the supply side
of bribery, it is not based on objective empirical data, but like the CPI is
grounded in the perceptions of the group of persons who are surveyed
(Chêne 2009).
The 2008 BPI ranks 22 of the leading exporting countries (both devel-
oped and developing) indicating the likelihood that firms headquar-
tered in those countries are likely to engage in bribery when operating
in a foreign country. The 2008 BPI rankings are based on responses to
surveys completed by 2,742 senior business executives from 26 coun-
tries. The ratings are used as follows: the ‘higher the score for a coun-
try, the lower the likelihood of companies from this country to engage
in bribery when doing business abroad’ (Transparency International
2008).
The 2008 BPI ranks Belgium and Canada in equal first place, scoring
8.8. This indicates that these two countries are less likely to participate
in bribery overseas. While the OECD countries dominate the top rank-
ings with the majority above 7.9, Italy is ranked slightly lower at 7.4.
While a score between 7 and 9 indicates OECD countries engage in cor-
ruption overseas at a minimal level, it is clear that these countries, to a
degree, participate in corrupt activities. Given that no country received
a ranking of 9 or 10, this would suggest that ‘all of the world’s most
influential economies were viewed, to some degree, as exporting cor-
ruption’ (Transparency International 2008). Whereas OECD countries
comprise a large number of the 22 countries surveyed, it is interesting
to note the countries in the Asian region (excluding China) scored fairly
well, between 7.5 and 8.1. The BRIC countries occupied the bottom of
the index, with scores ranging between 5.9 (Russia with the lowest score
in the BPI) and 7.4 (Brazil), indicating that improvement is needed to
combat corruption in these emerging economies.
10.3 Corruption risks for mining companies
The mining sector is complex with a wide range of players, ranging

from large multinational corporations to small junior companies. A
simplistic view of the structure of the mining industry would empha-
sise the different role of senior companies and more junior companies.
Whereas senior companies are well-capitalised companies typically
involved in exploration for minerals, mine development, operation and
processing, junior companies are smaller companies that focus largely
on exploration and promotion, sometimes called promotional juniors
(Marshall 2001).
There is a trend for major multinational mining companies to focus
on downstream activities, including the processing of raw materials,
while smaller, more junior mining companies are left to the business
of mining exploration. A number of commentators have observed that
this means that junior mining companies face higher ‘political, project
and country risks’ than their larger counterparts (Soros 2011; Global
Witness 2011, p. 9; Marshall 2001). Indeed, it is junior mining compa-
nies that will first encounter higher corruption risks in developing and
transient resource-rich countries, since they will be the companies that
negotiate with government officials the terms of the exploration and
other licences. There is a significant risk that smaller mining companies
with lower time horizons, weaker management and ‘lower oversight
capacity’ will be tempted to make illicit payments to government offi-
cials in poor developing countries. According to Marshall (2001, pp 12,
15–17), junior mining companies that face high commercial risks will
178 David Chaikin
sometimes ‘take the expedient way and bribe public officials to obtain
exploration rights or other approvals’.
Junior companies will frequently then sell their mining rights to a
major mining company in circumstances where the major does not fully
appreciate that the junior has become entangled in corrupt activity. It is
imperative that major multinational mining companies perform a com-
prehensive due diligence exercise when acquiring any mining interest
so as to avoid reputational damage that would arise because of the con-
duct of the previous owner. The major must take steps to ensure that
some ‘rogue employee’ does not continue the former corrupt practices.
The typical situation is where the employee relies on bribery because
of a belief that this is in the company’s best interest and that this will
‘improve one’s chances of promotion by becoming known as someone
who can get things done’(Marshall 2001, p. 17).
Other factors contributing to corruption risks, include:
● physical remoteness of a mining project, where there is an absence of

sound corporate governance and enforcement on the ground
● absence of public accountability, including the ‘failure of governmen-
tal systems to ensure legislature engagement and oversight of mat-
ters pertaining to the development of effective sustainable extractive
resource regimes’ (Bryan and Hoffman 2007, pp. 19–36)
● complexity and secrecy of mining contracts and the use of foreign
enterprises in tax havens to conceal beneficial ownership and illicit
favours (Commission Lutundula 2005)
● large number of transactions, and high levels of regulation involv-
ing approvals/permits/licenses, which provide an excuse for corrupt
public officials to extort monies from companies which face signifi-
cant costs if the capital-intensive and expensive project is delayed.
10.4 Role of OC syndicates in the minerals and

the mining industry
The most devastating form of corruption is OC which is a major chal-

lenge for mining companies operating in poor developing countries
which have weak central governments. A study by the Institute for
Securities Studies (ISS) and the Secretariat of the Southern African
Regional Police Chiefs Cooperation Organisation (SARPCCO) identi-
fied OC syndicates as a significant threat to the mining industry in
Southern Africa (Hübschle 2010 pp. 59–63).
The study provided the following examples of OC involvement in the

minerals and the mining sector:
1. Theft of copper from housing and metal fences in South Africa

which is linked to the growing demand for copper by countries such
as China
2. Smuggling of precious minerals (gold, silver, platinum, palladium
and rhodium valued at $40 million) out of South Africa using bogus
invoices to claim that the product was scrap precious metals
3. Illicit diamond dealing in Namibia, possibly involving high-level
local politicians and Italian OC
4. Exploitation of irregular migrants who are engaged in unlawful min-
ing (gold, precious metals) in Manica, Nampula, Tete and Niassa prov-
inces in Mozambique, which is then sold to ‘networks of Nigerian
and Lebanese buyers’
5. Using Zambia as a transit point for illegal gold ore and diamond smug-
gling sourced from conflict countries such as the Democratic Repub-
lic of the Congo (DRC), thereby evading the KP (see further below)
6. Infiltration by OC of the mining businesses (copper and cobalt) in
the copper belt and North Western provinces of Zambia
7. Massive smuggling (up to 98 per cent) of gemstones, gold and tan-
zanite from Tanzania to Kenya, South Africa and Madagascar, and
ultimately to Europe and the United States.
These examples show the transnational nature of OC and corruption in

the minerals sector. A vivid example of how OC works in both the legal
and illegal segments of the mining industry in Zambia is also found in
the Hübschle report (2010, p. 60):
The first level of operation includes a few large mines that produce
the ore, process and export it; the second level includes many small
companies (called jalabos) that have no mines but have legal licences
to sell ore or process metal; and the third level includes the mar-
kets (mostly Chinese), the large companies and the international
markets. Organised criminals infiltrate these levels, stealing ore and
processed minerals and committing fraud by supplying stolen equip-
ment and spare parts.
The significance of OC in the mining industry in Southern Africa is

also relevant for mining companies operating in other jurisdictions, for
180 David Chaikin
example, in Central Asia. Smuggling of sensitive minerals such as ura-

nium has potential national security and terrorist implications. Further,
the smuggling of minerals by OC is intimately related to problems of
corruption, transfer pricing, capital flight, tax avoidance/tax evasion
and money laundering.
10.5 International initiatives combating corruption
There are many different definitions of corruption, covering a wide

range of activities from low level bribery to grand corruption, from pri-
vate sector insider trading to public sector embezzlement (Chaikin and
Sharman 2009, pp. 8–14). From the perspective of the global mining
industry, it is the definitions of corruption enshrined in international
conventions and national legislation that are most relevant.
The international conventions are important because there is a trend
of harmonisation of bribery laws across different jurisdictions. The most
significant international legal instrument on corruption is the UNCAC,
which came into force on 14 December 2005. UNCAC has been ratified
by more than 160countries, including the following mining countries:
Finland, Sweden, Canada, Australia, Chile, the United States, Botswana,
Poland, South Africa, Namibia, Turkey, Ghana, Brazil, Peru, China,
India, Mexico, Zambia, Argentina, Kazakhstan, Bolivia, Indonesia,
Guyana, Mongolia, Ecuador, Philippines, Sierra Leone, Zimbabwe,
Ukraine, Cote d’Ivoire, Papua New Guinea, Venezuela, Democratic
Republic of the Congo (DRC) and Uzbekistan (United Nations Office on
Drugs and Crime 2012). This list indicates that a large number of coun-
tries have taken domestic measures to strengthen their anti-corruption
laws and programme. On the other hand, some mining countries such
as Tanzania, the Republic of Congo (also known as Congo-Brazzaville)
and Guinea have not ratified UNCAC, suggesting a lack of political will
to embrace the global anti-corruption standards.
UNCAC has an extensive definition of corruption in articles 15–22.
There is a distinction between corrupt activities that states are required
to establish as criminal offences and those activities which states are
only required to consider adopting as crimes. Under UNCAC the follow-
ing activities must be criminalised:
● Bribery of national public officials

● Bribery of foreign public officials and officials of public international
organisations
● Embezzlement, misappropriation or other diversion of property by
a public official
● Laundering of proceeds of crime, including crimes established under

UNCAC
Corrupt activities that states have the option of criminalising include:
● Solicitation or acceptance by a foreign public official of an undue

advantage
● Trading in influence by a public official
● Abuse of functions or position by a public official
● Illicit enrichment, such as a significant increase in the assets of a
public official, which cannot be reasonably explained by his or her
lawful income
● Bribery in the private sector
● Embezzlement of property in the private sector
The Convention thus requires the criminalisation of active bribery,

which refers to the person paying the bribe, but does not as such require
the criminalisation of passive bribery, that is the person receiving the
money. However, in most countries passive bribery will already be a
criminal offence. The Convention also requires states to impose crimi-
nal liability on legal persons, such as corporations, which some legal
systems based on the civil law tradition have not previously required.
The other important international legal instrument is the Convention
on Combating the Bribery of Foreign Officials in International Business
Transactions (the OECD Foreign Bribery Convention), which came into
force in February 1999. The OECD Convention was enacted after a long
campaign by US multinational corporations who complained that they
were at a commercial disadvantage to their foreign competitors because
they were subject to the US Foreign Corrupt Practices Act 1977 (FCPA
1977). For over 20 years, US corporations were subject to a law which
prohibited them from bribing foreign public officials, while foreign cor-
porations were able to engage in supply-side bribery and even claim tax
deductions for the bribes in their home countries. However, under the
OECD Convention, which has been ratified by 39 countries, includ-
ing nearly all countries where multinational mining companies are
headquartered, ‘transnational official bribery’ has been criminalised
(International Bar Association 2008, pp. 207–8).
Similarly, all the BRIC (Brazil, Russia, India and China) countries are
or have taken measures to criminalise foreign bribery. Brazil and Russia
have acceded to the OECD Convention (Kramer 2011). Anti-corruption
legislation is pending in India’s Parliament (Deshmukh 2011) while
China has recently amended its Criminal Law to criminalise corrupt
182 David Chaikin
payments to foreign public officials. According to Covington and

Burlington (2011), the new offence applies to ‘all PRC citizens, wher-
ever located, all natural persons of any nationality within China, and
all companies, enterprises, and institutions organized under PRC law,
which generally includes, in addition to PRC domestic companies,
Sino-foreign joint ventures, wholly foreign owned enterprises and rep-
resentative offices’. Although the enactment of this new Chinese law
may signal that China considers that corruption by its own multina-
tional companies operating in the resource-rich countries of Africa and
Central Asia is unacceptable, it is too early to predict whether China
will vigorously enforce this law.
10.6 National enforcement of transnational

anti-corruption laws
The question arises as to whether any of the parties to the OECD

Convention or the UNCAC will aggressively enforce their foreign anti-
corruption laws in regard to their own multinational companies. Here
the record is mixed. According to a TI report on foreign bribery enforce-
ment in OECD Convention countries, only seven countries were active
for the year 2010, including the United States (227 cases), Germany
(135 cases), Switzerland (35 cases) and the United Kingdom (17 cases)
(Transparency International 2011, pp. 8–9). Countries such as France,
Japan and South Korea engaged only in moderate enforcement, while
there was little or no enforcement in countries such as Australia, Brazil,
Canada, Chile and South Africa (ibid., p. 8).
The United States is the standout country in that both the Department
of Justice(DoJ) and the SEC have engaged in an aggressive campaign to
investigate not only US companies but foreign companies subject to
SEC jurisdiction that have allegedly engaged in bribery of foreign pub-
lic officials. FCPA enforcement actions have resulted in large corporate
fines and penalties, with the top ten settlements totalling $2.8 billion
(FCPA Blog 2010). Although the United States has not taken enforce-
ment measures against any multinational mining company, it has taken
action against a number of companies operating in the oil and natural
gas sectors, including providers of construction, engineering, software
and other services to the oil and gas industries. In many of these cases,
the companies have allegedly paid kickbacks or commissions, and then
concealed their crimes by falsifying their books and records.
Typically US enforcement actions do not lead to a criminal trial and
conviction of a company. Instead, companies reach a settlement with
the DoJ through a deferred prosecution arrangement under which

companies are required to implement changes in their compliance and
internal control systems to prevent corruption. The remedial costs to
a company of fully implementing such changes may be even greater
than the fines and penalties that they have paid. Other risks arising
from FCPA enforcement include securities class civil suits wherein it is
claimed that directors and officers of the company misled shareholders
by failing to disclose FCPA deficiencies.
It is not only companies that face increased legal and reputational
risks arising from aggressive enforcement. In the past five years US pros-
ecutors have adopted a strategy of targeting individuals, particularly
‘mid-level to senior-level corporate officers and employees ... (including)
CEOs, CFOs (and) heads of international sales’ in FCPA criminal pros-
ecutions ‘(Weissmann and Smith 2010, p. 2).
The enactment of the UK Bribery Act 2011 may signal an increased
level of enforcement against multinational mining companies which
have a business presence in the United Kingdom. The Bribery Act is
wider than the US FCPA in that it creates a specific strict liability offence
of failing to prevent persons associated with a ‘commercial organisa-
tion’ from committing bribery on their behalf, and has a wider ambit in
applying to facilitating payments, private sector corruption, as well as
promotional expenditure (Waite 2011). Although the Act only applies
to companies which carry on a business in the United Kingdom, there is
uncertainty as to how the courts will interpret this provision in practice.
Companies should examine the Joint Guidance issued by the Director
of the Serious Fraud Office and the Director of Public Prosecutions, as
well as the Guidance issued by the UK Department of Justice in con-
structing adequate bribery prevention procedures.
10.7 Transparency of payments by

mining companies to governments
One strategy to prevent corruption and ‘other dysfunctions’ in the

extractive resources industry, including mining, in developing coun-
tries is to require increased transparency in payments made by cor-
porations to host governments. This strategy has been supported by
international organisations such as the International Monetary Fund,
the World Bank and the OECD, resource-rich countries, 40 extractive
resource corporations, 80 institutional investors, and a number of civil
society groups (Ölcer 2009, p. 9). The idea is that increased transparency
about payments made to governments for exploitation of their oil, gas
184 David Chaikin
and mining reserves, production data and their contractual terms will
improve governance and fiscal management, as well as prevent public
sector corruption.
There have been a series of initiatives, including the Revenue Watch
Index (Revenue Watch Institute 2011) which compiles data on 41 coun-
tries, among the ‘world’s top producers of gold, copper and diamonds’.
There is also the Extractive Industries Transparency Initiative (EITI),
which has become the major vehicle for improving transparency in the
relationship between mining companies and host governments.
The EITI was developed in 2003 by the World Bank and the British
Department for International Development so as to improve the trans-
parency of payment and revenue streams in the resources sectors, par-
ticularly in developing and transient economies. The EITI established
a global framework for verification and publication of payments made
by oil, gas and mineral companies to governments. Under the EITI gov-
ernments, companies, institutional investors and international organi-
sations adhere to a Statement of Principles and Agreed Actions. The
International Council on Mining and Metals, which represents 20 of
the world’s leading ‘mining and metals companies and 30 national
and regional mining associations and global commodity associations’,
has also committed to implement the EITI through its membership
(International Council on Mining and Metals 2012).
The key idea of EITI is that governments of resource-rich countries
will publish information about the revenues that they have received
from the extractive industries, and that this will be compared to the
payments (taxes, duties, royalties and bonuses) made by these compa-
nies to those governments (Ölcer 2009, p. 13). Under EITI all companies
are required to produce the data; it makes no difference if the company
is state-owned or private, or whether it is a local or foreign. The infor-
mation concerning corporate payments and government receipts is
then subject to an examination by an independent auditor. The auditor
is expected to apply international accounting standards in reconciling
the data and to publish any discrepancies in the figures.
There has been a gradual implementation of the EITI, with interna-
tional organisations and multinational corporations putting pressure
on governments to adopt and enforce the EITI requirements (Hakobyan
2004, p. 2). Indeed, according to the website of EITI (2012) the following
12 countries have become compliant in their implementation of EITI:
Azerbaijan, the Central African Republic, Ghana, the Kyrgyz Republic,
Liberia, Mali, Mongolia, Niger, Nigeria, Norway, Peru and Timor-Leste;
Yemen was compliant but has been suspended. Important mining
countries which are candidates for membership but which require fur-
ther validation before they are considered compliant include Albania,
Cote d’Ivoire, DRC, Guinea, Indonesia, Mozambique, Republic of the
Congo, Sierra Leone, Tanzania and Zambia.
The theory of the EITI makes good sense, but there are several weak-
nesses. None of the Organisation of the Petroleum Exporting Countries
(OPEC) – with the exception of Nigeria– are members or candidates for
membership of EITI. Further, in some countries where there are high
levels of corruption, powerful political and business elites have resisted
subscription to and/or implementation of EITI. The case of BP in Angola
is frequently cited as an example, where BP’s attempt to publicly disclose
oil revenue payments that it had made under its contract was thwarted
by the host government of Angola (Hakobyan 2004, p. 3). Given that
the EITI relies on voluntary reporting by companies and governments,
it does not mandate a level-playing field between companies in extrac-
tive industries (ibid., p. 2).
There is a lack of consistency on issues such as the type of revenue
payments covered by the EITI, the absence of a definition of a mate-
rial payment and the poor quality of government revenue disclosures
(Ölcer 2009, p. 17; Global Witness 2011, p. 5). There is the bigger issue
whether transparency per se will work since the assumption is that the
international community and civil society will be able to change the
behaviour of corrupt governments.
10.8 National initiatives on transparency of

resource revenue payments
A major obstacle to improving transparency is that nearly all mining

contracts between companies and host government contain confidenti-
ality clauses which prohibit if not limit the disclosure of financial infor-
mation. In addition, it has been argued that the law of some countries,
such as Angola, Cameroon, China, and Qatar, prohibit publication of
revenue payments made by the resources extractive industries to foreign
governments or companies owned by foreign governments, although
this has been contested by a number of NGOs (Global Witness 2011;
Publish What You Pay 2011). It has been further argued that national
legislation is required to incorporate revenue transparency in the extrac-
tive resources industries. This has already occurred in countries such as
Nigeria, Sao Tome and Principe and Timor-Leste (Ölcer 2009, p. 22).
The most far-reaching regulations are the proposed rules of the US
SEC which will implement Title XV section 1504 of the Dodd–Frank
186 David Chaikin
Wall Street Reform and Consumer Protection Act (Dodd–Frank Act).

The rules governing disclosure of payments by resource extraction
issuers will apply to all companies subject to US securities laws juris-
diction. That is, those companies which presently file reports under s
13(a) of 15(d) of the Securities Exchange Act 1934. The rules will require
all resource extraction companies to issue a publicly available annual
report which sets out payments made to the United States or a foreign
government relating to the commercial development of oil, natural gas
or minerals (Securities and Exchange Commission 2010A).
When enacted, the rules will impose mandatory disclosure require-
ments on all mining companies which are listed or traded on the US
securities markets. This is the first comprehensive national law impos-
ing public disclosure of payment information. The mandatory disclo-
sures will be important for mining companies that operate in countries
with weak governance standards ‘resulting in corruption, bribery and
conflict’ that negatively impact the sustainability of such companies
(California Public Employees’ Retirement System 2011, p. 1). This man-
datory disclosure standard will affect how mining companies report
their revenue payments to investors.
The exact scope of the rules is being debated, with a number of
important issues yet undecided. For example, the definition of payment
and project, whether there should be any exemption for smaller mining
companies or certain issuers and whether violation of the rules should
provide a basis for civil liability to investors.
The potential impact of the law should not be underestimated. One
leading international mining company has submitted that the proposed
US law of extractive disclosure payments would impose new risks on
the company and might jeopardise its relationship with the host coun-
try (Spina 2011, pp. 2–3). The concern is that the US law may conflict
with mining companies’ existing legal and contractual non-disclosure
obligations. On the other hand, the law may be of precedential value
because the EU and countries such as the United Kingdom and France
are expected to adopt similar measures.
10.9 Trafficking of illicit and conflict minerals
The illicit mining, smuggling and trafficking of precious minerals, such

as gold, diamonds and coltan, has been a long-standing challenge to
mining companies, governments and civil society. The illicit trade in
precious metals has been associated with financial crimes, such as theft,
corruption, arms smuggling, money laundering and terrorist financing
(International Monetary Fund 2010). Illicit mining and trafficking of

precious minerals became a matter of international concern in the lat-
ter years of the twentieth century because of the special problem of
‘conflict diamonds’.
The term ‘conflict diamonds’ or ‘blood diamonds’ was coined to
explain the linkage between rough and uncut diamonds that could easily
be looted by rebel movements and used to finance civil wars/ insurgen-
cies in southern Africa (Global Witness 1998). Conflict diamonds have
fuelled internal political conflicts and lengthened civil wars in African
countries, such as Angola, Cote d’Ivoire, DRC, Liberia and SierraLeone
(Cilliers and Dietrich 2000; Hirsch 2001; Ross 2004). There were spillover
effects on neighbouring countries, resulting in new international conflicts
in the region. The human misery caused by the use of conflict diamonds
was evident in the increased violation of human rights, destruction of
the environment, exploitation of child labour and slavery.
The international community sought to end the civil wars in Africa
using economic sanctions as a lever to pressurise rebel groups to nego-
tiate peaceful solutions to end internal wars. It is estimated that the
Uniao Nacional para a Independencia Total de Angola (UNITA) received
US$3.7 billion in revenue from ‘conflict diamonds’ between 1992 and
1997 (Meyer 2010, p. 2; Grant and Taylor 2004, pp. 397–398). When
UNITA walked away from the Lusaka Peace Accords in 1998, the UN
Security Council passed Resolution 1173 which prohibited the direct or
indirect importation of diamonds from territories controlled by UNITA.
The sanctions resolution required imports of uncut diamonds to be part
of a certificate of origin scheme organised by the Angolan Government
of Unity and National Reconciliation. This was followed by UN Security
Council Resolution 1295 in 2000 which called for ‘arrangements that
would allow for increased transparency and accountability in the
control of diamonds from their point of origin to the bourses’. These
UN Security Council resolutions paved the way for international and
domestic action to combat conflict diamonds.
In 2003, after lengthy negotiations between governments, the dia-
mond producing companies, industry associations and NGOs, the KP
Certification Scheme (KPCS) came into effect. Supported by the United
Nations and given an exemption by the World Trade Organization, the
KPCS is a unique scheme that regulates the international trade in rough
diamonds. The aim of the KPCS is to prevent conflict diamonds from
entering the legitimate trade of international commerce so as to reduce
the funding available to rebel movements in civil wars (Kimberley
Process 2012; World Diamond Council 2011).
188 David Chaikin
Membership of the KP has grown, so that it now consists of 75 coun-

tries, representing diamond producing, processing and trading coun-
tries. The current members are Angola; Armenia; Australia; Bangladesh;
Belarus; Botswana; Brazil; Canada; Central African Republic; Peoples
Republic of China ; DRC; Côte d’Ivoire Croatia;Ghana; Guinea; Guyana;
India; Indonesia; Israel; Japan; Republic of (South) Korea; Laos; Lebanon;
Lesotho; Liberia; Malaysia; Mauritius; Mexico; Namibia; New Zealand;
Norway; the Republic of Congo; Russian Federation; Sierra Leone;
Singapore; South Africa; Sri Lanka; Switzerland; Tanzania; Thailand;
Togo; Turkey; Ukraine; United Arab Emirates; United States of America;
Venezuela; Vietnam; and Zimbabwe, as well as member countries of the
European Union (Kimberley Process, 2012).
The membership of the KP accounts for about 99.8 per cent of the glo-
bal production of rough diamonds, albeit that the two diamond produc-
tion countries of Cameroon and Gabon have not taken up membership
(Smillie 2011). The large number of non-producing transit countries
that have sought membership of the KP might indicate that there is a
change in attitude or policy in those countries to the problem of con-
flict diamonds. Another explanation is that that the KP is perceived as
a gateway for legitimacy in the diamond trade and that transit countries
have continued to turn a blind eye to this problematical industry.
The KPCS imposes extensive requirements on its members to enable
them to certify that shipments of rough diamonds are ‘conflict free’.
The KPCS requires its participant governments to adhere to certain
‘minimum requirements’ by enacting legislation and creating institu-
tions that regulate the exportation and importation of rough diamonds
through a process of certification and internal controls: see, for exam-
ple, the US Clean Diamond Trade Act of 2003. All rough diamonds must
be sealed in tamper-resistant containers and documented as complying
with the KP which must be verified on importation. Similarly, exports
of diamonds are only permitted if their destination is to a state that is a
member of and adheres to the KP.
Countries must agree to exchange statistical data on diamond pro-
duction and trade so that there is a means of assessing whether coun-
tries are complying with the KP standards. A peer review mechanism
is in place so that countries’ compliance with the KP standards may be
assessed. But the results of the peer review process are not published so
that NGOs and civil society are not in a position to judge the effective-
ness of the KP.
Sanctions are rarely imposed for violating the KP. There have been
two cases of expulsion from membership of the KP – DRC in 2004
(subsequently readmitted in 2007) and Côte d’Ivoire in 2005 – in both

instances because of ‘serious non-compliance’ with the KP. Politicisation
plays a role in decision-making because all decisions must be unani-
mous. For example, in 2006 Venezuela, which is only a small producer
of diamonds, was accused of turning a blind eye to the smuggling
of diamonds. However, supported by European countries, including
Russia, Venezuela resisted making any changes in its administration and
enforcement of the KP for 2½ years (Meyer 2010, p. 47). Subsequently,
Venezuela agreed in 2008 to ‘voluntarily suspended exports and imports
of rough diamonds until further notice’ (Kimberley Process 2012).Other
instances of non-compliance have not been punished. For example,
Lebanon, which does not produce diamonds, exports far more gem dia-
monds than it imports, and has been accused of ‘completely avoid(ing)
the Kimberley Process’ (Meyer 2010).
There has been ‘massive smuggling’ of diamonds out of Zimbabwe,
where President Robert Mugabe’s government has been accused of
using the KP as a pretext for violating human rights of alluvial miners
and enriching his cronies (Meyer 2011, p. 49). Further, there has been a
‘complete absence of internal controls’ concerning the diamond trade in
Guinea which is largely unaccountable and suspected of trafficking in
conflict diamonds (Smillie 2011, p. 2; Meyer 2010, p. 45). Finally, in 2012
the Chairperson of the KP warned that there was evidence of the use
of fake KP Certificates from Angola and Malaysia, as well as Cameroon
who was not a KP membern (Kimberley Process, 2012).
There is an ongoing debate concerning the achievements of the KP.
The most noticeable success is the impact of the KP on reducing the
flow of conflict diamonds to the rebel movements of UNITA in Angola
and the Revolutionary United Front (RUF) in Sierra Leone (Smillie 2011).
According to Haufler (2009) the KP has been a success to the extent
that it has reduced ‘conflict diamonds in world trade to less than 1 per
cent of the total’, with only northwest Côte d’Ivoire being an ‘official
conflict diamond zone’. The KP has reduced the level of smuggling in
some countries, such as Sierra Leone, thereby increasing tax revenues
(Hirsch 2001, Jumah 2009; Meyer 2010, pp. 16–17). However, perhaps,
the biggest beneficiary of the KP has been the diamond industry which
has obtained a reputational dividend thereby ensuring the continua-
tion and prosperity of the diamond industry (Meyer 2010).
Smillie (2011) has been the major critic of the KP arguing that as a vol-
untary self-regulatory tripartite agreement it has significant loopholes
in its design and implementation. There is an issue as to whether the
World Diamond Council, which represents the diamond industry, has
190 David Chaikin
been effective in coordinating the surveillance of national members of

the industry. Countries such as Côte d’Ivoire, DRC and Zimbabwe con-
tinue to be problematic, albeit in the case of Zimbabwe the diamonds
are not ‘conflict diamonds’ but are a source of enrichment for a corrupt
government.
10.10 US conflict of minerals law
There have been some efforts by the European Union (2009 to increase
the effectiveness of the KP. The most significant national development
is the enactment of section 1502 of the Dodd–Frank Act. Section 1502
is modelled on the KP but goes further by covering a wider range of
minerals than uncut diamonds, regulating large parts of the miner-
als processing industry including its users, and targeting not only the
DRC but also its neighbouring countries which have allegedly exploited
loopholes in the KP.
The key aim of section 1502 is to deter the ‘exploitation and trade
of conflict minerals’ that have ‘financed conflicts characterized by
extreme levels of violence in the eastern DRC, particularly sexual- and
gender-based violence, and contributing to an emergency humanitar-
ian situation’. In this sense section 1502 should not be regarded as a
mechanism to increase protection to investors, but rather as an instru-
ment to improve corporate behaviour based on ‘social criteria’. This is
a reflection of societal expectations that mining companies actively
assist in the prevention of violations of human rights in foreign coun-
tries (Drimmer and Phillips 2011).
Conflict minerals are defined in section 1502(e) as certain miner-
als sourced from the DRC and its nine neighbouring states, namely,
Angola, Burundi, the Central African Republic, Republic of the Congo,
Rwanda, Sudan, Tanzania, Uganda and Zambia (DRC countries). The
conflict minerals are:
● gold – which is used in jewellery and in the manufacturing of elec-

tronic communications and aerospace equipment
● cassiterite – a metal ore from which tin is extracted, and which is
used in ‘alloys, tin plating and solders for joining pipes and elec-
tronic circuits
● columbite–tantalite (coltan) from which tantalum is extracted, and
which is used in the manufacture of electronic components for
mobile phones and computers, as well as an alloy for making jet
engines
● wolframite – from which tungsten is extracted, and which is used for

‘metal wires, electrodes and contacts in lighting, electronic, heating
and welding applications’
● derivatives of these ores, or
● ‘any other mineral or its derivatives determined by the Secretary of
State to be financing conflict in the DRC countries’ (Securities and
Exchange Commission 2010B, par 80950).
Since the list of conflict minerals are commonly used in the manufac-
ture of a wide range of products, the proposed SEC rule is expected to
have a significant impact on US manufacturing industries (World Trade
Lawyers 2011). Further, the law will apply to ‘companies that have influ-
ence over contract manufacturers, as well as generic products under a
company’s own brand name’ (Heim 2011).
The SEC is mandated to issue rules implementing section 1502. Under
a SEC draft rule, issued on 23 December 2010, it is proposed that compa-
nies subject to US SEC jurisdiction would be required to file an annual
Conflict Minerals report concerning whether their use of conflict min-
erals are sourced from DRC countries. The companies would be obliged
to state whether their use of conflict minerals ‘directly or indirectly
finance or benefit’ armed groups in the DRC countries. In order to meet
this filing requirement, reporting companies would be required to carry
out a ‘reasonable country of origin inquiry’ concerning the minerals
that they use in manufacturing. This will entail ‘supply chain due dili-
gence’ supported by verification and certification procedures. There is a
specific requirement that reporting companies appoint an independent
private sector auditor who will apply audit standards established by the
Comptroller General of the United States.
The precise scope of the proposed SEC rule is yet to be determined.
There has been criticism of the proposed rule. For example, the gold
industry has pointed out that it will be extremely difficult to make a
‘supply chain determination’ where a refiner has used newly minted
and recycled gold (Securities Exchange Commission 2010B, par 80961).
Indeed, it has been argued that the commingling of gold at both the
smelter and refining stages will make it impossible to determine the
‘specific mine that was the source for the specific smelter or refiner
output’ (Barrick Gold Corporation 2011). Some mining companies have
questioned whether the rule should apply to their industry on the basis
that the legislative intent in section 1502 is to impose reporting require-
ments only on manufacturing companies that use the conflict miner-
als, not those that extract those minerals (ibid.).
192 David Chaikin
Whatever the ultimate outcome, the financial costs of the new rule
will be high, affecting both SEC-regulated companies and suppliers
to those companies. The SEC estimates that 1,199 companies will be
obliged to file a full Conflict Minerals Report and that the paperwork
burden on those companies will be 153,864 hours of personnel time, plus
$71,243,000 in hiring outside professionals (Securities and Exchange
Commission 2010B, par 80965). Although the SEC has not estimated
how many suppliers will be affected by the new rule, a conservative
estimate is that 12,000 suppliers will be impacted (Heim 2011).
10.11 Conclusions
The international spread of anti-corruption laws has resulted in

new legal and reputational risks for mining companies that operate
in developing and transient countries. There is a trend for increased
national enforcement of transnational anti-corruption laws and this
is no longer confined to the United States. The enactment of the UK
Bribery Act is likely to lead to changes in corporate behaviour so as to
minimise the increased legal risks arising from this widely drafted Act.
International self-regulatory measures such as EITI and the KP which
deal with the challenge of secrecy of payments by mining companies
to governments and conflict diamonds, respectively, will be beefed up
by new US securities laws that will impose significant obligations on
all mining companies which are listed or traded on the US securities
markets.
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Index
AASB 6, 102–5 Australian Securities Exchange (ASX),

AASB 112, 115–16, 118 160
AASB 136, 105–10 Austria, 131
AASB 138, 105–10
accounting Bankable Feasibility Study (BFS),
hedge, 160 83–5, 91–3, 96
reporting of clean-up costs and, BHP Billiton, 21, 56, 58, 59–60, 62–5
143–57 blood diamonds, 187–90
standards, 144, 153 BP, 185
tax, 3, 100–21 Bribe Payers Index (BPI), 176–7
Africa, 24, 176, 187 bribes, 175
Aloca, 22 Bronze Age, 9
aluminum, 21 business history, of mining, 1, 9–25
amalgamation, 19–23
Angola, 185, 189 California gold fields, 17
anti-bribery laws, 5, 174–5 Canada, 176
anti-corruption laws, 174–5, 181–3 cap-and-trade system, 131–2
Ashanti Goldfields, 23 capital asset pricing model (CAPM),
Asia, 176 42, 86, 98
Australia capital equipment, procurement, 2–3,
corruption in, 176 69–78
gold discoveries in, 17–18 capitalisation, of exploration costs,
greenhouse gas emissions, 122–5 155
terms of trade, 31–2 capital management, 4–5, 158–71
transportation issues, 2 capital markets, 10, 162
Australian Accounting Standards Carbon Pollution Reduction Scheme
(AAS), 144 (CPRS), 124, 131–2
Australian Accounting Standards carbon tax, 3–4, 122–37
Board (AASB), 160, 161 cartels, 1, 11, 13, 19–23
Australian Competition Tribunal, 63 cassiterite, 190
Australian economy Central Mining and Investment
commodity prices and, 34–40 Corporation, 21
current account deficit (CAD), 32, Chandler, Alfred, 10
42–3 Chile, 176
econometric model of, 38–40 China, 11, 13, 24, 34, 47, 54–6, 123,
outlook for, 32–3 181–2
role of mining in, 1–2, 27–43 Christmas Creek, 55
Australian mining industry clean-up costs, 4, 143–57
economic role of, 27–43 climate change, 4, 123
history of, 28 Cloudbreak, 55
transportation issues, 47–66 coal, 31
Australian Rail Track Corporation distribution networks, 48–52
(ARTC), 54 in Latrobe Valley, 125–6
197
198 Index
coal – continued developing countries, 24, 131

NSW coal distribution export diamonds, 175, 187–90
flows, 51–2 discounted cash flow (DCF)
production, 48 approach, 84–90, 98–9
Queensland coal distribution Dodd-Frank Act, 190
export flows, 49–51 dynamite, 15
supply chains, 52–4
transportation issues, 2, 47–55 economic rent, 40–3
columbite-tantalite, 190 economies of scale, 10
COMEX, 23 emerging markets, 13
commodity prices, 31–2, 34–40, 41 Emissions Trading Scheme (ETS), 123,
component performance risk 124, 130
classification, 77–8 environmental protection, 24
components, 70 environmental taxes, 130–1
Computable General Equilibrium exploration and evaluation
(CGE) methodology, 124, 133 expenditures, 102–15, 155–6
Comstock Lode, 17 Extractive Industries Transparency
conflict diamonds, 187–90 Initiative (EITI), 175, 184–5
conflict minerals, 5, 186–92
Consolidated Zinc, 21 farm-in, 93
consolidation, 1, 10 Financial Instrument Disclosures
contract negotation, 78 (FIDs), 4–5, 158–71
control premium, 93–6 financing constraints, 90–1
Convention on Combating the Finland, 131, 176
Bribery of Foreign Officials FMG, 55, 58, 60–1, 62–3, 65
in International Business Foreign Corrupt Practices Act, 181,
Transactions, 181 182–3
convertible notes, 93 Free Standing Company (FSC), 10–11,
copper, 13, 15, 16, 19, 21 18
corporations, 10, 19
payments to governments by, Germany, 131, 176
183–5 Ghana, 23
corruption, 5 Gillard, Julia, 3
initiatives to combat, 180–3 global economy, 9, 15, 38
in mining industry, 175–80 global financial crisis, 25, 28, 33–4
transnational, 174–92 globalisation, 24
transparency and, 183–6 gold, 16–18, 31, 32, 190
Corruption Perceptions Index (CPI), greenhouse gas emissions, 4, 122–5,
175–6 129–32, 136–7
CRA Ltd., 21
crime risks, 5 hedge accounting, 160
crude oil, 31, 32 horizontal integration, 10, 11, 19
current account deficit (CAD), 32, Hunter Basin coal fields, 51–2, 54
42–3
illicit mining, 186–90
Dampier, 64 Income Tax Assessment Act (1997),
debt markets, 42–3 111–15
Denmark, 130, 131 India, 13, 18, 181
derivatives, 158, 160 industrialisation, 11, 13
Index 199
industrial revolution, 9 mining industry

inflation, 35–7 corruption in, 175–80
International Accounting Standards history of, 1, 9–25
Committee (IASC), 143, 149–53, investment in, 18–19
155–6 nature of, 100–1
International Financial Reporting organised crime in, 178–80
Standards (IFRS), 3, 100–21 role of, in Australian economy, 1–2,
international mining industry, 27–43
history of, 1, 9–25 tax accounting in, 100–21
iron ore, 31, 32 transportation issues, 47–66
distribution networks, 58 mining projects, risk profiles, 83–4,
domination issues, 65–6 86–90
ports, 63–5 mining techniques, 15–16
pricing, 57–8 mining valuations, 3, 83–99
production, 55–6 discounted cash flow (DCF)
transportation issues, 2, 47–8, approach to, 84–90, 98–9
58–66 financing constraints, 90–1
Italy, 131 practical implications, 91–6
technical implications, 96–8
John Taylor and Sons, 19 Mount Newman Joint
joint ventures, 22, 24 Venture, 56
junior mining companies, 91–6 Mugabe, Robert, 189
multinational enterprises (MNEs), 11,
Kimberley Process (KP), 175, 187–90 16, 19–25
KP Certification Scheme (KPCS), 187–8
Kyoto Protocol, 123, 124 National Greenhouse Response
Strategy (NGRS), 123
Latrobe Valley, 3–4, 124–37 National Greenhouse Strategy (NGS),
liquefied natural gas (LNG), 31 123
London Metal Exchange, 13, 23 natural gas, 31
natural resources, control of, 24
maintenance, repairs and operations Netherlands, 131
(MRO), procurement, 2–3, 69–78 new private capital expenditure
market value, 96–8 (NPCE), 29–30
mergers and acquisitions, 10, 19–23 new product development (NPD),
metal exchanges, 23 72–3
Mexico, 176 New York Mercantile Exchange, 23
Mineral Resource Rent Tax (MRRT), nickel, 13
40–3 Nobel, Alfred, 15
mining companies non-systematic risk, 86
financial instrument disclosures by, Norway, 131
158–71 NSW coal distribution export flows,
head office locations, 24 51–2, 54
largest, 20
mergers and acquisitions of, 10, oil, 31, 32
19–23 Organisation for Economic
payments to governments by, Cooperation and Development
183–5 (OECD), 42, 174
small, 21 organised crime, 5, 178–80
200 Index
original equipment manufacturers South America, 176

(OEM), 70, 73–4 Spencer v. The Commonwealth (1907), 97
Statements of Accounting Concepts,
partial interest, 93 156n2
parts, 70 state-owned enterprises (SOEs), 1, 11,
Petroleum Resources Rent Tax (PRRT), 19–23, 24
41 steel, 47
Poland, 176 Stevens, Glenn, 33
porphyries, 19 suppliers, 72–4
Port Hedland, 64–5 supply risks, 74–6
ports, 63–5 Sweden, 130–1, 176
Port Waratah Coal Services Limited systematic risk, 86, 87
(PWCS), 52
Prain, Ronald, 17 tax
prices, 11–15 carbon, 3–4, 122–37
private placement, 92–3 environmental, 130–1
procurement activities, 2–3, 69–78 mineral resource rent tax, 40–3
production, 11–15, 16 tax accounting, 3, 100–21
product life cycle (PLC), 69–70 The Enormous Regional Model
decline stage, 75 (TERM), 133–4
growth stage, 75 tin, 13
introduction stage, 75 tin cartel, 21
maturity stage, 75 Toronto Stock Exchange, 23
risk management and, 74–6 train wagons, 61–2
supplier intelligence and, 72–4 transaction economics, 10
transnational corruption, 5, 174–92
Queensland coal ports, 50–1, 52–4 transparency, 175, 183–6
Queensland Railways, 48, 49–50 Transparency International (TI), 174,
175–6
railways, 47–52, 58–61 transportation issues, 2, 47–66
domination issues, 65–6 Transvaal, 17–18
third-party access to, 62–3 Turkey, 176
Rand Mines, 21 two-speed economy, 27, 30
Reserve Bank of Australia (RBA), 27, 33
resource revenue payments, 185–6 UK Bribery Act, 183
restoration costs, 153–4 United Nations Convention against
Revenue Watch Index, 184 Corruption (UNCAC), 174, 180–1,
rights issues, 91–2 182
Rio Tinto, 19, 21, 55, 56, 58, 59, 62–4 United Nations Framework
risk management, 74–6 Convention on Climate Change
risk matrix, 77 (UNFCCC), 123
rock drills, 15–16 United States
anti-corruption laws, 175, 181,
sales and operations planning, 71 182–3
Securities and Exchange Commission conflict of minerals law, 190–2
(SEC), 155, 175, 182, 185–6, 191–2 corruption in, 176
smelting, 17 gold mining in, 17
smuggling, 186–90 greenhouse gas emissions, 123
South Africa, 21 uranium oxide, 31
Index 201
Urgent Issues Group (UIG), 147 Wilkins, Mira, 18

US Foreign Corrupt Practices Act, 181, Witwatersrand, 17–18
182–3 wolframite, 191
Venezuela, 189 Zimbabwe, 189

vertical integration, 10, 11, 19 zinc, 13

Contemporary Issues in Mining Leading Practice in Australia

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Contemporary Issues in Mining

Also by Nigel Finch

BEST PRACTICES IN MANAGEMENT ACCOUNTING (with G. N. Gregoriou)

FUNDAMENTALS OF CORPORATE FINANCE (with Jonathan Berk, Guy Ford, Peter

List of Tables vii

List of Figures viii

Part I Strategic Perspectives

2 The Role of Mining in the Australian Economy 27

Part II Operational Perspectives

4 MRO Procurement: Best Practices Framework for

Part III Financial Perspectives

6 The Tax Accounting Interface in the Mining Industry

7 Carbon Tax: Economic Impact on the Latrobe Valley 122

Part IV Disclosure Perspectives

9 Capital Management Determinants of Financial

10 Transnational Corruption and Conflict Minerals 174

1.1 World production of selected non-ferrous metals 12

1.1 Comparative prices (five-year moving average),

Elizabeth Barber is an academic at the UNSW Canberra campus where

Mereana Barrett is Senior Lecturer in the Bachelor of Humanities

David Chaikin is Associate Professor at the University of Sydney

University of London. David’s research expertise is in comparative cor-

Hung Chu is Director at Lonergan Edwards Associates Ltd, Sydney.

Nigel Finch is an associate professor at the University of Sydney

Nigel Garrow is Lecturer in Management at Macquarie Graduate School

Ananda S. Jeeva is Senior Lecturer in procurement and supply man-

David Kelsey is a senior administrator at York St John University Business

Wayne Lonergan was Corporate Finance Partner at Coopers Lybrand

Svetlana Maslyuk is Lecturer in Economics at the School of Business

Simon Mollan is Lecturer in International Business at the University

and international taxation. He was previously a research associate at

Les Nethercott is Associate Professor at the School of Accounting, La

Daniel Pambudi is a consultant (data analysis) for Livestock

Greg Tower is a research professor at the School of Accounting, Curtin

Tom Valentine graduated from the University of Sydney with a B.Ec.

Robert Walker is Honorary Professor of Accounting at the University

0.1 An overview of the business history of the

This chapter surveys the international business history of mining from

0.2 The role of mining in the Australian economy

employment, exports and the current account balance. Second, it

0.3 Transportation issues of Australian coal and iron ore

The Australian export minerals industry is a leading user of transport

0.4 MRO procurement: best practices framework for

Maintenance, repairs and operations (MRO) of capital equipment is a

Procurement activities must consider the product life cycle of expen-

0.5 Practical problems in mining valuations

Whilst rarely applied in practice, the use of differential discount rates to

0.6 The tax accounting interface in

The interface of tax and accounting concepts has troubled account-

0.7 Carbon tax: economic impact on the Latrobe Valley

On 24 February 2011, the Australian Prime Minister Julia Gillard

reducing the nation’s greenhouse gas (GHG) emissions as the long-term

0.8 Permissive and uninformative reporting of

0.9 Capital management determinants of financial

This chapter investigates the communication patterns of Financial

overseas stock exchange listing of firms is negatively significantly asso-

0.10 Transnational corruption and conflict minerals

The global mining business faces a series of interrelated financial crime

enterprise is therefore important, because the decisions, choices and

formed to probe for mining opportunities. However, many FSCs were

1.2 Production and prices

Gold Mercury Silver

1851–1860 1,897.2 – – – 665.80 1,239.60 – 18,375.0 – 0.0 9754.0 192.20 – 724.4

Source: Schmitz, 1979 and Kelly and Matos et al., 2010.