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Regime Change and Australia's Resources Super Profits Tax
By Peter Staas 6/25/2010 Energy Stocks In the most recent issue of The Energy Strategist, Editor Elliott H. Gue noted that any summer rally will have to contend with the threat of correction--a common occurrence during midterm election years.

Although President Obama’s approval ratings have ebbed and a bit of a shakeup in Congress is a distinct responsibility, the US political situation is hardly as fractious as Australia’s has been over the past month and a half.

Disenchantment with Prime Minister Kevin Rudd, simmering over the past month and half, came to a boil yesterday after a mutiny within the Labor Party government forced him to resign his post.

When Rudd and the Labor Party swept into power in December 2007, ending the 11-year rule of John Heward’s conservative coalition, few could have foreseen that his tenure would end in the ignominy of becoming the first prime minister since World War II to fail to secure a second term.

The rapidity with which Rudd burned through the goodwill he built up after steering the country through the credit crunch and global recession is truly amazing. Rudd’s approval ratings tumbled from 74 percent in March 2009 to 41 percent in early June.

What prompted this precipitous fall from grace? It wasn’t anything as tawdry as a sex scandal or other ethical issue, but rather a controversial tax policy that would have screwed the mining industry.

Initially pitched as a populist move to prevent profits from Australia’s mineral wealth from heading overseas--foreign interests own large portions of mining giants BHP Billiton (ASX: BHP, NYSE: BHP) and Rio Tinto (ASX: RIO, NYSE: RTP)--the measure called for a 40 percent headline tax on so-called “super profits,” or any profits above a 6 percent return on assets, to correct this situation. The RSPT also played a key role in the government’s plan to pay off its debts three years ahead of schedule.

The outcry over the resources super profits tax (RSPT) didn’t pick up until early May, when Rudd officially unveiled the tax, though the proposed tax it was first announced in July 2009 and has been public fodder in Australia since early January. Why the delayed reaction? Most analysts expected policymakers to make at least a good-faith effort to consult with the industry on the terms of tax reform. Rudd’s staunch refusal to negotiate with Australia’s miners proved a huge mistake and likely increased the vitriol of their response.

What Rudd, a respected foreign policy expert and Mandarin speaker, failed to grasp was the importance of the mining to the health of Australia’s economy, especially in rural districts where the industry has been a boon to the local economy and tax rolls. Rudd’s rallying point: His contention that the mining industry generated AUD180 billion in higher profits over the past decade, while the people of Australia (represented by the federal government, of course) received only an additional AUD9 billion in tax revenues.

There’s no question that the minerals industry has thrived. Australia boasts deposits of wide range of metals and minerals, including iron ore, nickel, bauxite, copper, gold, silver, uranium, zinc and coal. In many instances, it’s a top-five producer of these commodities.

Robust demand in China for coal, iron ore and other commodities has been a huge boon to profits at BHP Billiton and Rio Tinto, and the companies’ efforts to sell more iron ore on the spot market should only increase revenues going forward.

But the mining industry’s good fortune has filtered through to the Australian economy. The Minerals Council of Australia (MCA) estimates that the mining industry accounted for 8 percent of Australia’s gross domestic product in fiscal year 2009-10, up from 6 percent the year before. Mineral resources also accounted for roughly AUD1 of every AUD2 in exports in 2008.

The strength of the mining industry and Chinese demand for its products is widely acknowledged as a key reason why the Australian economy grew 2.2 percent in 2008 and 1.4 percent in 2009 amid a global credit crunch and recession. And the MCA estimates that the industry has invested AUD125 in Australia, much of which has flowed to rural areas.

By and large, Australian’s didn’t buy Rudd’s rhetoric.

A massive publicity campaign on the part of the mining industry to “Keep Mining Strong” drove home the adverse impact that the world’s most expensive mining tax would have on the mining industry, pensions and the Australian economy. In early June a public opinion poll found that 36 percent of participants favored the mining tax, 41 percent opposed the measure and 98 percent acknowledged that mining firms were integral to the Australian economy.

Perhaps the final nail in Rudd’s coffin was his controversial decision to allocate AUD37 million in taxpayer funds to launch an ad campaign to counteract the mining industry’s rhetoric.

Yesterday the ruling Labor Party elected former Deputy Prime Minister Julia Gillard to replace Rudd, making her the country’s first female prime minister. One of Gillard’s first moves was to cancel Rudd’s publicly funded ad campaign in support of the RSPT and express her willingness to negotiate with the industry. The market regarded the change as a near-term positive for miners of coal and iron ore, two of Australia’s biggest exports.

But politics are an uncertain beast, and questions remain about whether the Gillard-led government ultimately will reach a settlement with the mining industry before the likely election in October. (Heck, questions even remain about whether the RSPT would be as damaging as the mining industry claims--after all, it would replace state level taxes and much of the costs would likely be pass through to China).

However, there is one certainty--and it’s a compelling reason to invest in coal and iron-ore producers with Australian assets. China’s appetite for mineral resources will only grow as its economy develops. In fiscal year 1998-99, roughly 5 percent of Australia’s mineral exports were destined for China; in 2008-09, that share had grown to 33 percent.

This growth--and Chinese investment in Australia’s mining industry--stands to increase as the Middle Kingdom seeks to secure the resources vital to its future growth.

Elliott highlighted the strength of Chinese demand and Australia’s coal industry--the black gold accounted for roughly 20 percent of Australian exports in 2009--in the Dec. 9, 2009, issue of The Energy Letter, “Coal’s Bright Future”:

Asian countries outside the Organization for Economic Cooperation and Development (OECD) currently generate roughly 70 percent of their power from coal. Coal-fired generation in the region is expected to soar more than 176 percent by 2030.