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Dave Forest

Dave Forest

Dave is Managing Geologist of the Pierce Points Daily E-Letter.

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Chile Introduces Sliding Royalty Scale on Copper Production

I wrote yesterday about the importance of tailoring royalties to fit the situation for different oil and gas plays.

Today, there's news on an interesting riff on this idea. Tailoring royalties to fit the situation for the collecting government.

The government of Chile needs funds. The Chileans are looking at several billion dollars in costs to repair damage from the recent mega-quake.

On Friday, the government outlined plans to raise these funds. Announcing tax hikes that will bring in an estimated $3.1 billion.
Some $700 million of that will come over the next three years from the copper mining sector.

The government is introducing a sliding scale royalty on copper production. Under the scheme, producers will pay between 3.5% and 9% of revenues, up from the current 4-5% flat rate.

There's a problem, however, with changing the royalty regime. Most of the major copper producing companies in Chile have "invariability agreements" with the government, that prohibit unilateral changes in fiscal terms like royalties.

Faced with this situation, the government could have been heavy-handed. They could have nullified the invariability agreements and imposed royalty changes on a "take it or leave it" basis. After all, Chile is one of the premier copper districts on the planet. It's unlikely producers would pull up stakes and leave.

But the Chileans have come up with an interesting alternative. They're giving producers a choice on paying higher royalties.

Specifically, they're offering companies something in return for electing to pay higher royalties during this time of need. Here's how it works.

Companies can opt to pay according to the sliding scale royalty for 2010 and 2011. After those two years, royalties will return to the 4 to 5% fixed rate.

Any company that does take a voluntary increase in royalties will receive an eight-year extension to their invariability agreement with the government.

This is a sizeable carrot. Most companies' invariability agreements are set to expire around 2017. At that time, they would be completely and legally subject to any royalty or tax increases the government imposes.

By paying up a little more over the coming two years, companies can buy an "immunity idol" for eight additional years of royalty certainty. Not a bad trade. Giving producers an economic incentive to help the government meet its short-term funding needs.

This is creative and progressive thinking at its best. The Chileans have always been very good at balancing the interests of state and business. Even the new sliding scale royalty will be calculated based on profitability. Only companies whose profits are greater than 75% of income (that is, very high profit margins) will have to pay the top 9% tax bracket.

This is another smart approach: tax people who can afford to pay. Too many governments make the mistake of imposing off-the-top taxes that make projects unprofitable. If companies can't make money they're going to stop operating. And the government will collect zero in royalties, no matter how high the rate is.

By. Dave Forest of Notela Resources

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