Peruvian royalty proving problematic

Lima, Peru — Record international metals prices have been hugely profitable for Peru. They also brought with them a nasty surprise: mining royalties. Everyone, it seemed, wanted a slice of the pie. But if an additional tax on mineral sales was not enough, the new levy provoked more than a year of confusion and uncertainty, as lawmakers, government officials and high court judges argued over who should actually pay the royalty.

Now the authorities say the saga is over. This month, Peru’s mines ministry published a list of 27 mining projects that are exempt from the 1-3% royalty, which is levied depending on the size of a company’s turnover.

The projects include Barrick Gold‘s (ABX-T) Alto Chicama and Pierina gold mines, Phelps Dodge (PD-N) and Minas Buenaventura‘s (BVN-N) Cerro Verde copper pit expansion, and BHP Billiton‘s (BHP-N) Tintaya copper pit, which has the longest exemption, running through 2018. From then on, all mining companies operating in Peru must pay the royalty. The reality is that most projects will face the royalty in 2007, as the majority of exemptions expire.

The list brings a measure of clarity, but remains imperfect. The government must still decide when the exemption expires for three projects, including Alto Chicama, while it is not apparent how it arrived at its methodology. Peru’s top tribunal, the Constitutional Court, ruled this year that all miners must pay the royalty, regardless of their tax stability contracts. But companies argue those tax agreements are set in stone. More are worrying since, because the list is the interpretation of legal rulings, there is no guarantee future governments will stick by the exemptions. “It’s a bit of a guessing game to know if the list will be respected,” concedes Cesar Polo, a former deputy mines minister and currently an adviser to the mines ministry. “There will probably be some adaptation as the law is applied based on what works and what doesn’t,” he added. Indeed, President Alejandro Toledo’s unpopular government has only a year left in office and Peruvian politicians are not known for carrying on policies passed down by previous governments.

Perhaps the root of the royalty’s disarray is that, unlike in Chile, it was never the government’s idea, rather a knee-jerk reaction by legislators to soaring metals prices. One of the royalty’s principle proponents, left-leaning lawmaker Javier Diez Canseco, says the tax is a fair way to charge miners for mining a non-renewable resource and sees the law as a success. “It’s time mining companies gave Peru something back!” he says.

Lawmakers voted overwhelmingly in favour of the law in June 2004, maintaining that extractive industries enjoyed low taxes for more than a century. But from the start, miners warned that such legislation would kill the goose that lays the golden egg. Mining generates 55% of Peru’s exports and has flourished since 1990, not just because of mineral prices, but also thanks to billions of dollars of investment and a constructive operating environment. Now, Peru’s National Society of Mining estimates the royalty makes around one-third of a pit’s resources unprofitable to mine, leaving much ore in the ground.

Analysts argue that since Peru’s pro-mining government had misgivings about the royalty, it should never have signed it into law. “We’ll make changes later,” was Prime Minister Carlos Ferrero’s response, at the time. That stance turned out to be extremely optimistic given that Toledo’s ruling Peru Posible party lacks a majority in congress and attempts to tinker with the royalty have failed. The government has tried to impose a mechanism within the law that freezes the royalty when metals prices fall below a certain floor. When asked whether the modification will be accepted, Mines Minister Glodomiro Sanchez said: “It’s up to lawmakers to decide,” admitting that the proposal is stalled in congress. For mining companies, that omission throws salt in the wound. “We’ll be paying the royalty even if we’re losing money,” says one mining executive.

There are also doubts that the US$50 million the government estimates the royalty will generate every year will reach the communities that most need it. By law, royalty money must go to mining regions and universities, via the central government, which is itself short of funds. Peru’s finance minister Pedro Pablo Kuczynski has suggested mining companies administer some funds directly and help build the infrastructure that villages so desperately need, but the proposal has yet to gather official support.

To both the detriment of Peru and to mining companies, the royalty is likely to be permanently flawed because it was never clearly thought out. According to lawyers representing mining companies, it is unconstitutional because it was not voted on twice, as natural resource laws must be in Peru, and it infringes on existing tax stability contracts. It is also likely to hurt small miners most, as they are least able to cope with higher tax demands, preventing the future development of smaller, though equally important, projects.

Miners also complain that the government is not clear on how it is levying the tax — the royalty is on sales of “concentrates or equivalent” — although it began charging the royalty in March. The royalty scenario increases the possibly of sending future investors elsewhere, notably to Chile or Mexico. Oscar Gonzalez, Southern Peru Copper‘s (PCU-N) chief executive, says he is already considering moving some funds to Mexico, as the Peruvian royalty will cost the company $20 million a year. Mexico, meanwhile, says it is unlikely to introduce royalties, mainly because the sector makes up a much smaller part of its economy.

— The author is a freelance writer based in Peru.