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Potash Royalties and Mine Expansions

Saskatchewan’s NDP opposition recently called for higher potash royalties, a position long advocated by this blog.

Not surprisingly, the Saskatchewan Party government and the potash companies have objected. The argument from Premier Brad Wall and PotashCorp CEO Bill Doyle seems to be that mine expansions are occurring in Saskatchewan only because of royalty concessions granted by the previous NDP government. Raising royalties would allegedly “risk expansions and the jobs.”

In fact, as I pointed out months ago, raising royalties would not necessarily mean doing away with incentives related to mine expansions. Saskatchewan’s potash royalties consist of a base payment and a profit tax. In 2003 and 2005, the province instituted an inflated writeoff of new investment, a profit-tax holiday on production above the 2001-2002 average, and a base-payment holiday on production from mine expansions.

Saskatchewan could continue any or all of these concessions, but collect more royalties by charging a higher profit-tax rate on production up to the 2001-2002 average. In other words, it could maintain holidays for new capacity while collecting higher royalties from long-established capacity. However, it could also end the holidays without affecting mine expansions.

Did Royalty Holidays Cause Mine Expansions?

I have always been skeptical that the mine expansions happened because of royalty concessions. The existing companies want to increase their capacity to meet growing potash demand and perhaps to deter potential competitors from entering the industry.

It is much faster and cheaper to increase capacity by expanding existing mines in Saskatchewan than by building new mines. These factors, which PotashCorp emphasizes in its own reports, were enough to motivate mine expansions without royalty holidays.

At the time, the argument was that lower royalties were needed to ensure that expansion occurred in Saskatchewan rather than in New Brunswick. But New Brunswick responded with its own royalty concessions and PotashCorp is expanding its New Brunswick mine by 150%: a 1.2-million-ton expansion of a 0.8-million-ton mine.

Saskatchewan’s royalty concessions failed to attract any investment away from New Brunswick. However, mines are also expanding in Saskatchewan simply because it has so many more opportunities for expansion than New Brunswick. In other words, Saskatchewan’s royalty concessions just gave the companies extra profits on expansions that would have happened anyway.

Are Royalty Holidays Still Warranted?

But even if royalty concessions were needed in 2003 and 2005 to prompt mine expansions, it does not follow that they are still needed today. PotashCorp reports an average potash price (per KCl ton) of $80 in 2003, $143 in 2005, and $316 in 2010. Measures that might have tipped the balance in favour of mine expansions at previous prices are clearly not required to continue those expansions at today’s prices.

Indeed, BHP Billiton recently chose to build the huge Jansen Lake mine even though it will not benefit as much as existing producers from royalty concessions. Whereas the profit-tax holiday is for all new sales by existing producers, it will apply only to new sales in excess of 1,000,000 tons of K2O annually by BHP.

Furthermore, BHP cannot immediately deduct investment spending from current potash profits. It is hard to understand why PotashCorp, Agrium and Mosaic need royalty holidays to expand existing mines when BHP decided to build a new mine in Saskatchewan based on significantly less generous concessions.

UPDATE (February 4): Quoted in today’s Saskatoon StarPhoenix and Regina Leader-Post

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Comments

Comment from George Hambleton
Time: February 2, 2011, 8:44 am

I felt that the tax incentives of 2003 and 2005 were a reasonable effort to encourage development. I was, however, under the impression that these were temporary measures with a specified time limit. Now it appears as if no time limit was introduced. Is that the case or have I misconstrued the legislation?

Comment from Erin Weir
Time: February 2, 2011, 8:55 am

The base-payment holiday lasts for ten years after a mine expansion. The far costlier profit-tax holiday has no expiration date.

Comment from George Hambleton
Time: February 2, 2011, 1:16 pm

Thanks, Erin. I’m vexed at the thought of no expiration date on reduced taxes on profits.

Comment from Erin Weir
Time: February 2, 2011, 2:02 pm

The only overriding limit on this holiday is that each producer must pay profit tax on at least 35% of its total sales. However, that means a producer could pay no profit tax on up to 65% of its sales, which I do find vexatious.

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