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Mining exploration finally gets some love from regulators    

Industry wants government to emulate Canada’s hugely successful exploration model to unlock financing.
A flow-through tax incentive wouldn’t hurt SA’s revenue collections and would deliver considerable macro-economic impact, including immediate job creation. Image: Shutterstock

It’s astonishing how fast things can change in a few months. A year ago mining exploration, while not exactly dead, was gasping for air.

“There’s no reason why SA should not account for a far larger share of global investment in mineral exploration,” says Errol Smart, MD of junior miner Orion Minerals, which has invested R450 million over the last five years on the Prieska Copper-Zinc Project in the Northern Cape.

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Smart was speaking at the Joburg Indaba last week. This is a bold statement, given the wholesale desertion of SA as an exploration venue in the last 10 years.

Orion is reviving a copper and zinc deposit abandoned 30 years ago by Anglovaal, when it ran into technical difficulties and sharply falling commodity prices.

“I went looking elsewhere in the world for minerals and eventually came back to SA,” says Smart.

“Geologically, the Northern Cape is excellent. We have 23 commodities of interest on our property, from nickel and copper to rare earths.

“There are few places in the world that have been underexplored, and yet have superior geological endowment. The Northern Cape is one of them. Give us the right regulatory environment and some seed capital, and exploration will explode.”

Read: While no one was looking, a miner pulled off a major gold find

Glen Mc Gavigan, head of technical and projects at Kumba Iron Ore, echoes this view: “The Northern Cape is underexplored. These mines we are working were mostly found in the 1950s with some deposits in the 1980s. We need to look again.”

Exploration tech has changed the game

Exploration technology has evolved in leaps and bounds since the 1980s. There are new technologies that can be applied to the local terrain, with potentially huge deposits waiting to be discovered.

SA has among the richest mineral endowments in the world, yet accounts for less than 1% of the $10 billion global exploration budget: the result of previous government hostility to mining and several early iterations of a Mining Charter that insisted on black economic empowerment (BEE) participation in exploration, one of the riskiest sectors of the economy.

This made no sense to mining investors, particularly those willing to put money up for high-risk, early stage exploration.

Why, they wanted to know, should they have to take on BEE partners who carry none of the downside risks, but all of the upside?

When Gwede Mantashe took over as mines minister he got the message, and BEE obligations were removed from the latest version of the Mining Charter for those seeking exploration licences.

“The Covid crisis has changed things and the big difference is the government and industry are talking to each other rather than confronting each other through lawyers,” says Smart.

The Canadian model, and why it would work in SA

One plan on the table to unlock financing for exploration is to adopt the hugely successful Canadian model of ‘flow-through’ shares (FTS).

An FTS is a type of share issued by a corporation to a taxpayer.

It allows the exploration company to raise finance through the issue of shares, and pass its tax benefit on to the taxpayer. The taxpayer is then able to sell that share to others looking for a tax benefit.

In practical terms the introduction of this model in SA would have little or no negative effect on tax revenue (due primarily to the secondary and induced taxes resulting from exploration expenditure, such as PAYE on salaries and value-added tax on goods and service providers) – and it would allow for a potentially huge injection of capital at the local level, where it is needed most.

It would also open up SA exploration for foreign capital.

As things stand, Smart estimates that every R100 spent on exploration expenditure results in R30 flowing to the South African Revenue Service (Sars) as secondary and induced taxes.

Read: South Africans are making waves in North American mining

A study by PwC suggests the introduction of FTS could be close to revenue-neutral for Sars by allowing investors to claim their total equity investment in an exploration company as a deduction against earnings and thus experience the benefit of a small deduction (28% of the value invested for companies or 45% for marginal taxpayers).

Exploration expenditure spent within one year after the investment will result in secondary and induced taxes roughly equal to the reduced direct taxes that the investors, who would be a blend of both corporate and marginal tax payers, benefitted from as a tax reduction in the same year. The exploration company in turn sacrifices its tax deduction for the exploration capital expenditure and thus pays taxes earlier when mining commences.

SA ‘needs’ this flow-through incentive

“We have fantastic Tier 1 [large, low-cost and long-life] deposits in SA that have not been touched,” says Smart.

“The volume of exploration capital flowing to the TSX and TSX Venture Capital market in Canada has been built largely on the back of the flow-through incentive. We need to introduce this in SA.

“The recent ANC economic policy document suggests that investors in exploration should be incentivised, so we think government should be receptive to this proposal,” says Smart.

“The big benefit is that we are not asking government to fund exploration; rather we are incentivising profitable businesses and individuals to direct their reinvestment of profits to a deserving industry with large macro-economic impact and immediate job creation.”

Read: SA looks to mining industry to fuel Covid-19 recovery

Unlocking finance is just one part of the puzzle in reviving exploration. The challenges in obtaining exploration licences and the need to wade through the bureaucratic miasma have also been identified as obstacles to investment.

Mining executives have been working with the minerals department and the Council of Geosciences to streamline the licence-issuing process.

Ranking system to cut red tape

“You cannot have a one-size-fits-all approach to mining regulations,” says Smart.

“We need a ranking system so that those licences that have little or no environmental impact can be fast-tracked. The same applies to other departments that get involved in the issue of licences, such as Heritage, Water Affairs and Human Settlements.”

With these problems solved, SA mining could again become a world leader.

“In 2007, mining was seen as sunset industry, and it took a lot of work to demonstrate this was not the case,” says Mosa Mabuza, CEO of the Council for Geoscience, also speaking at the Mining Indaba.

“We believe it is a sunshine industry. There is no reason we shouldn’t have the world’s largest share of global exploration and it can be done in three to five years.”

Former Billiton CFO Sir Mick Davis told the Indaba that SA mining will only survive if it can encourage future new investment.

This requires three elements to be settled, he said:

  • There has to be absolute clarity on how much the investor owns of what they invest in, and the extent of value leakage to meet the government’s objective on empowerment “needs to be defined and locked in stone”;
  • The lack of infrastructure required to support the industry both in power and logistics needs a clear government plan – even if the industry has to play a role in the development of infrastructure; and
  • There has to be an agreement with labour as to what the rules of engagement actually are, “and the industry cannot be part of a political interplay between government and labour”.

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I still don’t get it. Exploration is not subject to BEE, but the minute you have the ore body and want to mine you have to give away a third.

So it’s still pointless

It would also assist if the DME’s mining cadastre was far more accessible to potential investors than it currently is (in effect nil access).

Exciting prospects. SA regulators need to act fast and take this brilliant advice!

The BEE deal between Shanduka Resources and Lonmin proved how a BEE deal is a free Call Option given away as a donation by the owners of the business for the benefit of the BEE partner. Nothing is for free and an option structure has a cost involved, a premium to pay. It gets worse though. The Lonmin saga has also shown us that a BEE deal also brings the risk of a “margin call” for the “empowering” business. Lonmin was forced to pay special dividends that were supposed to be used by Cyril to service the loan, but he syphoned off the money and never repaid the loan. Therefore, for the empowering business, a BEE deal is not only the donation of a free call option to the beneficiary but also a perpetual margin call if things go the other way.

BEE is a Call Option that incurs a margin-call risk for the writer. For the business, it is zero potential upside with an unlimited downside. This is absolute insanity and no participant in the financial market would enter into such a deal. It is financial suicide, a recipe for bankruptcy. This “graveyard option structure” called BEE, buried Lonmin.

This proves the financial insanity of BEE.

Sage advice from Mick Davis – if anyone knows this field it’s him.

… essentially saying: set the rules, let business get on with it and government and politicians stays out of interfering from then on.

End of comments.

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