Ecuador: Talk of mining tax reform is fools gold

Country Background:
GDP growth forecast: 4.5% (2012, IMF forecast)
GDP per capita: US$4,424 (2011)

ASX stock relevance: Copper and Gold sector

Last month the Ecuadorian government suggested they may revise the current punishingly high royalty and windfall tax applied to mining projects. While it sounds good in theory, there is no guarantee the old system would not be reinstated longer-term once capital hungry projects are operational. This comes from the same government which named mining as a key sector for nationalisation as recently as 2009. It seems extremely unlikely that Ecuador overnight has earnestly turned pro-foreign ownership overnight. Any investment by ASX-listed miners should be viewed as high risk.  

Taxation or Nationalization

Ecuador’s copper and gold projects have been at a virtual standstill since 2008 when a punitively high royalty and profit windfalls tax on the resources sector was introduced. As it stands, the windfall tax requires a base price by commodity and contract, negotiated between mining companies and the state, and any revenue above 70% of the base price goes directly to the government. In addition to this the base royalty payment is a minimum 5%, with no defined maximum rate.

Excessively high windfall taxes and royalties have been used in Ecuador to nationalise the oil industry. In 2007 Ecuador raised the windfall tax on oil from 50% to 99% while offering foreign owned companies the option of either accepting the tax, or selling their projects to the government at a ‘fair price’. As a result effectively 100% of Ecuador’s oil production is now state owned. The difference in the mining sector is that many of the biggest projects have not yet been built. This puts the Ecuadorian government in a bind; it wants to diversify revenues away from the oil sector, but doesn’t have the capital or expertise to develop the mining industry itself.

Canadians getting their bacon burned

Luckily for Australia, ASX-listed exposure to Ecuador is limited. Panterra Gold (ASX:PGI) has the Azuay project which it believes will begin construction this year – sounds ambitious given the ambiguous royalty landscape. Most projects are Canadian owned. Kinross Gold (TSX:K) owns the hugely gold rich Fruta del Norte (FDN) project, and Corriente Resources (TSX:CTQ) has the Mirador project; two of the more advanced projects in Ecuador. Dynasty Metals (TSX:DMM), International Minerals (TSX:IMZ), and INV Metals (TSX:INV) also have significant mining projects in the country.

Given Ecuador’s track record in oil & gas and the rising tide of nationalism in South America as a whole, I have more faith in eating a garden salad from a street vendor than believe that a revised royalty scheme will be honoured. It at least one Canadian mining firm seems to agrees. Last month Iamgold Corp (TSX:IMG) sold its 3.3m oz Quimsacocha gold project to INV for a fire sale price of C$30m in stock.

Fools Gold

The prospect of tantalizingly cheap copper and gold projects could tempt ASX listed miners into taking a gamble on Ecuador. Even at paltry low prices, investment could prove to be a false economy. Acquisition of a project itself is often only a fraction of overall project costs. Even if roadblocks of royalty payments and mining concessions can be surpassed, indigenous protests can pose serious problems – just ask Newmont in Peru. While talk of mining reform in Ecuador may seem encouraging, it’s more likely just a wolf in llama’s clothing.