How profitable is mining?

According to the ABS, very profitable.

At the end of last month (May 28), the ABS published their annual “Australian Industry” release which looked at a wide array of comparative industry performance measures for the Australian economy in the 2008/09 financial year. The results for mining are probably worth going over considering the hyperbole venting from some sections of that industry at the moment over the RSPT, particularly when it comes to issues of comparative industry profitability.

First off for some context, it’s worth looking at the number of people employed in each major industry sector in Australia at the end of last financial year, and the proportion of all jobs in the Australian economy that each of these sectors made up.

Mining makes up 1.3% of all jobs in the economy. If we break the mining numbers down by state, this is what we get:

However, while mining employs only a relatively small number of people, it does have a much larger total economic effect as a consequence of the way mining investment flows through the economy – the so called “economic multiplier” of mining.

This multiplier is fairly large. The Qld government estimated in 2007 that the employment multiplier – the number of jobs created elsewhere in the economy for every job created in the mining sector – was around 4. That is similar to the employment multiplier for the construction industry, so it’s probably a little on the high side since the input-output tables of the national accounts and the old input-output multipliers that the ABS once produced suggested that the construction multiplier was a bit higher than that of mining.

But whether it’s 2,3 or 4 – mining dollars spread far and wide through the economy.

(Though, looking at the partisan political angle for a minute – it’s interesting that the Coalition is concerned about the negative effects of the RSPT in terms of the way the multiplier spreads the alleged impact of the RSPT through the wider economy, but ignore the same or larger multipliers that exist for the construction industry when it comes to the BER. But hey, this is politics and consistency has never been a particularly strong suit of the profession).

Before we get to profitability, it’s worth taking a slight sidetrack for a moment and look at a thing called EDRs. EDR stands for Economic Demonstrated Resources and is a measure of the demonstrated amount of various mineral resources available in the world. In Australia we also have a more refined measure known as Accessible Economic Demonstrated Resources. The AEDR is the size of total Australian EDR that is actually accessible and available for mining. AEDR excludes mineral resources which are inaccessible for digging out of the ground due to things like various environmental restrictions, the minerals sitting underneath land owned by the the Dept of Defence or resources that are inaccessible as a result of various government policies. AEDR measures the amount of stuff in the ground we can actually use under current law in Australia.

Using the AEDR measure, we can calculate the size of Australia’s known mineral wealth that can be dug up as a proportion of total known deposits on earth. Effectively, we can see what proportion of the world’s minerals Australia owns and can mine. This data comes from Geoscience Australia: (click to expand)

If we just look at those minerals where Australia owns more than 15% of all known deposits:

That last chart shows the minerals where Australia is not only a major global supplier, but where we have a significantly robust market position. We also need to remember that these resources are not only immobile, but finite – so keep that in your thought orbit for a bit.

Now lets talk about profit margins.

In the ABS “Australian Industry” publication linked at the start of the post, our national statisticians also calculated a number of ratios for industry sectors in the

2008/9 financial year, one of which was profit margin. If we compare the total profit margins of each industry sector in Australia, this is what we get:

Mining comes in highest with a profit margin of 37.1% and, well, daylight is second. Worth mentioning is that the average profit margin for all industries in Australia is 11.2%.

How does this profit margin compare to other mining operations around the world?

Price Waterhouse Coopers produces an interesting little publication every year called “Mine” where they track the fortunes of the worlds 40 largest mining companies by market capitalisation. Their latest publication was released last month, which you can download for your perusal here.

If we look at page 13 of that document, we can see the average profit margins of the largest 40 mining companies in 2008 was 17% while the profit margins of the largest 40 mining companies in 2009 was 15%. Since companies fall into and out of the top 40 every year towards the end of the list, PWC also produce an average profit margin for the largest same 40 mining companies and tracked them over 2008 and 2009 on page 27. On that measure, the aggregate profit margin was 16% in 2008 and 15% in 2009.

However – and typical with these bloody things (thanks to Scott in comments – here’s where the UPDATE comes in) –  these guys are walking to the beat of a different definitional dictionary, making a direct comparison impossible (insert much swearing, fist shaking and cursing at accountants for attempting to reinvent what was a perfectly operational and mostly round wheel)

Because of the lack of directly comparable definitions here between Australian mining profitability and the top 40 miners, we have to make a consistent estimate of our own from the data each provides.

So rather than use “operating profit before tax” to get an estimate of Australian mining industry profitability (what our ABS has used), we can use the ratio of EBITDA (earnings before interest,tax,  depreciation and amortisation) to revenue. Not the measure of profitability, but a estimate of profitability

For the Australian mining industry, this comes out at around 43%.

For the largest 40 global miners, after re-adjusting for PWC’s  “adjusted EBITDA” to get raw EBITDA, their ratio comes out at around 30% for the 2008/9 period (29.8% for one year, 30.3% for the other – split the difference for the two years and we get around 30%)

In 2008/09, the Australian mining industry had a EBITDA/Revenue ratio of 43%  while the worlds largest 40 mining companies had a comparable estimate of 30%

Note: Not quite as dramatic as earlier, but still very substantial and the argument holds.

When mining companies in Australia say that their investment in mining will cease domestically as a result of the RSPT, they are effectively stating that their firm will not exploit these immobile, finite resources which make up to nearly 40% of the total global supply of these minerals.

Should we care if companies like Fortescue, Xstrata or Clive Palmer’s operations pull the plug or cease investment?

With profit margins that high in Australia compared to the profit margins that other domestic industries in Australia receive, and with EBITDA/Revenue ratios much higher in Australia compared to what the largest global miners are receiving around the world (especially considering that a part of these global earnings ratios are slightly boosted by Australian operations),  even under a worse case RSPT scenario where mining profits in Australia take a significant haircut ( a dubious argument at best considering the design of the tax), for every noisy mining interest in Australia that walks away, there will, literally, be an army of mining investment and general investment  lining up to take their place.

Our profits and our resources are simply too good an opportunity to pass up – even if the profit margins involved in Australia are halved seriously reduced. When the noisy miners say that their capital is mobile, they are dead right – their capital is indeed mobile, but in exactly the same way that every other mining firm’s capital is mobile, including the capital of the worlds largest 40 miners.

With industry profits in Australia so high compared to both other domestic industries and the largest 40 global miners, with Australia owning a substantial piece of the worlds immobile and finite accessible  mineral resources, Big Dirt walking away from Australian investment will be their loss, not ours – because someone else will simply take their place.

Big Dirt – welcome to capitalism.

It’s also worth mentioning that the RSPT operates such that owning 60% of a highly profitable operation for 60% of the cost and receiving 60% of the profits (or taking only 60% of the losses – less across the board for less profitable mines) only makes the balance sheet burden-sharing of the governments cost rebates and the engineering of financial products to more equitably share that burden-sharing the actual key problem when it comes to sustaining rational economic investment in Australian mineral exploitation.

Don’t be surprised if something is negotiated on that issue which in  some way ameliorates companies carrying the full burden of the governments “promise to pay” on their own balance sheets.

UPDATE:

How profitable is mining Part 2 – mining industry profits by business size, proportion of unprofitable firms and how the anti-RSPT hysteria is not representative of the economic self interest of the majority of the firms in the industry.