Toronto, Ontario – December 5, 2011 - Kinross Gold Corporation (TSX: K, NYSE:KGC) announced today it has reached a non-binding agreement in principle with the government of Ecuador regarding key fiscal and legal parameters for the exploitation of the Fruta del Norte (FDN) deposit in Ecuador’s Zamora Chinchipe province.
A number of additional steps are required to conclude a final and binding agreement, including: the completion and approval of the project feasibility study by Kinross; a change in project status from economic evaluation to exploitation in accordance with Ecuadorian law; and, following the completion of negotiations, entering into definitive exploitation and investment protection agreements in a form satisfactory to the parties.
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The key terms of the agreement in principle include the following:
- An obligation to maintain the government’s share of project economic benefits at a minimum of 52%…
- A sliding-scale net smelter return royalty linked to the realized gold price, with a royalty of 5% for gold sold at a price of $1,200 per ounce or less, 6% for gold sold above $1,200 up to $1,600 per ounce, 7% for gold sold above $1,600 up to $2,000 per ounce, and 8% for gold sold above $2,000 per ounce. The net smelter return royalty is calculated on the basis of revenues after the deduction of windfall profits tax payments (see below) and customary transportation and refining charges;
- Advance royalties of $65 million credited against future royalty obligations…
- A corporate income tax rate of 22%…
- A profit sharing contribution equal to 15% of earnings before tax…
- A windfall profits tax, whereby the government would receive 70% of the excess of the realized gold price above an agreed base gold price. The base gold price is defined as the greater of $1,650 per ounce and the spot gold price at the time of signing of the definitive exploitation agreement. The base price is indexed to the United States Consumer Price Index (CPI) on a monthly basis. The windfall profits tax would be deductible for the purpose of calculating royalties, profit sharing contributions and corporate income taxes;
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[emphasis ours]
Zurbo, I was in the process of writing some comments in response to Silverax’ subscribers’ article; but I have now come upon your review, which challenges my thinking.
I haven’t gotten past the illustrative calculation table, assuming a gold price of $1730 and a cash cost of $366. That would result in an operating margin of $1364, right?
And since gold price of $1730 exceeds the windfall threshold of $1650, there would be a windfall tax of .70 x 80 = $56 payable, right?
Now, as I work out the tax payable in my Simple Simon the luddite fashion, I compute an effective tax rate of 56%.
I respectfully suggest that in all cases where the price of gold is greater than $1650, the effective tax rate will be greater than 52%, as there will be an incremental increase in the royalty (5% royalty is included in the 52%) and the windfall tax.
You posit the untenability of huge operating cost increases. Be reminded that this will be mitigated somewhat by upward adjustments to the windfall threshold of $1650, tracking increases to the U.S. CPI. Admittedly, local inflation could exceed that adjustment; but it does buffer your extreme.
Another observation: in the Technical Report, they report their expected cash cost of $366. They also say that operating costs include 12% value added tax on all items except Kinross labour, so this too can be backed out notionally – ie. won’t be subject to inflation.
Zurbo, I am having a hard time embracing your extreme cash cost inflation. It’s interesting to me that the Technical Report, dated 31dec10, was clearly prepared as a working paper for the negotiations with the government, as they assume the 70% windfall tax. “19.8.2 Windfall taxes, whereby the government will receive 70% of the revenue above a set gold price have been included in the model. It was assumed that the windfall profit trigger price, to be negotiated in the exploitation contract, will be above the assumed metal sales prices used in this study or sensitivity analysis range.” Throughout the month of December, 2010, the POG was bouncing in and around $1400/oz.. K’s sensitivity analysis range – in the series of Table 19’s only extended to $1400/oz! So, K, with Tye the gold bug at the helm (why else does he pay record breaking prices for projects?) clearly contemplated that $1650 could be the windfall tax threshold. Those guys can surely crunch numbers, albeit not as well as you, perhaps. Could they possibly be so stupid as to expose themselves to such cost inflation as you posit?
Enough for now.
There is an error in title: you said “agreement … on Fruta del Norte exploitation contract”, but the right wording is “agreement … on Kinross exploitation contract”.
In my opinion the company would be better not to mine FDN at these conditions, or at least to have Ecuador banks financing the project like Orvana did in Bolivia. Correa could even behave like Chavez and change the conditions in the future if the company were able to make a small profit. A lesson I learned on my skin is to AVOID every mining company operating in Venezuela/Ecuador/Bolivia/Mongolia/etc.
That is the correct wording per the news release on Marketwire. Sometimes the company will change the title on its website but technically what goes out on the wire is the correct version. I do agree Kinross will have to do something creative such as get special financing for building this mine. On avoiding EVERYthing in countries that have geopolitical risk I would say that can be a good tactic given the number of companies out there but under some circumstances it could make a lot of sense to make an exception. Without that, Tahoe would not have one of the world’s most valuable silver deposits in Guatemala and Ivanhoe Mines in Mongolia did go from $2 to almost $30 between 2008 and this year. Not only that, sometimes the wrong projects in the best jurisdictions can be ruined by geopolitical issues such as gas shale and uranium in Quebec for example.
@silverax
I agree exceptions exist and it is possible to earn money in all jurisdictions, just I fear it is not easy to understand before when the geopolitical risk is going to eat every profit and when not. At the time I bought Apex Silver, RML, DMM, SRL, KRI, etc. they all made sense to me, but I always lost money, so I suppose I was wrong, so why not make life easier and simply look elsewhere?
I do not avoid ALL unsafe jurisdictions, just the ones where other producers are never been able to make profits and the ones where the government has already shown it can change the rules and the previously contracted agreements. I’m not sure how many more than the 4 I mentioned there are that I would prejudicially avoid, maybe just Zimbabwe, so my red list is actually very short. For example I do have exposure in South Africa despite I’m not all that comfortable with it…
Guatemala is not in my red list nonetheless I believe Tahoe is overvalued and for me it is very difficult to believe that such a developer (with commercial production scheduled for 2014) can be worth 2.7 B $, it is more expensive than Pan American Silver or Coeur D’Alene, more than Hecla and Minefinders together, it is worth 2 times more than Silvercorp, 6 times more than Mag Silver, 10 times more than Orko Silver, etc.
@Giuseppe
Tahoe may end up producing as much silver as Silver Wheaton gets in streams, but at negative cost … yet trades less than a quarter SLW’s valuation. So it is all relative. That said, I would not look for a grand slam with that one, just a solid double.
I agree with your other points but there are more countries you should avoid if you avoid those: DRC, Kyrgyzstan, Egypt and maybe now Tanzania and Ghana since both are looking to grab more of the mineral wealth. Also China and Russia, Mexico, Brazil and some others could have a very negative geopolitical outcome in the longer term. In the U.S., they could change the
18781872 mining law and impose massive taxes to make sure only the most profitable mines have a chance to be developed. And so on. The point is that no absolutes exist and rather it is a scale — everybody must find their line in the sand and the tradeoff is still going to be risk vs. reward.@Giuseppe
Guatamala should also be on your red list. It is #5 from the bottom on the 2011 list from the Fraser institute, and even lower than Zimbabwe on #9.
That list is more or less as expected, although it’s a surprise for me how low an American state like Wisconsin can sink – exactly one place below Zimbabwe.
I realy like that list as it gives an insight into the knowledge of mining people. I just wish that they’d go into a state level detail with countries like Argentina and Peru just like they do for Canada and the USA.
@Tweetie
So of course we get into the problems of provinces as with Argentina and Peru, but yes the same also applies in Guatemala and in fact in Mexico itself and many other places. Even within a province you can have a vast difference between anti and pro mining sentiment by locals so really what I am still arguing, as I have from the start, that we should not necessarily place a “no go” on a country or region without looking at the specifics. Yes it takes more work than simply saying “I will not invest in any of these countries for any reason” but without the work you aren’t going to get the reward.