Chilean Mining’s New Regime
The Chilean government offers new regulatory clarity
According to recent data from the US Geological Survey, Chile has the largest copper reserves of any country by a wide margin. The country has 190 million metric tons (t) as of 2022, nearly double the reserves of second-placed Australia. The reserves guarantee copper production for the next century at the current extraction rate.
The most significant factor inhibiting Chile’s full-throttle development of its already strong and established copper industry has been a lack of legal certainty. As a result, the country dropped significantly in the Fraser Institute’s index of economic freedom, from 13th in 2019 to 33rd in 2022. Wary of civil unrest and regulatory uncertainty, investors have hesitated to move into Chile. However, as one CEO explained, the Fraser Institute’s index is based on perception, not reality. Investors may have developed a negative perception of Chile, but this does not mean that the country is risky.
Pablo Peñaranda, director of business development at Black & Veatch, stated: “It has been forecasted that by 2031 at least US$74 billion in investment will be required for the Chilean mining industry to keep up with demand. However, approximately 60% of mining professionals and executives believe achieving this investment is not probable.”
If the investment flowed in, however, the industry could utilize it. Peñaranda continued: “There are enough resources and capacity to develop at least three new greenfield projects every year.”
The moment for that increase in investment has come, both for copper and lithium. After years of a lithium industry in limbo, on April 21st, President Gabriel Boric announced Chile’s National Lithium Strategy, providing the rules and regulations of the lithium industry. Two weeks later, on May 10th, 2023, after nearly five years of uncertainty, the Chilean senate approved the final form of the long-awaited royalty bill.
In a sector hampered by uncertainty, the mining industry was prepared to accept and handle nearly anything so long as the rules of the game were clear. Now, these rules exist, and Chile is well positioned to attract investment and develop in the context of regulatory and fiscal certainty.
The royalty reform is limited at last
In early September 2022, President Gabriel Boric’s proposed new constitution came to a referendum and was defeated soundly. The mining industry breathed a sigh of relief as the proposed constitution would have dramatically dampened investor enthusiasm. The proposals included a change to water use, which would be regulated via authorizations rather than property rights; the prohibition of mining near glaciers without a clear definition for a glacier, potentially prohibiting projects such as Codelco’s Andina; plurinational governance that would dramatically increase permitting requirements and the number of players involved in any given project; and a change in mining concessions for administrative approvals.
The constitutional referendum’s failure averted a major crisis for the industry, but the industry has spent much of 2022 and early 2023 concerned about changes to the royalties system. On May 10th, Chilean lawmakers approved the final version of the royalty bill, and now it only awaits signature by President Boric.
The royalty bill establishes a maximum tax of 47% for companies that produce more than 80,000 tons of copper annually (t/y) and a flat-rate ad valorem tax of 1% on miners that produce more than 50,000 t/y. Additionally, they will have an 8 to 26% tax depending on their operating margin.
The new tax rate, which takes effect on January 1st, 2024, is undoubtedly a noticeable increase. At present, Chilean mining companies are taxed at a rate of between 41% and 44%, which is similar to competitors such as Peru. And indeed, that ad valorem component is viewed harshly, as when prices are low, mines can generate a loss with the tax and low profits. However, the bill includes wording clarifying that firms with operating profits in the negatives will not pay the ad valorem tax.
This increased tax will undoubtedly provide the government with a rapid increase in cash. It is expected to generate approximately an additional US$1.5 billion a year for the Chilean state. Uniquely for a country where the vast majority of social spending is concentrated in the Santiago metropolitan region, nearly US$450 million will be directly distributed to regional governments. Of that, US$225 will be dedicated to productivity and development, focused on increasing regional economic activity and innovation. US$55 million will be distributed to mining communities directly involved with mining, focusing on improving ports, tailings dams, and other mining-related areas, aiming to compensate for the external negatives of mining. The last US$170 million will be dedicated to territorial equity, focused on supporting the most vulnerable areas in the country, with approximately 300 communities identified as recipients.
“Our institutional framework favors mining. Unlike other Latin American countries, we have institutions such as Enami, that support small and medium scale mining and promote formality and good practices within the industry, since 1960.” Miguel Zauschkevich Domeyko, President, Chilean Mining Chamber
However, many industry leaders argue that more development within the mining sector, not higher taxes, would increase the state’s coffers and enable the Boric administration to fund its ambitious social plans. The short-term gains in funding by increasing the government’s cut of private sector profits will be less than the government could have gained by mining-friendly policies that incentivized an expansion in mining and the taxation to match. Manuel Viera, CEO of Metaproject, explained: “It is vital to find the equilibrium point at which the government can maximize the funds it raises for social development and ensure that a mine is still sufficiently profitable for the owners.”
The industry is committed to paying its fair share. “Mining was always willing to assume a higher tax burden and has never refused an expectation of paying more taxes. Often in the political world they say that mining has always refused to pay, but this is not true,” emphasized Joaquín Villarino, executive president of the Consejo Minero.
He noted, however, the squeeze on mining from all sides: “Costs have also increased dramatically due to lower ore grades, more difficulty accessing water, greater distance from the airport, and other factors. Profits are continuously shrinking.”
A strong, supported mining sector means a strong Chile. Sergio Demetrio, president of the Instituto de Ingenieros de Minas, said: “Chile is a mining country. Mining is an industry that drives development, not only because of the income and jobs it generates but also because it generates a value chain that benefits various sectors of the economy.”
It is this strong value chain for which Chile stands out, and that makes Chile an attractive place for investment. The country has a skilled workforce and a vast network of support services, paired with a rare degree of governmental stability, making it a comparatively simple country to mine. Now that the legal certainty is here, the future for Chilean mining is bright.
Productivity remains a challenge
The current state of the Chilean mining industry is shaped by more than just mining-specific legislation. President Boric and his supporters have seized upon their electoral mandate as an opportunity to make wide-ranging transformations to the current Chilean system. Alicia Domínguez, energy and mining leader at Ernst & Young Chile, said the industry is also impacted by other reforms beyond the tax reform. Domínguez stated: “The pension reform and the discussion of the new constitution are also flanks of normative discussion, generating spaces of uncertainty.”
“The conversation in the mining industry primarily revolves around the royalties bill, but to discuss reforms, we need to put everything on the table, including labor, pensions, and health,” Philippe Hemmerdinger, president of APRIMIN, agreed, noting, however, that the government’s wide-ranging reforms have met with significant resistance: “The government came in with a revolutionary program, but over the past year, but the country has communicated that it is not willing to accept such drastic constitutions or reforms.”
Considering the broader public pushback, the greatest success for the government among these reforms is the 40-hour bill. Currently, Article 22 of the Chilean Labor Code allows for a 45-hour work week, divided into a minimum of five days and a maximum of six. The new bill will reduce the maximum weekly working hours to 40, comparable to the OECD average. However, Chile’s worker productivity in terms of average hourly contribution to the GDP is below the OECD average. According to OECD data, in 2020, each Chilean worker contributed US$30.4/hour to Chile’s GDP. Of the 39 member states, Chile ranks 36th at this productivity level, with productivity well below the OECD average of US$54.5/hour.
Productivity per dollar spent is a significant challenge for the country and the mining industry. On the one hand, this is a nationwide problem – despite the country’s stability, the education system has low levels of achievement in English, math, and other areas. On the other hand, it is also specific to the mining industry. Germán Millán, a partner at PwC, explained: “Compared to mining jurisdictions such as South Africa, Australia, and Canada, we have much lower productivity and outcome levels per person for every dollar spent on the workforce.”
This lack of productivity has resulted in slower local capability development in the services industry. Millán continued: “A significant proportion of the mining services value chain is international players with a local presence rather than locally developed companies. In jurisdictions like Australia, a great part of mining services providers are Australian companies.”
Chilean mining’s productivity problem provides a window of opportunity for an industry-wide rethink of systems and processes. Historically, the mining industry has been comparatively risk-averse and slow to innovate. Now, however, necessity is opening doors. New technologies and innovative approaches are filtering through the industry on all levels of the Chilean mining value chain, from camp construction to drilling, building a more efficient mining sector.
Article header image courtesy of Glencore