Perilya Broken Hill Limited v Valuer-General

The cost of pre-production development 13There was no evidence of the cost of re-establishing the mine. Mr Herdman allowed $60,000,000 for this item. Mr Hopcraft did not make any allowance for this item. Counsel for both parties, however, accepted that there would be some cost, which would be in addition to the agreed capital cost of $195 million for plant and equipment. It is self-evident that costs would be incurred in employing staff to plan and design the required plant, machinery and buildings; to call and assess tenders for the provision of plant, machinery and buildings; to supervise the installing and commissioning plant, machinery and buildings; and to engage and employ about 350 staff required to operate the mine. In the Court's experience approximately $10 million would be incurred under this item. 14There would be no cost in extending shafts and drives as they are assumed to already exist at the valuation date, so that the mining machinery would immediately have direct access to the ore body. 15As noted at [13] above, in the Court's experience, the cost which would be necessarily incurred is about $10 million, of which $3 million would be incurred over the first year and $7 million over the second year.

Pre set-up period 16It follows from [13] - [15] above that a start-up period of two years would be required before any production could commence. This is consistent with the expert evidence. Mr Herdman, who has had considerable experience in the field, said that it would take a minimum of two years for a mine operator to design, call tenders, order and install the necessary plant, machinery and buildings before the mine could commence operating. Mr Hopcraft initially made no allowance for a start-up period but conceded in his evidence that there should be an allowance for a start-up period of between one and two years and that a two-year period would be reasonable. I am prepared to accept the specialised expertise of Mr Herdman and adopt a two-year deferral period before the commencement of production.

The capital cost of equipment 17I have noted that the parties agree that the cost of purchasing, installing and commissioning the necessary plant and equipment for mining is $195 million. Mr Herdman accounted for the entire cost in the first year. I have noted at [16] above that Mr Hopcraft conceded that it would be reasonable to allow a period of two years to return the mine to an operational condition if all the plant and equipment had been previously removed. In the Court's experience this expenditure would not be totally incurred in the first year, and a more realistic approach is adopted by allocating $95 million in the first year and $100 million in the second year.

The anticipated prices for the extracted minerals 18Mr Herdman contends that the anticipated prices should be based on the average price of the minerals from 2003 to 2012 to allow for the cyclical nature of the commodity markets. Mr Hopcraft contends that the prices should be based on the spot prices on 1 July 2007, being the relevant date of valuation. Both parties agree that the prices spiked in 2007 and the market was then generally optimistic. 19I am not persuaded by either approach. Mr Hopcraft's one day spot price approach is to take a view which is far too short. It is highly unlikely that an operator of the mine who had to commit some hundreds of millions of dollars to the project would rely on a sudden spike in mineral prices. It is more likely that a range would be taken proximate to the valuation date. From the Court's experience, in the bullish economy existing in July 2007 a prudent hypothetical mine operator would base its calculation on the average annual prices for 2005, 2006 and 2007 with a double weighting being applied to the 2007 figures. The anticipated mineral prices thus adopted are: zinc $3,547.74 per tonne lead $2,406.81 per tonne silver $ 434.92 per kg

Expenses as proportion of earnings 20Neither valuer provided detailed evidence of the ratio of costs to expenses. Mr Herdman reviewed the financial statements of Perilya for the years 2004, 2005, 2006 and 2007 and determined that the average for fixed and variable operating costs were 71.31 per cent of gross revenue. Mr Hopcraft's review of the financial statements showed that fixed and variable operating costs were 65 per cent of gross revenue. This is, coincidentally, the Perilya figure, rounded to the nearest whole number, on the 2007 accounts and is the mid-point for mines in New South Wales generally. 21Having regard to the cyclical nature of mining profits, the optimism in the market for minerals in July 2007 - confirmed by statements in Perilya's 2007 annual report - it can be concluded that a prudent hypothetical purchaser would approach the question of the expense ratio in a similar manner to the price of minerals - that is, by considering the 2005, 2006 and 2007 figures actually achieved in this mining operation, with double loading being applied to the 2007 figure. This results in an expense ratio of 61.74 per cent, resulting in a profit margin of 38.26 per cent, which I adopt.

Discount rate 22Both valuers agreed to adopt a discount rate for profit and risk of 25 per cent. There are a number of variables which bear upon the discount rate, including ore prices, the cost ratio, currency risks, and start-up costs. The agreed discount rate should be applied for the life of the mine.

Rehabilitation security cost 23Each of the mining leases in the present case require, individually and collectively, the provision by the leaseholder of a security in the sum of $23,893,742 to be given and maintained with the Minister, to secure the fulfilment by the leaseholder of its obligations under the lease. The leases state that the security must be in cash or a security certificate in a form approved by the Minister and issued by an authorised deposit-taking institution. 24Mr Herdman's uncontradicted evidence is that it is uniform practice in the mining industry to bring the security into account as a cost at the commencement of the mining project. Accordingly, I find that the security must be included as an establishment cost of the mining operation. Mr Herdman, however, made no balancing entry to reflect the return of the security at the end of mining operations. 25If the security is included as an establishment cost of the mining operation, then clearly it should also be included as a non-taxable sum available to the mine operator when the mine is closed. It cannot be assumed that the mine operator would not fulfil its obligations under the lease.

Depreciation 26The Valuer-General submits that allowing for depreciation amounts to double counting the cost of the plant and machinery. 27However, an examination of the calculations adopted by Mr Herdman in his spreadsheets tendered in evidence show that the only function of including depreciation as a cost is to calculate tax. That is, the cumulative cash flow which he adopted is a pre-depreciation cash flow and the amount of depreciation is not reflected in the discounting process other than to calculate tax. There is no double counting of the $195 million cost of the plant and equipment. I thus do not accept the Valuer-General's submissions.

Rate of payment to landowner 28As noted at [8] above, the parties agree that the rate of payment to a notional lessor would be four per cent of the profit to be derived from the mining operations. The parties do not agree as to whether this should be applied to the cash flow before or after tax. 29Mr Herdman's evidence is that in his experience a percentage royalty is always calculated on an after-tax basis, this being the actual cash which is available for payment. 30Mr Hopcraft's evidence, based mainly on his expertise in valuing quarries, is that royalties are frequently based on a rate per tonne. 31I prefer the evidence of Mr Herdman, who has had extensive experience as a mineral valuer in the operation of underground mines and of the practice generally adopted in such enterprises. I thus accept that the royalty should be based on an after-tax calculation. 32In passing I note that the parties accepted that in this case it is not appropriate, when deducting the cash flow upon which the royalty is based, to deduct the Crown royalty. For the purpose of the present exercise it is ignored.

Conclusion 33In the light of the foregoing, the resultant net cash flow to the mining operator, from which the 4 per cent royalty is to be paid, is calculated in accordance with the spreadsheet which is annexed to this judgment. Three matters should be noted. Firstly, the royalty would only be payable once the mine achieved a positive cash flow. Secondly, the royalty would be payable on the annual cash flow and not on the cumulative cash flow as shown on Mr Herdman's spreadsheet which was tendered. Thirdly, the calculation in the annexed spreadsheet is based upon the actual figures set out in the evidence, rather than some of the rounded figures. As demonstrated by the annexure the net present value of the royalty stream, as at 1 July 2007, is $4,904,435.66 (after tax), which may be rounded to $4,900,000, this being the capital sum which the fee simple of the land might be expected to realise if offered for sale on such reasonable terms and conditions as a bona fide seller would require (assuming that the improvements, other than land improvements, had not been made). 34I acknowledge the assistance of Acting Commissioner Cowell, who heard the case with me.

Orders 35The Court makes the following orders: (1)The appeal is allowed. (2)The determination of the Valuer-General is revoked. (3)The value of the property described as ID3448162 as at 1 July 2007 is determined as $4,900,000. (4)The exhibits may be returned.

Annexure DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated. Decision last updated: 19 October 2012