In 1806 the Cape came under British rule and though the Roman-Dutch legal system was retained as the common law, it became "overlaid with a substantial blanket of English Law". The Cradock Proclamation of 1813 was the first significant alteration to the Roman-Dutch Law as it was practised in the Cape at the time. This Proclamation reserved the ‘right to mine’ precious stones, gold and silver for the government of the Cape Colony as was the custom in English Law. Having acquired this right the state was in a position to lease these rights to whoever it pleased.

After the 1836 Great Trek into the interior, several independent provincial governments were established. Each of these governments of the Republics of the Transvaal, Orange Free State and Natal, passed statutes which reserved certain minerals to them. Natal reserved to itself the right to mine all minerals, including coal, while the Transvaal and Orange Free State Governments followed the example of the Cape by reserving the right to mine gold, silver and precious stones for their respective states. Probably as a consequence of the discovery of vein gold at Eersteling in 1871, the Transvaal Republic passed Law 1 of 1883 which reserved the rights to all minerals for the state, and not only the right to mine for precious stones and metals. This statute was quickly repealed by Law 8 of 1885, which reintroduced the reservation of (only) the right to mine for precious stones and metals to the state. The Natal Government introduced the category that later became known as Trust Land by the enactment of (Natal Native Trust) Law 15 of 1867.

With the unification of the former independent Republics into the Union of South Africa in 1910, an attempt was made to consolidate the various Provincial Statutes. The first statute affecting mineral rights ownership in this consolidation process was the Land Settlement Act 12 of 1912. This Act specifically reserved ownership of all mineral rights, and not only the right to mine, for the state. However, the reservation to the state was overturned in 1917 so that mineral rights reverted back to the landowner. By the repeal of the reservation, to the extent that it affected privately owned land (and therefore also the mineral rights), the principle was established that the state owned the mineral rights to the vast tracts of land it owned at that time. As the state disposed of this land to individuals it retained to itself the right to the minerals. Such land subsequently became known as Alienated State Land. The Union still wanted control over the industry and therefore reserved to itself the right to mine gold, silver and precious stones on all remaining categories of land. The Union also upheld the Proclaimed land category, the lease consideration concept (for the right to mine) as well as the mining lease administration procedures introduced by the Transvaal Republic. The year 1942 saw the introduction of a provision whereby the state reserved the right to prospect and mine for oil to itself (Natural Oil Act 46 of 1942). The move towards state control continued in 1948, with the promulgation of the Atomic Energy Act 35 of 1948, which vested the right to prospect and mine for prescribed materials i.e. radioactive minerals, in the state.

The next stage in the constitutional development of South Africa was the formation of the Republic of South Africa in 1961. Over the years mineral rights legislation developed in such a way that various minerals were regulated by separate statutes which added to the complexity of the system. The Mining Rights Act 20 of 1967 was an attempt to consolidate the plethora of legislation under a single Act. However, it was decided that precious stones should continue to be governed by the Precious Stones Act 73 of 1964. The 1967 Act recognised the historically different categories of land as they had developed over the years and dealt mainly with administration of land over which the state had some control (e.g. proclaimed land). Mineral rights were again affected in 1975, this time with the passing of the Mineral Laws Supplementary Act 10 of 1975 which provided first a means by which mining companies could obtain mineral rights over land where:

· private mineral rights ownership was separated from the land;

· the mineral rights were held in undivided shares, and;

· permission to exploit the mineral rights could not readily be obtained;

and, second it prevented further fragmentation of private mineral rights by testamentary succession without state approval.

With the passing of the Minerals Act 50 of 1991 in 1992, the ‘right-to-mine’ principle, which had been a legal cornerstone of mineral exploitation in South Africa, expired. Perhaps the most interesting feature of the Minerals Act 50 of 1991, from a mineral rights ownership point of view, is section 64 that allows for the outright disposal of state-owned mineral rights to the private sector. The aim was to reduce government involvement and to create a market for state-owned mineral rights. This provision was directly opposed to the declared political philosophy of the up-and-coming ANC calling for state ownership in respect of all mineral rights.

South Africa has a complex system of mineral rights and land ownership with a strong racial bias towards whites. During white-dominated rule, land in South Africa was generally categorised into four main types, that is, Private, State, Alienated State and Trust land. The principle of severance of land and minerals title was embedded in the Cradock Proclamation of 1813. Such separation of rights was recognised through either separate registration of a certificate of mineral rights holding or a notarial registration at the Deeds Office. For each category of land there is a unique procedure by which prospecting and mining rights are acquired.

Since the late 1970s the multinational investor has shown renewed interest in developing the mineral resources of those countries whose mineral and fiscal policies promised significant returns in exchange for investment. This trend emerged because of a shortage of mining capital in the developing world. In return for capital, the investor is offered highly rewarding partnerships. Motivated by the need to attract essential capital into their economies, developing countries revised their mining and fiscal policies to attract foreign investment and promote their mineral industries. This trend in mineral policy reform has resulted in the fiscal regimes of many countries becoming more and more similar as policy-makers focused on maximising competitiveness.

Economic models, such as those proposed by Hotelling, which effectively state that a mineral resource would increase in value if left alone in the ground, bears little or no truth to the economic reality of mining. The truth is that the value of an exhaustible resource does not necessarily rise over time because new discoveries and technological advances together contribute to an increase in the reserve base rather than an increase in scarcity. Tilton asserted that economic rents should be utilised in specific ways in order to stimulate economic growth. This required that rents be invested in health, education, infrastructure and other sectors of the economy in order to secure prosperity and provide the impetus for other positive spin-offs to the economy.

Mineral production involves the transformation of non-renewable physical assets into reproducible capital. In the process returns on investment are produced. Economic rent is the financial return over and above that required to induce the investment. Economic rents are also sometimes referred to as distributional surpluses. If the definition of economic rent is applied to the minerals industry, the wording may change as follows: ‘Mineral rent is the present value of the future stream of net revenues that mineral deposits can generate over time, where net revenues are the difference between total revenues and total costs and costs include a competitive return on investment’. ‘Mineral rent’ may be regarded as ‘payment for mineral rights or the gifts of nature’ and it is no wonder that mineral economic literature frequently refer to mineral rent as ‘mineral royalties’ or ‘price of the mineral rights’.

The debate on mineral resource rent started when Smith (1776) adopted the classical view that the highest cost mine would determine the economic rent received by other mines. Mines whose costs were equal to mineral prices would receive no rent while others that mined higher-grade deposits or were located close to their markets, received rents. Smith’s definition for rent closely resembled the current point of view. A drastic departure from Smith’s way of thinking came when Ricardo (1821) argued that: "Rent is that portion of produce of the earth which is paid to the landlord for the use of the original and indestructible powers of the soil". Ricardo’s understanding of rent led to the term ‘mineral royalty’, which is a facility to compensate the owners of mineral resources for the depletion of resources when they are mined and removed from the land. Other approaches to rent developed over the years that emulated these early contributions, all of which, to some extent, resembled the theories of either Smith or Ricardo, or a combination of the two. Carey (1837) supported Smith’s work and explained how technological advances and capital investment could secure future mineral production and rents. Sorley (1889) published a paper that significantly shaped the understanding of mineral rent and its impact on mine profitability. According to Sorley, rent has two key components, namely fixed or Ricardian rent (periodic payments to the landlord regardless of the levels of production) as well as excess rents determined by the relationship between the costs of production and the market price. He proposed that mineralised land be nationalised in an effort to stop greedy landlords from charging heavy royalties, thereby forcing marginal producers out of the market. Ideologies such as these resulted in the current international norm where most countries do not allow private ownership of mineral rights. Taussig (1911) expanded Sorley’s concept that royalties were a combination of fixed payments (per ton) and variable payments according to the quality of minerals and ease of extraction. He argued that the fixed and variable components of a royalty together constituted rent. Taussig appreciated the reality that the owner of a high quality mineral resource was entitled to a higher royalty or mineral rent. This approach has led mineral resource owners to introduce excess rent capturing instruments similar to the present royalty regime in Ghana and the sliding scale taxation system in South Africa.

The recipients of mineral rent depend on the legal system of the host country. The simplest type of ownership is a system where private ownership of property and business are not allowed and the government, on behalf of the public, is entitled to all the rents. However, the demise of the former Soviet Union is proof that state intervention in the control and ownership of properties is not sustainable in the long run. The other extreme is private control of all categories of rights and property, allowing for little or no state control. The disadvantage of such a system is that many stakeholders share the rent, thereby reducing each recipient’s portion. This is particularly true for South Africa where the mineral rights in some areas are subdivided into undivided shares resulting in large numbers of mineral right holders over the same piece of land.

Essentially, any government has three ways in which to claim its share of mineral rent. The first is when the state owns the land and mineral rights and secures the rent either through leasing or selling the rights. The second is when the state imposes taxation to extract the rents. Finally, economic nationalism has led some governments to believe they are entitled to all of the rents generated by their mineral industries. Such ideologies have resulted in the creation of state mining enterprises through nationalisation of mineral properties or excessive state intervention in mine finance and management. Efficiency in production and economic principles in decision making are not generally synonymous with state mining enterprises, just as centrally-owned and managed minerals industries are not usually sustainable. Rents soon disappear when the costs of production exceed the revenue earned from mineral sales. There is currently a global shift away from nationalisation policies towards policies of free enterprise and privatisation. This has happened because host governments have realised that it is better to share mineral rents with investors rather than receiving no rent at all. Public policy will attempt to optimise a country’s mineral resource by ensuring the best possible use of the resource, that the split of rents is fair and the use of the resource is in the long-term interest of society.

The first recipient of investor rent is the investor, who will demand some blue-sky returns to compensate for the risks involved. The host government, as custodian of a country’s mineral wealth, is also entitled to a share of the mineral rent because the public will demand a return on the country’s mineral resources. The next recipient is the mineral rights owner who will expect payment for the depletion of its mineral resource. Because of its destructive nature, mining operations could severely impact on the quality of the land making the landowner, although not the owner of the mineral resource, a worthy and entitled recipient of mineral rent. Finally, the environmental and indigenous rights movements have become significant forces in deciding whether a minerals project will go ahead or not. This has resulted in rising costs which, by default, impact on the size of the mineral rent.

Recipients use a multitude of instruments to govern the size of the mineral rent they receive from mining projects. For example, the investor uses efficiency in production and good management, host governments use fiscal instruments, the mineral resource owners use a royalty, land owners use surface rental fees, environmental pressure groups use their influence on society to change the pattern of wealth sharing and, finally, local or aboriginal communities require compensation and contributions towards socio-economic programs.

A mineral royalty, is by definition, payment to the holder of the mineral rights when minerals are extracted from the land and sold on the markets. If a country’s legal system does not allow for private ownership of mineral rights, the mineral royalty will, by default, be payable to the state. It is the identity of the resource and not of the owner that is important when determining the amount applicable. Private sector royalties should therefore theoretically be equal to public sector royalties. Having said that, one should appreciate the vast differences in agendas between private owners and those of government officials administering the rights on behalf of the public. For this reason, there may be significant differences in the expected royalty for comparable mineral resources depending on the owner. This is because first, private owners of mineral rights negotiate the mineral royalty on a case-by-case-site-specific-basis while state-owned mineral rights are governed by an official royalty policy giving officials less room for negotiation. Second, the difference in royalty payment is that a private owner has only its own interests in mind when negotiating lease agreements while government royalties must support the national objective and still compete with the policies of other countries seeking investment.

The value of the minerals in the ground should be equal to the net present value of the royalties received by the owner of the mineral rights. The price for the mineral rights is always measured in net present value terms (equal to the value of the rights) regardless of whether it is determined by sales agreement or royalty instalments. The structure of the agreement depends on the risk the owner of the mineral rights is prepared to take. If the owner is risk averse, it would prefer an outright sale of the mineral rights with some additional compensation disguised as opportunity and user costs to cover the value of undiscovered minerals (opportunity) and future price increases due to scarcity (user cost).

The wide range of mineral royalties can be divided into three main categories, namely lump sum, production and profit royalties. Lump sum royalties represent an outright purchase of the mineral rights. It is also sometimes called the bidding price. The method works well when private ownership of mineral rights is allowed and there is an active market that trades the mineral rights. When the mineral rights owner sells the rights, the structure of the royalty changes from a periodic instalment to a one-off payment equal to the selling price. The table below provides a summary of periodic mineral royalties that are frequently encountered.

Resource owners prefer production royalties for various reasons. The first is that there is virtually no risk of losing the asset without receiving adequate compensation. Second, the instrument provides for a stable income and because it is attached to production, the amount is certain and reasonably predictable. Finally, production royalties ensure a stable flow of revenues over the life of the mine even when company profits are low or non-existent. On the other hand, investors do not favour production royalties because they are not based on the ability to pay principle and therefore fail the efficiency and neutrality economic criteria. Marginal deposits may become uneconomic to exploit because of the royalty burden and high grading may be encouraged in quality mineral deposits when the royalty is tonnage-based.

Sometimes revenue-based royalties allow certain deductions from the sales price to enable the calculation of the royalty. These are then called net smelter return royalties. Net smelter value means market price less transportation, handling, processing and marketing costs. Free-on-board (or rail) prices are calculated by subtracting transport costs (rail or shipping depending on the point of sale) from the sales price. Typically, the term ‘free-on-board’ is used for export materials while domestically-consumed products will attract a free-on-rail value. Considering the differences in definition of the two methods, net smelter value will theoretically assume a higher royalty rate. However, this is rarely the case for government royalties because the royalty is a policy instrument promoting further downstream processing of mineral production. Another example is the Western Australian system that allows for a decreasing royalty, depending on the increased degree of processing.

Royalties may also be claimed on profits or net income, rather than on revenue or production. Profit-based or net income royalties are normally imposed on the difference between market price and average operating expenses. The method allows for profits participation because both the resource owner and the producer share in the upward and downward fluctuations of mine profitability. The biggest advantage of this type of royalty is that it is a neutral instrument as it does not influence resource allocation in any way. Because it is based on realised net resource value, the method has the added advantage of using the value of the resource in the ground as the maximum royalty liability. A third advantage is the smaller impact on marginal mines. In exchange, resource owners generally require a higher percentage rate in order to receive the same revenue over the life of a mine as that of revenue-based royalties. Although profit-based royalties are fair to the investor because of their ‘ability to pay’ principle, the disadvantage from a resource owner’s point of view is that there are no royalties when a mine runs at a loss. Although it is true that the resource owner will benefit if profits rise above the inflation rate, the opposite is also true in that the owner will lose out when profits decline. A major disadvantage of the method is the complex calculations in determining the amount on which the royalty must be based, making it subject to ‘creative accounting’ practices aimed at reducing the royalty payment.

There are also other variations of mineral royalties, but they fall outside the scope of this presentation. These include sliding scale or formula-type royalties, additional mining royalties, linking royalties to net resource value, initial payments for permits and/or licences, de facto royalties, joint ventures, minimum royalties and retention fees. Other revenue collection instruments, namely production sharing agreements, service/management contracts and joint venture agreements are also sometimes used.

MINERAL ROYALTIES IN SOUTH AFRICA

Compensation for the utilisation of the state’s mineral resources entails any, or a combination, of a number of considerations. At present there are a number of royalty options available to investors. Unfortunately, these are not standardised and the lack of a clear-cut policy means investors must go through a lengthy process of negotiation before the type and rate of royalty payments are determined. The advantage of the system is that it gives investors the opportunity to negotiate tailor-made royalties for their particular circumstances. Generally speaking, all categories of royalty instruments, as described earlier, are available to investors. Those based on revenue or costs plus a premium normally range from one, but more often 2,5 to five per cent while profit-based royalties are usually charged at ten per cent. The 2,5 per cent royalty had its origin in Law 14 of 1878 of the old Transvaal Republic, which allowed for a state royalty of 2,5 per cent on gross returns. This mineral royalty applied to all categories of land and remained in force until 1910, when the lease consideration concept was introduced. By then Act 14 of 1887 distinguished between mineral types and stipulated a rate of one per cent of the value of the minerals mined for base metals, regardless of mineral rights ownership. Sliding scale royalties are a further option and have their roots in the repealed lease consideration system. In terms of section 31(1)(c) and (3) of the Exchequer and Audit Act of 1975, the Minister of Minerals and Energy may determine standardised lease payments, royalties or any other consideration payable to the state in respect of state-owned mineral rights. Such standardised tariffs currently only apply to small-scale mining concerns and are available from the DME’s web-site.

A ‘Competitive Investment Framework (CIF)’ was compiled using the policy information of countries that have similar risk profiles to South Africa and who have succeeded in securing significant foreign investment for their mining sectors as a direct result of changes in policy. The purpose of the CIF is to serve as a framework for determining the competitiveness of policy instruments in countries wishing to attract foreign direct investment.

Source: Cawood (1999)

Note: Average for Yes/No rows is the highest frequency

The investment-attractive countries¹ all have systems of publicly-owned mineral rights and adequate security of tenure, despite the fact that private ownership of mineral rights is not allowed.

1 These are Chile, Argentina, Indonesia, Peru, Mexico, Ghana, Brazil, Malaysia and the

Philippines.

The way in which minerals-related legislation will be administered in terms of the Draft Bill, compared to the criteria of the CIF, is given in the next table.

Sources: Cawood (1999) & Draft Bill

More details are available from Cawood and Minnitt’s comments on the Mineral Development Draft Bill, which are contained in a submission to the Department of Minerals and Energy.

Barberis, D. (1998). Negotiating Mining Agreements: Past, Present and Future. International Energy and Resources Law and Policy Series, Kluwer Law International, London, 1998. Pp. 252.

Cawood, F.T. (1999). Determining the optimal rent for South African mineral resources. PhD Thesis, University of the Witwatersrand, Johannesburg, August 1999. Pp. 221.

Cawood, F.T. and Minnitt, R.C.A. (In Press). Distribution of mineral rents in South Africa. Resources Policy

Cawood, F.T. and Minnitt, R.C.A. (In Press). A new royalty for South African mineral resources. Journal of the South African Institute of Mining and Metallurgy

Cawood, F.T. and Minnitt, R.C.A. (2001). Comments on the Mineral Development Draft Bill – Submission to the Department of Minerals and Energy.

Scott, A. (1978). Who Should Get Natural Resource Revenues? University of British Columbia Library Box 3-28, no Journal/monograph information. Pp. 51.