How sustainable is the strong performance of oil and mining stocks?

Oil and mining stocks are currently the best performers in the Philippine Stock Exchange (PSE). For the month of October, the PSE mining and oil sector index is already up by 25.3 percent. In contrast, the PSEi index is hardly changed, increasing by less than a percent in the same period.

One of the main catalysts for oil and mining stocks’ strong performance is the news that the government wants to revive the mining industry. The revival of the industry is expected to create more jobs and raise more tax revenue which will help the government fight the impact of the COVID-19 pandemic. The government intends to revive the mining industry by privatizing state-owned mining assets including Nonoc Mining and Industrial Corp., Basay Mining Corp., Hercules Minerals and Oils Inc. and Marinduque Mining and Industrial Corp. The government also wants to pass a legislation that will provide a new fiscal regime for the mining sector, allowing it to increase the taxes and royalties that it collects from mining companies.

Another catalyst for the strong performance of oil and mining stocks is the news that the government lifted the suspension of oil exploration in the West Philippine Sea which has been in effect since 2014. Just last week, the Department of Energy issued a “resume-to-work” notice to service contractors doing oil exploration in the areas of service contracts (SC) 59, 72, and 75. Although Philex Petroleum Corp. (PXP) is the main beneficiary of this development since it owns SC75 and 79.1 percent of Forum Energy Ltd which has a 70 percent interest in SC72, several listed companies will also benefit as they have some interest in either PXP, Forum Energy, or SC72. These companies include Philex Mining (PX), Atok Big Wedge (AB), Apex Mining (APX).

Nevertheless, the strong performance of oil and mining stocks might not be sustainable.

Although the government wants to revive the mining industry, the sale of mining assets and the creation of a new fiscal regime might not be good enough to encourage new investments into the said industry.

Note that the mining assets that the government plans to privatize are already old mines and, as such, have fewer mineral reserves making them less attractive.

A more effective way to revive the mining industry is to lift Executive Order (EO) 79, which is the moratorium on new mining projects imposed in 2012. By lifting EO 79, companies can pursue new mining projects in areas that have more mineral reserves, justifying the high level of capital expenditure needed to operate mines.

Moreover, the creation of a new fiscal regime will increase the taxes paid by mining companies. Aside from making royalties charged on mining operations within and outside mineral reservations uniform at 5 percent, the new fiscal regime is expected to impose an additional 2 percent tax on mining companies’ gross output to increase the funds it can allocate to educational programs, technological and research programs, health services, and disaster risk reduction management initiatives in areas where the mines are located.

Although the creation of a new fiscal regime will pave the way for the lifting of EO 79, the higher costs brought about by the additional taxes may discourage mining companies from increasing investments. Note that the excise tax charged on mining companies’ value of production was already increased from 2 percent to 4 percent in 2018 under package one of the Tax Reform for Acceleration and Inclusion.

Meanwhile, despite the resumption of oil exploration activities in the West Philippine Sea, there is no guarantee that the service contractors will strike oil. It also takes years of careful planning and a lot of resources to find oil. As such, prices of oil and mining stocks will most likely go down once the excitement over the resumption of oil exploration activities dies down. Service contractors will need to successfully strike oil for share prices to go up on a more sustainable basis.

Although we are not too optimistic about the growth prospects of the oil and mining industry, developments affecting the said industry are worth monitoring. After all, the Philippines is one of the most highly mineralized countries in the world, and relaxing rules that would encourage more investments in the industry is a low hanging fruit for the government to generate the additional revenues it needs to help the country recover from the impact of the COVID-19 pandemic.