MODULE 3

Auditing Mining Industry

Overview:

The mining industry sector is a major backbone of the Philippine economy. The long history of the
industry has been much affected by the vicissitudes of the international market, as well as other domestic
factors. With the adoption of the 1986 Constitution, the concept of awarding mineral rights has been
drastically changed from leasehold to a system of contracts for various modes of production. Such changes
have, as expected, temporarily unsettled the industry. The preponderance of small-scale mining, the
growing public awareness on the environment, increasing labor and energy costs are concerns which
should be addressed. Amidst all these, and in the framework of very stiff competition in the region for
investments, new thrusts and directions, without compromising general stability, are urgently required for
the overall development not only of the industry but for the whole country.

The Philippines is the fifth most mineral-rich country in the world for gold, nickel, copper, and
chromite. It is home to the largest copper-gold deposit in the world. The Mines and Geosciences Bureau
(MGB) has estimated that the country has an estimated $840 billion worth of untapped mineral wealth, as
of 2012. About 30 million hectares of land areas in the Philippines is deemed as possible areas for metallic
minerals. According to the Mines and Geosciences Bureau (MGB), about nine million hectares of land
areas is identified as having high mineral potential. The Philippines metal deposit is estimated at 21.5
billion metric tons and non-metallic minerals are at 19.3 billion metric tons, as of 2012.

Nature and Background of Specialized Industry

A country’s socio-economic development largely depends on the extent and composition of its
natural resources. Examples of natural resources include forestry, minerals, and commercial sources of
energy (like coal, oil, natural gas, and hydro power). Mining and mineral processing are activities for
extraction and processing minerals for commercial use. The mining sector is likely to contribute to the
development of the economy of any country through taxes from large-scale mining companies and
contribute to social–economic infrastructural development within the area where the mine is located. The
mining sector can:
• create employment opportunities both directly in the mines and indirectly on services
to the mines,
• provide education and health services,
• increase foreign exchange reserves,
 (reducing a country’s foreign exchange deficit),
• improve infrastructure like roads and water supply, and
• create other economic activities to support the mines instead of importing all supplies from
abroad.

A working definition of mining according to the United Nations Environmental Program (UNEP)
could simply be “the extraction of minerals from the earth”. The word “minerals” in this case would cover a
wide variety of naturally occurring substances extracted for human use.
Although this definition is adequate for our purposes, mining can also be seen as a process that begins
with the exploration and discovery of mineral deposits and continues through ore extraction and processing
to the closure and remediation of worked-out sites.

Minerals are a non-renewable resource, so mining represents a temporary use of the land. The
mining life cycle during this temporary use of the land can be divided into the following stages: exploration,
development, extraction, processing, and mine closure. In this section, we explain
the various phases of mining, the associated impact in each phase, and the suggested mitigation or
amelioration measures. The figure below sets out the five physical stages of the life cycle of a mine.

Figure 2
Life cycle of

Project
Exploration Mining and milling
development

Abandoned mine / Smelting and refi-

Mine closure
rehabilitation ning (benefication)

The exploration phase of mining

Exploration activities encompass all actions in the field that precede feasibility studies.
Exploration activities include initial reconnaissance flights and geophysical surveys, stream sediment
studies and other geochemical surveys, construction of access roads, clearing of test drilling sites,
installation of drill pads and drilling rigs, benching, trenching/pitting, erection of temporary accommodation,
and power generation for exploratory drilling. Exploration activities also include determining the location,
size, shape, position, and value of a body of ore using prospecting methods.
The development phase of mining
The development of a mine consists of several principal activities: conducting a feasibility study,
including a financial analysis to decide whether to abandon or develop the property; designing the mine;
acquiring mining rights; filing an Environmental Impact Assessment (EIA); and preparing the site for
production. The development phase may include such activities as
• overburden stripping and placing,
• road/trail, building and/or helicopter transport,
• drilling and trenching,
• erecting treatment plants, preparing disposal areas, and constructing services, infrastructure such
as power line or generating plants, railways, water, supplies and sewerage, laboratories and amenities.

Overview, Updates, Statistics of the Specialized Industry in the Philippines

The extractive sector in the Philippines makes a relatively small contribution to the national
economy. The latest disclosure (2018 EITI Report) shows the mining sector contributes the most in the
sector with 0.89% to GDP and 5.99% to total exports. However, there is considerable anti-mining sentiment
in the country especially at subnational levels where environmental impact and displacement of indigenous
peoples caused by mining operations have been the focus of much debate. Small-scale mining is also
contentious, due to poor regulations and overlapping policies between central and local government.

The Philippines is a leading producer of mineral commodities such as nickel, gold and copper.
While mineral production volume increased slightly in 2018, production has gradually decreased since
2015 -2017. Nevertheless, the country is only behind Indonesia as the world's leading producer of nickel.
Other commodities being produced in the Philippines include chromite, zinc, iron, silver, crude oil and
natural gas. While the mineral sector slightly picked up in 2018, coal saw a slight dip in production
compared to its 2017 value. Domestic oil production follows a similar trend as coal - declined from 3 million
barrels of oil in 2014 to only 1.1 million barrels in 2018. Exploration activities in mining are spread
nationwide, while coal production is focused in the province of Antique. Oil and gas exploration is focused
offshore.

The Philippines is one of the most highly mineralized countries in the world with vast reserves of
gold, silver, copper, nickel, and chromite. In 2018, the Philippines accounted for 6.4% of the world’s total
estimated reserves of nickel.
 The main taxes levied on the mining sector are corporate income tax, excise tax on minerals and
royalties on mineral reservations, while the major oil and gas levies are the government’s share in oil and
gas revenues, corporate income tax and withholding tax on profit remittance to principal.

The Bureau of Internal Revenue (BIR) is the main body responsible for collecting taxes paid to
central government, while the Mines and Geosciences Bureau of the Department of Environment and
Natural Resources and the Department of Energy collect sector levies for mining and coal, oil, and gas
respectively. Local government units (LGUs) are responsible for collecting subnational payments.

Oil and gas service contracts (PSCs) are awarded through competitive public bidding, while mining
permits are awarded through direct negotiation. Several moratoriums on the issuance of mining licenses
implemented in previous years from 2012 to 2017 have affected the number of mining projects in the
country.

As of February 2021, there were 309 Mineral Production Sharing Agreements, 5 Financial or
Technical Assistance Agreements and 13 existing Exploration Permits for the mining sector.

Beneficial Ownership (BO) disclosure and Politically Exposed Persons (PEP) reporting in the
Philippines has been a significant aspect of transparency in the Philippines. The multi-stakeholder group
identifies tax evasion, money laundering, and compliance with the Constitutional provisions on the
nationality of mining companies as the national issues that their work on beneficial ownership aims to
address. It faces constraints, however, in terms of data privacy restrictions.
The Philippines EITI previously published a Beneficial Ownership (BO) roadmap on 15 December
2016. Several milestones of the Roadmap have been accomplished by the beginning of 2021, including the
integration of BO in the mainstreaming efforts of PH-EITI, the increased coordination with the SEC and the
pilot disclosure of BO information. According to the 2018 EITI Report published in December 2020, 41 out
of 65 covered companies/projects fully or partially disclosed beneficial ownership information. A total of 128
name entries were declared as beneficial owners.

Securities Exchange Commission (SEC) Memorandum Circular (MC) No. 15 (issued in July 2019)
enhanced the BO Declaration form. The revised General Information Sheet (GIS) under MC No. 15
mandates corporations to fill out a beneficial information declaration form that asks for nine categories of
beneficial owners and their information, including complete name, residential address, nationality, tax
identification number, and percentage of ownership or voting rights. While there is currently no public
register of beneficial owners, work has begun to ensure that BO information, contracts and extractives
information is integrated into one publicly-available portal.

Audit Considerations

Key Financial Concepts in the Mining Industry (see PFRS 6 Exploration and Evaluation of Mineral
Resources for more information)
 Revenue: Ore (tons) x Grade (g/t) x Recovery x Payability x Metal Price
 Royalties: Properties often have royalties on them (e.g., 2% Net Smelter Return)
 Operating costs: Per ton basis (e.g., $2.50/ton for mining)
 Capital costs: Includes initial capital (construction of mine) and sustaining capital (ongoing
equipment, etc.)
 Reclamation costs: Takes place at the end of a mine’s life; accrued for accounting purposes but not
accrued in a cash flow model.
 Depreciation: A percentage of production bases over the entire life of the mine
 Taxes: Can often be complicated with mining companies operating in several countries; mining
specific taxes and royalty agreements need to be considered
 Changes in working capital: Changes in accounts receivable, inventory, and accounts payable
should be factored into a cash flow model.

Challenges in Mining Industry in the Philippines

 Responsible Mining under Philippine Mining Act
 Circumvention of Permits
 Interfacing with LGUs
 Delays in the declaration of Indigenous Peoples (institutional issues with National Center for IPs)
 Impact of COVID-19 pandemic
High-Level Questions About Revenues from the Extraction of Minerals

 Are the revenues from the extraction of minerals significant? (Each source of revenue should be
assessed individually, and their importance should also be assessed in the aggregate. While large
revenues can be significant on their own, some smaller sources of revenues may also be significant
because of their function. For example, leases, licenses, and permits may be important because
they enable departments to know who should be paying royalties and fees.)

 Is there a significant difference between predicted and actual revenues? If so, what is the
explanation for this difference?
 Are there any new revenue sources? (For example, is there a new resource with its own royalty
system, such as a recently developed diamond mining industry?)
  Has new relevant legislation or regulation been introduced or have significant changes been made
to existing legislation and regulation recently?
 When was the last review of the revenue framework conducted? When is the next one planned?
 Where significant changes in revenues are observed, are they in line with current market conditions
and production levels?
 Has the revenue framework (and supporting regulations) been criticized for being overly complex or
unclear? Is there significant public interest in the topic?
 Have there been any public complaints or reporting of any inappropriate practices in the sector
(transfer mispricing, for example)?
 Have annual financial audits identified significant or chronic issues with regard to the collection of
revenues from the extraction of minerals?
 Is there a regulated royalty audit regime in place? If so, is there 100-percent audit coverage or risk-
based coverage? Are audits completed on a timely basis? In addition, have internal audits of
revenue collection processes been conducted?
 Is there significant reliance on self-reporting of production level?
 Does the government have sufficient expertise to verify information reported by the private sector?
 Have previous performance audits of mining revenues been conducted by the audit office? Has
progress been made by the government to address prior recommendations?
 Is there segregation of duties between the collection of revenues and the assessment of the
completeness of revenues received?
 Has the government clearly established the objective it is pursuing through its revenue framework
for the mining sector?
 Is there legislation or regulation in place to ensure the public has access to reliable information on
the payments the government receives from mining companies?

High-Level Questions About Financial Assurances for Site Remediation

 Is there a regulated system of financial assurances for site remediation in place? Is the system
recent or well-established? Has a remediation fund been established?
 What is the current cost estimate (potential liability) for rehabilitating all mining sites in the
jurisdiction?
 What is the state or risk of unfunded liability in the jurisdiction? Is the risk increasing over time?
 If there is a remediation fund, what is the current balance of this fund?
 Have there been any recent or looming changes in environmental standards or legislation that are
expected to affect required securities?
 Does the duration of the securities match the expected duration of the expected liability?
 Is there documented guidance on how to estimate remediation costs?
 Are remediation cost estimates periodically reviewed by the government or an independent expert?
 If regulations allow for self-insurance, what is the relative frequency of self-insurance by mining
companies in the jurisdiction?
 Are there mechanisms for regular monitoring of sites and monitoring of associated securities? Are
these mechanisms implemented? What is the frequency of site visits?
 Are the licensing and inspection functions segregated?
 Is there a process to ensure that financial assurances are released only when compliance with site
remediation requirements is achieved and documented?
 Are site inspections providing sufficiently complete assessments? (For example, can inspections
identify underground contamination?)
 Are there sufficient penalties in place to encourage compliance with financial assurance
requirements?