This is a benchmark comment for me.
The great Australian mining investment boom is about to be substantially curtailed. Government officials have been informed of the pending major curtailment, and why it is taking place, but there is nothing they can do about the dramatic fall in Australian productivity and the market change that have been the key causes.
Let me detail why it is happening, reveal some of the projects in the front line of curtailment plus those likely to proceed and finally make a first attempt of projecting what it means to the Australian economy.
Current mining investment is running in the vicinity of $40 billion to $45 billion a year – a more than five fold increase in a decade. In the next few years it is expected to at least double, making mining investment more than twice as large as the domestic housing market (according to Macquarie Equities).
The momentum of current projects being constructed will keep the numbers high for two or three years but then the rate of construction will fall sharply. Many projects will be shifted to Africa or other regions.
Why has this happened? Firstly, obviously the recent softness in commodity prices has played an important role. And that softness is related to current events in Europe and China and affect the total global minerals industry. But the Australian projects were long-term plays and a softness was anticipated by most miners.
A second factor is a rising shortage of long-term capital, which was highlighted by BHP’s recent statements. To some extent the fall in availability of capital is related to the softness in current mineral prices and to the European banking crisis. But the main reason why Australian capital is going on a widespread strike is the enormous rise in the cost of building and operating our mines – it's a productivity issue.
In the past few years the cost of installing a coal mine has risen an incredible 300 per cent. The cost of most other mines has risen between 100 and 300 per cent. These are staggering increases so to justify investment requires either very low operating costs or enormous optimism that we have a further boom in prices on the horizon. It is hard to see such a boom.
Why have costs risen so far? There are a number of reasons, including the shortage of labour and materials caused by the prospect of the boom. The carbon tax has also played an important role. But the biggest reason for the rise in cost is the productivity of labour – the so-called Victorian desalination plant effect.
It is unfair to blame all the labour cost rise to the flow on from the desalination productivity disaster, but there is no doubt it was a key driver.
Effectively, desalination contractor Leighton (via its Thiess subsidiary) signed a contact with the unions which gave the unions enormous power over the project. Now the unions are seeking to gain the same power in all new work. Leighton looks set to incur close to a well deserved $1 billion loss (including penalties) on the desal project. While both the weather and the bad managerial executives Leighton chose were important contributors to the desal loss, union control was the main force.
Leighton’s John Holland subsidiary originally tendered a lower price and did not give the unions control. Unfortunately the Victorian government took the higher bid from the rival Leighton subsidiary Thiess, which gave unions control. As was feared at the time, the desal cancer created by Australia’s largest construction company signing such a deal has spread around the nation, spurred on by the stipulations in the new industrial relations laws. All miners have watched with horror at what has happened to BHP Billiton and Mitsubishi in Queensland coal. BHP is paying a big price for not shutting the mine down earlier and sending both managers and workers packing. It is probably only a matter of time before they do.
But it means that there will be very few new coals mines in Queensland and NSW unless they are a very cheap addition to capacity.
At this stage the LNG plants near Gladstone will go ahead because they are well underway and had construction contracts signed before desal cancer spread. The WA gas projects have risen in cost but most are likely to go ahead, driven by Japanese and Chinese demand.
It is hard to see any major aluminum/alumina/bauxite plants proceeding. BHP’s Olympic Dam project in South Australia will probably go ahead at the slowest allowable rate under the government agreement. It is a huge investment in overburden removal, which must be undertaken in the most cost efficient and productive way. The project cannot stand desal cancer.
The Rio Tinto and BHP inner Port Hedland harbour iron ore projects will almost certainly proceed but BHP’s outer Port Hedland iron ore project is very vulnerable. Once Rio Tinto completes its current expansion there will be no more. These are the big ticket projects but underneath them are a myriad of small projects which are unlikely to proceed.
Once the market understands the extent of the curtailment of the investment boom, plus the current setback in mineral prices, there will be further damage to the Australian dollar. That will help Australian employment in many non-mining areas – although only those enterprises where workers and managers are interested in achieving high levels of productivity.
Interest rates will tend to fall further but the costs of overseas borrowing by the banks will rise.
Almost certainly we are set for further rises in unemployment as the combination of a rapidly slowing mining investment sector and a sluggish domestic non-mining economy coincide.
Eliminating the carbon tax will help but much greater structural changes are required.