Another double-tap to a dying super-cycle

Announcements from Xstrata and BHP Billiton show that coal has joined iron ore in the wounded tent and that not only new projects will be victims of the mining slowdown.

Much of the discussion about the end of the resources super-cycle has been about the fate of projects still on the drawing board. Today’s news has made it clear that it isn’t just new projects that are at risk from the crash in commodity prices.

While BHP Billiton’s decision to mothball a planned $30 billion expansion of its Olympic Dam project and Fortescue Metals’ job-shedding and winding back of its expansion of its iron ore production from a planned 155 million tonnes per annum to 115 million tonnes have been the highest-profile demonstrations of the new circumstances, the back-to-back announcements today from Xstrata and BHP illustrate that it isn’t just new projects that are under pressure.

Xstrata announced plans to cut 600 jobs from its Australian thermal coal operations and said that the investment decision on its proposed $6 billion Wandoan coal project in Queensland was contingent on market conditions. BHP announced the closure of its Gregory open-cut coking coal mine in Queensland with the loss of about 300 jobs.

Like iron ore, coal prices have been tumbling since about last September as China’s economy has progressively slowed and its steel industry has come under intensifying pressure. The ripple effects of that slowdown have steadily spread throughout the other Asian economies, magnifying the impact on the resource sector.

BHP said production costs at Gregory now exceeded revenue from product sales. That’s not just a function of the dramatically lower prices, which have fallen about 30 per cent in the past few months alone. As Xstrata said, the miners are responding to low prices, high input costs and a strong dollar.

There was a time, before the super-cycle element of the resources boom kicked in, where Australian iron ore and coal producers regarded themselves as almost cycle-resistant because of their high quality and low costs relative to global peers and proximity to their markets. Production from other higher-cost jurisdictions would be displaced before they were under real pressure.

Soaring capital and labour costs have, however, increasingly turned the Australian resource sector into high-cost producers and a succession of industry leaders have warned that Australia was beginning to price itself out of the market, certainly where new investment was concerned.

It hasn’t helped that the Australian dollar isn’t behaving as it historically has. Commodity prices started tumbling in September last year but the dollar hasn’t done what it has historically done and fallen in tandem.
That’s a function of the distressed state of much of the globe and Australia’s perceived status as a relatively safe haven offering among the highest real interest rates of any developed economy with deep and liquid financial markets. The Australian dollar is one of the more heavily traded currencies in the world.

Even foreign central banks have been buying Australian dollar to diversify their holdings away from the troubled euro and to generate positive returns rather than the negative real returns available in Europe and the US.

The coal sector has an extra issue to deal with. The shale gas boom in the US and the subsequent collapse in shale gas prices means there has been a flood of abundant cheap energy in the US which has displaced coal and diverted it into export markets, adding to the pressure on price and the competition for customers.

Coking or metallurgical coal prices had held up relatively well because BHP, the dominant seaborne trade producer, was severely impacted by the long-running industrial disputes which hit production from its BMA alliance with Mitsubishi in Queensland. The recovery in the output from those mines has coincided with the general dive in commodity prices.

In the long run the truncation of new investment and the weeding out of sub-economic production will be good for the resources sector. There will be reduced pressure on costs from reduced activity and as existing capacity is withdrawn a better balance between demand and supply, which until recently was predicated on a seamless and near-endless continuation of China’s apparently voracious appetite for resources.

In the near term, however, considerable investment and jobs are at risk, not to mention taxation revenues and royalty streams. There will inevitably be a lot more announcements like those from Xstrata and BHP today, or Fortescue’s last week, unless China is able to arrest and reverse its slowing growth rate.