Coming to terms with a more subdued resources sector

Perhaps it took a little longer than it should have but the Reserve Bank's belated recognition that the peak of the resources investment boom has been brought forward by the dive in commodity prices associated with weakening demand from China may perhaps change some of the language around the debates about the mining sector.

In the minutes of the RBA's monetary policy meeting earlier this month, at which official interest rates were lowered by 25 basis points, there is a substantial discussion (in the context of the minutes) about the sector and its prospects.

Despite some recovery in iron ore prices after their steep falls in August the prices for both iron ore and coking coal (which had continued to slide) were about 25 per cent below their levels in June and the terms of trade for the September quarter were estimated to be about 10 per cent below their peak last year.

The volatility in those commodity prices had affected the outlook for mining investment over the next year or two with mining companies increasingly reluctant to commit to new investment projects that had previously been under active consideration, the board members concluded.

In some cases the companies had delayed spending on committed projects and closed some older higher-cost mines earlier than expected. While the prospects for LNG projects remained positive some projects were running behind schedule and the members noted that there had been cost over-runs on some projects.

‘'These developments suggested that the forecast profile for mining investment might not be as strong as previously expected. Overall resource investment could peak earlier and at a lower level than had been previously forecast.

While there remained considerable uncertainty about the outlook the lower resource investment profile suggested growth in demand and output over the coming year could be below previous forecasts.

‘'Members discussed the implications of the revised outlook for the labour market and tax receipts,'' the minutes recorded. One assumes they concluded that the implications weren't positive.

While there is still a pipeline of resource investment in projects that are too advanced for their sponsors to pull the plug on them it is evident that the super-cycle in commodity prices that sparked the investment boom is rapidly fading and that investment in new production is going to be far lower and more selective than anyone would have anticipated a year ago when the boom was still roaring.

The spate of projects that were on the drawing board that have now been mothballed – Olympic Dam and its $30 billion expansion being the biggest and most high-profile – has more than halved the investment that was in the pipeline.

More disconcerting are those older coal mines that have been closing as a result of the combination of rising costs and tumbling prices, particularly for energy coal, as well as the persistently high Australian dollar.

While there has been a significant focus on the implications of the declines in commodity prices for the controversial Minerals Resource Rent Tax – a tax designed to capture a share of ‘'super profits'' that now won't materialise – the falls in prices and the mine closures and production cutbacks could have implications for the core tax base and, of course, Wayne Swan's guarantee of a surplus.

In the longer term, a somewhat more subdued resources sector isn't such a bad thing for the economy or the industry.

It will help alleviate the pressure on labour and capital costs than has been undermining the Australia industry's competitiveness, free up labour and capital to support investment in other sectors of the economy and, perhaps, help weaken the Australian dollar (although the traditional nexus between commodity prices and the dollar has itself been weakened).

For the industry, if the commodity super-cycle was driven by a mismatch of supply and demand because the pre-crisis growth in China's economy was not anticipated, its truncation will reduce the massive amounts of new supply that were in the pipeline and help put some kind of floor under the prices.

With the RBA board noting that China's exports to Europe, its biggest market, and more recently the US and Japan, have been declining it is improbable that there is going to be sudden return to boom conditions for the sector, particularly as China, while undertaking some modest stimulatory measures, appears determined not to spark the kind of speculative and inflationary activity that its response to the global financial crisis generated.

The problem for the government and its economic agencies, of course, is that the rest of the economy appears to be weakening further, with consumption, non-mining investment and both business and households still in a very defensive mode. As the levels of mining investment begin tapering off, it is unclear where the growth might come from.