A dramatic shift is unfolding in the balance of power from suppliers to consumers in our three big export commodities: iron ore, coal and gas.
We are seeing that play out in big price falls, which have not yet greatly affected the dollar but are highly likely to reduce the currency in the year ahead as we reach the end of the mining investment boom and the market understands that the actual fundamentals have changed. The price falls are not simply market fluctuations.
To illustrate the change in the balance of power, in different times the Ukraine crisis might have been seen as a boost for our commodities. Yet in 2014, Ukraine may even work against us by accelerating and increasing Russian gas exports to China.
Let’s start with gas. Last night, oil prices fell 3 per cent because of a huge rise in global production and demand is sluggish.
Unfortunately, while the demand-supply pattern is different, gas prices are closely linked to oil prices. It’s true that demand for gas will rise because China is shifting from coal to gas in power generation. By 2020, there won't be any coal-fired power stations supplying Beijing (Australia’s coming coal firestorm, August 15).
But a large part of that higher gas demand will come from Russia. Last week Russian President Vladimir Putin travelled to Siberia to meet Chinese Vice Premier Zhang Gaoli to mark the start of construction of the 3,000km gas pipeline that will transport Russian gas to China in five years.
According to the Financial Times, Western sanctions threatened the financing of the pipeline’s construction, but Zhang made it clear that Chinese money would be available .
Russia had been reluctant to get much closer to China in the development of its gas but the sanctions have given it no choice. China will be looking to go even further to lift supplies from Russia. It’s costly to build pipelines but, once they are built, the cash costs of gas are very low. In comparison, Australian gas must be liquified and shipped, which is a costly process.
In iron ore and coal, China has done what Japan did in the 1960s -- encourage as much new production as it could to bring down prices. In many cases, the Chinese invested in new production.
With demand now sluggish, there is chronic oversupply. Although China has a domestic iron ore production business, its steel industry and indeed global steel producers are set to enjoy low-cost iron ore for a long time (Iron ore tipped to hit $US75 a tonne, September 3).
My guess is that China will support an array of high-cost producers to keep the market in oversupply. There is no way China will let BHP, Rio Tinto and Vale again control the market and shift the balance of market power back to producers.
In steaming coal demand, once again we lifted production and are now faced with much lower demand.
According to PricewaterhouseCoopers, Australian miners led by BHP and Rio Tinto are the most inefficient in the world outside of Africa (Some hard truths for our biggest miners, August 15). But the good news is that BHP aims to cut costs by $10 billion in three years. Rio Tinto has a similar program but both can do much more if they rate their equipment usage practices (wage costs are a separate matter) against the best North American producers.
Of course, better mining practices will further lift production.