Welcome to the boom: Part II

Martin Ferguson may have been premature in declaring the resources boom over but there is no doubt it is shifting into a different phase now that the ripples from the slowing of China's economy are finally impacting investment.

BHP Billiton's decision on Wednesday to freeze two of its mega projects – the $30 billion Olympic Dam expansion and $20 billion Outer Harbour project at Port Hedland – perhaps permanently, caused the Resources Minister to say that the boom had ended, provoking denials from Penny Wong and others.

"We've got over half a trillion dollars and over half of that, over half of that is at the advanced stage," Senator Wong said.

That's true. There are projects involving investment of $260 billion to $270 billion that are committed and too far advanced to be pulled. It's the remaining $300 billion or so – of which BHP's two projects were a major chunk – that now has a question-mark over it, along with Wong's conviction that the boom still has "a long way to run".

The reality is that unless China reignites its growth rate most of the uncommitted investment is also going to be withdrawn from the investment pipeline and at this point the Chinese, despite using most of the policy options available to them, have yet to stabilise their growth rate.

The latest HSBC "flash China manufacturing PMI", while showing a modest improvement from June, was still below 50 and therefore says the rate of growth is still declining, albeit at a slightly lower rate. As HSBC says, the index implies that while the monetary easings and other measures are having an impact, demand remains weak and employment is still contracting.

The slowdown in China's economy isn't surprising given the state of its two biggest export markets, Europe and the US. With neither likely to enjoy a speedy turnaround, a sharp rebound in China's growth rate is also unlikely.

The resources boom was ignited by China's surging demand for raw materials at a time when the mining industry had completed quite a lengthy period without adding significantly to supply.

Even as it scrambled to invest to alleviate that shortfall the global financial crisis intervened, new investment was frozen and with China's growth rate – after a sharp but brief initial dive in response to the GFC – taking off in response to a massive fiscal stimulus program, that shortfall was exacerbated.

Once global conditions stabilised the race to bring new supply into the market resumed around the globe and the Australian pipeline swelled dramatically, as did the capital and operating costs of new projects as a result of the competition for people, services, construction materials and equipment.

In effect, the imbalances in supply and demand were because of the distortions created by the GFC exaggerated and triggered an equally exaggerated response – a super-cycle overlay to what would in any event have been a boom. That overlay is now disappearing.

It is also becoming clear that the underlying structural leap in demand – China's economy today would be more than 50 per cent larger than it was pre-crisis – is permanent and that China will continue to grow, albeit at a lower and more controlled rate than has been the case in recent years.

But with new supply pouring into the market, China slowing and the rest of the world economy largely anaemic, the "super" element of the cycle has evaporated. As have the super prices.

A year ago iron ore prices were about 40 per cent higher than they are today. Metallurgical coal prices are down more than 40 per cent and energy coal about 25 per cent. Price dives of that magnitude have to impact activity and they are impacting activity.

China's commodity stockpiles are at levels last seen when activity froze at the peak of the GFC and there are reports that, just as occurred during the GFC, steel mills are refusing to accept shipments of bulk commodities on the contracted terms.

If the super-cycle is going to be a receding memory and prices, while still elevated compared to their pre-boom levels, are going to be 30 per cent or 40 per cent lower than their peaks, if not more, a lot of planned investment is going to be rendered either marginal or simply uneconomic, particularly while the projects still under construction put a floor under costs. Some of the projects still being completed might share the same fate.

In a post-super-cycle environment there will be strong demand for the bulk commodities – China, India and the rest of the region are generally still growing – but at materially lower prices, even if there is some modest bounce in prices from today's levels if and when China manages its growth back into its target level of around the 7.5 to 8 per cent mark.

That will shift the emphasis to costs and volumes, with the big established low-cost projects like the Pilbara iron ore mines or Queensland coalfields far better placed than newer greenfields and higher-cost producers.

That's why Rio Tinto, and BHP, are still expanding their iron ore output.

The maturing of the resources boom will leave us with the very positive legacy of a much larger resources sector and much bigger export volumes but the terms of trade peaked last year and will continue to decline and the rate of new investment committed to the sector should decline sharply.

What's left of the boom element of the structural change in the scale of the Australian resource sector is mainly what's left in the existing pipeline of committed but not-yet-completed projects.

Let's hope not too many of them were predicated, like the Minerals Resource Rent Tax, on the super-cycle being the norm for years yet to come rather than the aberration it now appears to have been.