Why life is more complicated than boom and bust

For the mining layman, you could get the impression that the drop in commodity prices seen recently is a disaster for all. But a fall in prices will create winners as low-cost suppliers take over.


Maybe it's like this in other countries, maybe not. But one of the recurrent features of Australian business and the media coverage of it is amnesia, and a tendency to repeat the same rituals over and over again, each time convinced they're being conducted for the first time.

So if you read the business pages, or listen to the investment gurus, then Australia is in the midst of a resources crash that is going to have major impacts on the economy. Even as wise a soul as Ross Garnaut joined in today, warning of a decline in living standards as the boom unwound. But the same gloom could be found after the resources boom (especially in coal) following the 1973 first oil shock, after the second oil shock in 1979-80, and the boom and bust in 2008 as the GFC hit.

First, some historical context on the recent fall in the iron ore price. This is the price in US dollars for the past 30 years, from IndexMundi:


Sure the strong Aussie dollar means that slightly overstates the current price, but nonetheless if you could make a buck from iron ore five years ago, you should be absolutely coining now.

Many commentators and analysts seem to think that what we are going through is somehow special, a one-off, the worst crisis since, well, they can't really make a comparison because they have little history of understanding of the boom/bust nature of the Australian commodities sectors, or other sectors like property, and the busts a decade and two decades ago. The bust in the property market in the early 1990s caused far more damage to the economy, banking and business than anything we have been through in the past five years.

Costs always rise in a boom and industries (coal, iron ore, you name it) moan about them and demand the government do something. But when the boom is pricked, prices fall and we get a shake-out that cleans out a lot of fluff and froth, the new entrants lured in by record prices and the incompetent managers and investors.

This week we had the latest forecasts from the Bureau of Resources and Energy Economics about 2012-13 mineral and energy exports. Coming on top of the fall in the spot price for iron ore and weaker coal prices, plus the problems with Fortescue's ambitious expansion, the downgrade in the estimates for resource export income was seen as bad, very bad and the start of a slide that will go on.

But BREE expects resource exports to generate about $189 billion in export income this year. That's down from previous estimates of about $209 billion because of lower iron ore and coal prices. It assumes no real rebound in iron ore and coal prices, which is probably sound thinking at this stage. But it is only $4 billion less than the $193 billion export figure for 2011-12. Don't be misled by the price: prices for iron ore and coking and thermal coal are coming off a freak year in 2011, which saw rain in Queensland, Brazil and Indonesia, the fall in Indian iron ore exports and cyclones in WA cut supplies of coal and iron ore for months on end. This forced up prices to record levels, from which they always had to retreat.

Another forecast also got lost in the coverage: that export volumes are expected to rise again this year, especially in coal and iron ore. That is, demand will continue strongly, pushing up export volumes over the next year. That's despite the slowdown in China and elsewhere in Asia and the recession in Europe and the weak level of activity in the US.

Why? Many commentators have ignored or don't even know that iron ore exports from India, the world's third largest exporter, have been falling all year and were down 40 per cent in the first seven months of the year from already weaker 2011 levels. Australia and Brazil are making up the shortfall in markets in Asia, starting with China and Japan. India is rapidly losing market share as mining is restricted or stopped complete in states such as Goa.

Plus there's the natural cycle of the industry: the closure of Norwich Park, Hail Creek and the Gregory mine this year are somehow linked by many people to the slowdown in prices. But all are old mines and it has become increasingly more expensive to mine: all are open-cut; the overburden above the coal is too deep, the seams too small and quality too poor to justify mining. The weakening prices in export markets from the record highs last year made the decisions easier. Without that boom in prices last year, these expensive mines would have closed then and not in 2012.

But other markets are also undergoing significant – indeed, much bigger – changes that also affect us. In the US, the surge in shale and tight gas production has slashed demand for thermal coal for the power industry. Gas has passed coal as the most important source energy for the US electricity industry. This in turn has seen coal demand fall, production cut and exports jump as companies turn to exporting to get rid of their surpluses, driving down coal prices, especially in the European and Asian markets. This is a more important influence than the slowdown in China, but doesn't get mentioned in the local press.

But the dumping of coal in export markets is no longer enough. In the US, earlier in the year one of the country's biggest producers, Patriot Coal, collapsed with several billion dollars of debt. The industry leader, Peabody, has cut capex by more than $US200 million, cut production in the US and Australia (it paid $A4.9 billion for Queensland company Macarthur Coal last year. Never ever buy at the top of the market). This week, the largest coal producer in Appalachia, Alpha Natural Resources, closed eight mines overnight and sacked up to 1400 employees because of the coal glut and the impact of the shale gas boom.

Right across the US coal industry, companies will similarly need to cut their capacity. Similarly, in Australia, old and marginal mines where the costs of extracting minerals is too high will be closed. These are actually positives, even though it's tough on the employees in the short term.

That is why the likes of BHP Billiton and Rio Tinto in Australia and Vale in Brazil are continuing with their expansion plans for iron ore. They are the low-cost operators and intend to remain so, able to make a profit at or above $US40 to $US50 a tonne. World prices fell to just over $US62 a tonne following the GFC in 2008-09. Current prices about $US105 a tonne were seen as boom-like three years ago.

And for all the ups and downs of the US and European economies, demand isn't going to disappear.

This story first appeared on www.crikey.com.au on September 20. Republished with permission.

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