now loading...
Wealth Asia Connect Middle East Treasury & Capital Markets Europe ESG Forum TechTalk
From champion to casualty
Australia’s resources may no longer be able to drive its growth
Lachlan Colquhoun 28 Nov 2012

Australia has gone through a remarkable mood swing in the last six months. At the beginning of the year politicians, miners and economic forecasters were talking up the resources boom that would last for decades and underpin the country’s prosperity well into the future.
 

Then all of a sudden the mood switched. BHP Billiton decided against the A$20 billion expansion of the giant Olympic Dam project in the South Australian outback and then the A$20 billion port expansion at Port Hedland so the end of the boom was called immediately, by none other than the federal resources minister Martin Ferguson.
 

In the public perception at least, boom turned to bust and Australia contemplated a lonely future as an unwanted mine. Not only was the demand from China which had underpinned the growth on the wane, but mines in emerging markets in Asia and Africa were more productive and competitive.
 

The public debate had gone full circle from the headlines about manpower shortages in Western Australia, and how workers from the eastern seaboard of Australia were heading to WA on a “fly in fly out” basis to double the salaries they were making back home.

Bearish predictions
With this in mind, Australia’s richest person, iron ore queen Gina Rinehart, admiringly spoke of African mine workers happy to work for US$2 a day, implying that Australian miners should do the same. Australian mine truck drivers, it is now claimed, are 80% more expensive than their counterparts in the US.
 

Australia, said the newspaper columnists, was just waiting for the outbreak of the “Dutch disease” which saw the Dutch economy fail to bank the economic benefits of the North Sea oil boom of the 1970s.
 

Meanwhile, Rinehart’s iron ore rival Fortescue Metals – founded by Andrew Forrest – laid off 1,000 workers and scrambled desperately to refinance A$4.5 billion in debt.
 

The company has invested heavily in growth as it shoots for the ambitious target of producing 155 million tonnes of iron ore per year, and yet there are reports of massive inventories of the commodity on Chinese docks. China takes around 70% of Australia’s iron ore exports, and 25% of total exports.
 

According to research from ANZ Bank, if the iron ore price averages US$100 over 2012 and the Australian dollar remains at around US$1.04, then profits for Australian ore companies will fall by A$16 billion this financial year.
 

Fortescue shares slumped to their lowest level in three years and the company’s market capitalization fell to around A$9 billion – less than the A$10 billion in debt the company has taken on as it funds its massive expansionary phase. With those gearing levels, Fortescue is the company which has taken the biggest punt on continuing Chinese demand, and the one with the most to lose.
 

Other miners, such as BHP Billiton and Rio Tinto, are well established players who have ridden the waves of the market for decades, not so Fortescue. More than any other Australian player, the company is highly vulnerable to any slowdown.
 

“In the short-term, the iron ore market will continue to suffer from oversupplying and the downward trend seems irreversible,” argue the analysts from Xinhua.
 

Shanghai based economist Andy Xie(謝國忠) forecasts that iron ore prices, currently at around US$100 a tonne, having peaked at US$190 in early 2011, would fall to US$50 a tonne by the middle of next year, and stay there. China, says Xie, was experiencing the “bubble phenomenon” and one of the major economic casualties will be Australia.

No plan B for Australia
The Bureau of Resource and Energy Economics is slightly less bearish than Xie, but the Australian government agency still forecasts that Australia’s mineral export volumes will fall by 6% to A$108 billion in 2012-2013 largely as a result of a 16% decrease in the iron ore price.
 

He Fan (何帆), assistant director at the Institute of World Economics and Politics within the Chinese Academy of Social Sciences, the leading think tank for China’s top leadership, has warned Australia to prepare for lower Chinese demand. “The bad news [for Australia] is the strong demand for commodities is not sustainable in the long term,” he told a conference in Canberra. “If Australia takes it for granted that China demand for minerals will continue, well you’d better come up with a second plan.”
 

Not everyone is a bear, however. David Utting is the head of the Yilgarn Iron Ore Producers Association in Western Australia and expects Chinese demand and prices to rebound in 2013. “People are concentrating far too much on the negatives,” said Utting, whose producer group is contemplating a A$300 million investment in its local port, Esperance. “The long range forecast for China’s peak demand is still ten years away, so watch this space, there’s room for more.”
 

Even so, the recent surge in commodity prices peaked around September 2011, with prices for key exports such as iron ore and coal on the decline ever since.
 

This has occurred at the same time as investment in resource projects has risen, and that pipeline cannot be turned off overnight. But the Australian Government has warned that up to A$230 billion of new investments could be at risk unless the resources industry can cut costs and boost productivity.
 

The engine for that investment, Chinese demand, has slowed and China looks like posting its slowest growth since 2009, even though at around 7.5%, the figure is stellar in world terms.

LNG drives investments

At BHP Billiton, the company has warned that Australian exports could slump by 25% if the “inertia” in China continues. “We are already beginning to see the end of the first stage of economic development in China,” believes Alberto Calderon. “The pace of demand for iron ore, from China, has slowed by more than half, and the mining industry is expanding supply at a very considerable pace,” adds the BHP chief executive of aluminium, nickel and corporate development. “These, along with declining commodity prices, will continue to squeeze margins and make some mining projects uncompetitive.”
Rio Tinto, however, believes that the pace of the Chinese slowdown has been overstated. “It slowed right down to around 7.8% for the first half of this year – which is hardly stagnant,” Rio’s Australian managing director David Peever said at an industry event recently in Canberra. Rio, however, has stated it would close its Blair Athol coal mine in Queensland this year, rather than seeking to extend the life of the operation.
 

“There is no question that the level of scrutiny that projects are coming under in Australia has been heightened quite significantly in recent times,” Peever said.
 

While the traditional commodities of iron ore and coal are under pressure, analysts say the development of the liquefied natural gas (LNG) industry – in which Chinese companies Sinopec and China Petrochemical Corporation have invested – will compensate and keep resource industry investments high. “In view of the large LNG and other mining investment projects already under way, the Reserve Bank of Australia (RBA) staff still expect there to be a substantial increase in resource investment over the next year or so,” read recent RBA published minutes. The oil and gas sector alone has A$250 billion in projects under construction, dominated by seven giant liquefied natural gas projects.
 

One major consequence of the current scenario could be a fall in the value of the Australian dollar and a spate of asset sales of Australian resource assets to a new wave of Asian, and largely Chinese, investors. This is part of a wave of M&A developing through the Asia-Pacific, where investment bankers see “smart money” coming into a sector such as coal, where the perception is that the bottom has been hit.
 

In Australia, where the resources industry is already 80% foreign owned, that M&A focus will be on smaller players who have been wrongfooted by the slowdown, and have over invested in expectation of more growth.

Overcommitted relationship

The leadership transition in Beijing is making Chinese corporates more cautious, but there is still an amount of bargain hunting that can be done at lower prices in the Australian resources space. Fortescue, for example, has responded to its recent problems by saying it could sell some non-core iron ore assets, and would be willing to consider bids for port and rail assets.
 

It all makes unusual timing for an Australian government white paper “Australia in the Asian Century” that is due to be released within weeks.
 

A year ago, the paper would have been released into an environment of confidence and certainty that Australia’s resources and its proximity to Asia guaranteed it long term prosperity. Now, the reminder is of just how vulnerable Australia is to winds of change in Asia, and particularly China. The white paper, written by the former treasury secretary Ken Henry, is reportedly set to make some radical recommendations, such as advocating freer, more flexible labour links between Australia and the region. Perhaps controversial, it would be one way of addressing the productivity issue.
 

While that might bring some protests in the popular press, Australian policy makers have known for decades that – regardless of popular opinion – Asia is the key to the country’s growth. It was in the 1950s after all that Australia and Japan, who had been at war barely a decade earlier, struck a deal which opened up Australian mines and helped drive Japan’s post-war economic growth. Australia and Asia need each other, but it seems that Australia may have just overcommitted to the relationship and might suffer the consequences, in the short to medium term at least.
 

Conversation
Robert Coughlan
Robert Coughlan
finance sector lead
Google Cloud
- JOINED THE EVENT -
Webinar
Unlocking the value of automation and AI in asset management
View Highlights
Conversation
Janet Li
Janet Li
partner and wealth business leader, Asia
Mercer
- JOINED THE EVENT -
Webinar
Developing strategies supporting sustainable investing
View Highlights