When the large resource houses seek to invest in capital-intensive and costly minerals projects, what goes through their mind? If the so-called resources boom is over, why are companies still investing in assets that are designed to last a very long time?
A year ago Victoria University’s Peter Sheehan wrote about the likelihood of the resources boom being sustained for some time yet. He suggested there were three possibilities that could define precisely what the end of a resources boom looks like.
The first is the end of a period of very high commodity prices and high terms of trade. Under this definition then, the boom has clearly ended. The second is an end to high resource-related capital investment. Capital investment has slowed and while it will remain at least until 2015 as investment in natural gas continues (from both the North-West shelf and from coal seams in Queensland and NSW), it is likely to stall soon thereafter.
The third is that the end of the boom would be represented by a sharp fall in the exchange rate. The Aussie dollar has weakened by over 15% against the US dollar in recent months.
Taken together, these possibilities suggest that the resources boom may indeed be over. Nowhere is this more apparent that in forecasting changes to the Federal Budget. The Commonwealth Government is lamenting the end of the resources boom and shudders to think that the world’s major miners might reduce their Australian investment to a trickle and put most of their mines into long-term care and maintenance.
But despite many mines continuing to operate at a loss, why was mining investment, exploration activity, downstream infrastructure and recruiting so aggressive in recent years? And why does there continue to be a positive outlook for mining, as demonstrated recently by BHP’s new chief executive Andrew Mackenzie ?
Well, we need to see the opportunity from a miner’s perspective. At the very core, resource firms view their survival in terms of the continued global demand for energy and industrial metals. But a mining executive is not likely to invest time and money where the risks outweigh the reward. Luckily, the demand projections for both raw energy materials and industrial metals remain compelling.
The figure below shows the relationship between GDP per capita and energy consumption (coal, oil, gas and nuclear) per capita for the US, Japan, Korea, Taiwan, China and India from 1960-2006 (using World Bank data). This type of representation is what every resource company boardroom in the country confronts when seeking self-assurance that the demand for their wares will continue.
The trajectory of each country in the graph illustrates their annual consumption of all forms of energy through time. Taking the US trajectory (in dark red), the figure shows that GDP per capita has risen over the last 50 years. This growth is loosely associated with a gradual rise in energy consumption. Recently developed countries like Taiwan (in green) and Korea (in black) however show a much more direct and rapid link between GDP per capita growth and energy consumption.
The critical curves on this graph are shown in the lower left-hand corner (near the origin). China’s energy consumption (in red) is starting to rise rapidly in line with its GDP growth. It is tracking very close to the energy consumption trajectory experienced in Korea and Taiwan in the early part of their growth phase. China clearly has a long way to go to match the trajectory of its Asian neighbours, but the potential trend is very clear. Even more significant is the tiny line near the origin that depicts India’s forecast trajectory (in brown). Assuming that India also closely tracks the energy consumption profile of other growth countries for the next 50 years, we anticipate that India’s primary energy use will also increase markedly as it grows.
The profiles measure energy consumption per capita, so to gauge future energy consumption these numbers need to be scaled accordingly. The combined population of India and China is almost five times the combined population of the US, Japan, Korea and Taiwan. Whatever energy the US, Japan, Korea and Taiwan consume now, multiply that by about five to get a sense of the energy demand by the two growth economies. That represents a lot of additional coal, gas, oil and uranium.
What is interesting about these projections is that the measurement can be replicated for almost any other commodity. And the results are similarly compelling.
For instance the graph below depicts the same general representation but this time it measures steel consumption per capita relative to GDP growth. The trajectories for developing nations are remarkably similar to the energy consumption profile, although Taiwan appears a bit spaghetti-like in recent years. Chinese and Indian consumption, relative to its developed neighbours, is very small on a per capita basis. Steel consumption is likely to at least double, and then double again, in the next 40 years. China and India’s journey has only just begun.
As every junior economist knows, the consumption of energy and industrial metals are very closely linked to a developing country’s stages of growth. The demand for early cycle commodities like coal, iron ore and potash will eventually slow and be replaced by demand for late cycle commodities like industrial metals. The demand for resource exploration and extraction may shift, but it will inevitably continue. Growth is therefore central to the continued demand for resources; historical growth estimates are thus monitored almost religiously from month-to-month .
These projections are not earth shattering revelations by themselves. But they do allow mining executives to sleep easier at night.
And it is not just the resource houses that place great faith in these trajectories. Construction firms, port operators, rail companies, freight companies, engineering houses and most state and federal governments have all staked a large claim on Chinese and Indian growth.
They can’t all be wrong. Can they?