tag:theconversation.com,2011:/us/topics/iron-ore-prices-3762/articlesIron ore prices – The Conversation2019-06-30T11:58:58Ztag:theconversation.com,2011:article/1194552019-06-30T11:58:58Z2019-06-30T11:58:58ZBuckle up. 2019-20 survey finds the economy weak and heading down, and that’s ahead of surprises<figure><img src="https://images.theconversation.com/files/281502/original/file-20190627-76701-1cldpad.png?ixlib=rb-1.1.0&rect=377%2C0%2C2868%2C2000&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">As uncertain as 2019-20 is, The Conversation's team of 20 leading economists are in broad agreement that the outlook isn't good. Scott Morrison and Treasurer Josh Frydenberg will also have to deal with the unexpected.</span> <span class="attribution"><span class="source">Wes Mountain/The Conversation</span>, <a class="license" href="http://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a></span></figcaption></figure><p>During the election we were promised jobs and growth. But in 2019-20 The Conversation’s forecasting panel is predicting an economic growth rate as weak as any since the financial crisis, as well as dismal consumer spending, no improvement in unemployment or wage growth, and an increased chance of recession.</p>
<p>As in <a href="https://theconversation.com/no-surplus-no-share-market-growth-no-lift-in-wage-growth-economic-survey-points-to-bleaker-times-post-election-110315">January</a>, The Conversation has assembled a forecasting panel of 20 leading economists from 12 universities across six states. Among them are macroeconomists, economic modellers, former Treasury, IMF, OECD and Reserve Bank officials, a former government minister and a former member of the Reserve Bank board.</p>
<p>Whereas in January only <a href="https://theconversation.com/no-surplus-no-share-market-growth-no-lift-in-wage-growth-economic-survey-points-to-bleaker-times-post-election-110315">three</a> members of the 20-person panel expected the Reserve Bank to cut interest rates, and most expected an economic growth rate approaching 3% (which is the Treasury’s estimate of the <a href="http://treasury.gov.au/speech/the-macroeconomic-context">best that can be achieved</a> on a sustained basis), this time all but two expect the bank to cut again, and most expect a growth rate closer to 2% – one of the most anaemic since the financial crisis.</p>
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Read more:
<a href="https://theconversation.com/no-surplus-no-share-market-growth-no-lift-in-wage-growth-economic-survey-points-to-bleaker-times-post-election-110315">No surplus, no share market growth, no lift in wage growth. Economic survey points to bleaker times post-election</a>
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<p>On the upside, the panel expects iron ore prices to stay higher for longer than did the budget, it expects home prices to stabilise, and it is predicting the lowest government bond rate on record, making it cheaper than ever before for the government to borrow and spend its way out of trouble.</p>
<p>The panel predicts a surplus in name only in 2019-20, and overwhelmingly believes the government should be prepared to abandon it if it has to in order to keep the economy growing.</p>
<h2>Economic growth</h2>
<p>The panel’s average forecast for year-on-year growth is 2.1%. Year-on-year growth is the measure used in the budget. It compares economic activity throughout all of one financial year with activity throughout all of the previous financial year. The budget forecast for 2019-20 is 2.75%. </p>
<p>Respected forecasters including former Reserve Bank board member Warwick McKibbin and former OECD director Adrian Blundell-Wignall expect much lower growth than 2.1%. McKibbin expects 1.8%; Blundell-Wignall expects 1.5%. Only three of the panel’s 20 forecasts are close to Treasury’s. The rest are lower.</p>
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<p>Some panellists submitted forecasts for Chinese economic growth under sufferance. They made it clear they were forecasting “official” growth, not actual growth which they think is much lower. Even so, most expect official growth to slow as the trade war between the United States and China intensifies. Nigel Stapledon says unless it is reined in (and he thinks it will be) it could bring on recessions. </p>
<p>Other panellists including Rebecca Cassells say the impact of US tariffs on Chinese goods has so far been positive for Australia. China has responded by investing in infrastructure projects that need Australian iron ore and coal. This, together with reduced competition from other suppliers of iron ore after the collapse of a tailings dam and mine closures in Brazil, has lifted the price and volume of Australian exports to levels not seen for some time.</p>
<p>The panel expects robust United States growth of 2.6% in 2019, although many members are concerned about the year that will follow. The only panellist to forecast low US growth in this year (1%) is Blundell-Wignall, who until last year analysed world economies in his role as special advisor to the OECD secretary general.</p>
<h2>Living standards</h2>
<p>Jobs growth will disappoint both the Treasury, which has forecast unemployment of <a href="https://budget.gov.au/2019-20/content/overview.htm#our-plan">5%</a> by the end of the financial year, and Reserve Bank Governor Philip Lowe, who has adopted a target of “<a href="https://www.rba.gov.au/speeches/2019/sp-gov-2019-06-04.html">4 point something</a>”.</p>
<p>All but three of the 20-person panel expect the rate to stay above 5%. The average forecast is 5.3%, which is close to the present 5.2%.</p>
<p>Stapledon says Australia’s recent strong employment growth has been “out of kilter” with slower GDP growth and the winding down of housing construction, meaning jobs growth is set to slow down, pushing up unemployment.</p>
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<p>Brendan Coates says underemployment is also climbing as more people work fewer hours than they would like, making it harder for them to push for wage rises. Rebecca Cassells points out that full-time employment has grown almost twice as fast among women than men, which, given the low rates of pay in the industries that traditionally employ women, is likely to further depress average wages.</p>
<p>The headline measure of living standards, GDP per capita, has been falling, but a better measure, real net disposable income per capita, which takes better account of buying power, has been continuing to climb. The panel expected to climb a further 1% over the year to June 2020, after climbing 1.3% in the year to March. </p>
<p>Nominal GDP, which takes full account of mining revenue and drives company profits and the budget revenue, has grown 5% over the past year and is expected to grow 3% in the year ahead.</p>
<h2>The risk of recession</h2>
<p>The panel regards a recession as more likely <a href="https://theconversation.com/no-surplus-no-share-market-growth-no-lift-in-wage-growth-economic-survey-points-to-bleaker-times-post-election-110315">than it did in January</a>, assigning a 29% probability to a conventionally defined recession in the next two years, up from 25%.</p>
<p>Economic modeller Janine Dixon says the bulk of Australia’s recent economic growth has come from higher commodity prices via exports.</p>
<p>She says without them, Australia would be reliant on weak wage and consumption growth, although she believes high population growth will be enough to ensure economic activity doesn’t shrink for two consecutive quarters which would be the conventional definition of a recession.</p>
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<p>Former Treasury and ANZ Bank economist Warren Hogan says with consumers tightening their belts, an external shock could easily knock Australia into a recession. </p>
<p>Julie Toth, an economist at the Australian Industry Group who has also worked for the Productivity Commission, says with growth already low, it won’t take much to turn it negative.</p>
<p>Debt theorist Steve Keen, who assigns a 95% probability a recession (as he did in January) says Australia escaped that fate during the global financial crisis in part by boosting grants to first home buyers, which made Australian households among the most indebted in the world and “put off the day of reckoning” when those debts would be unwound.</p>
<p>Through a mix of good luck and good management, Australia has avoided a recession during three global downturns since the early 1990s: the 1997 Asian economic crisis, the early 2000s dotcom collapse, and the 2007-09 global financial crisis. If it succeeds again it will enter its fourth decade recession-free in this term of government in mid-2021. </p>
<h2>Wages and prices</h2>
<p>The panel expects continued historically wage growth of only 2.2% in 2019-20, slightly weaker than the latest reading of 2.3% and well short of the budget forecast of 2.75%. If that average forecast is right, it will be the seventh consecutive year in which wage growth has <a href="https://theconversation.com/its-the-budget-cash-splash-that-reaches-back-in-time-114188">fallen short of the budget forecast</a>. </p>
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<p>The good news (for wage earners) is that even that unusually low rate of wage growth would be well above the rate of inflation, which is expected to be only 1.5%, or 1.4% on the so-called “underlying” basis watched closely by the Reserve Bank.</p>
<p>The bad news for the Reserve Bank is that it will put inflation well outside the bank’s target band of 2-3% for the fifth consecutive year, raising questions about whether there is <a href="https://theconversation.com/vital-signs-the-rbas-marching-orders-are-no-longer-realistic-theyll-have-to-change-118693">any point to the band</a>.</p>
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<a href="https://images.theconversation.com/files/279442/original/file-20190613-32335-10rbga9.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/279442/original/file-20190613-32335-10rbga9.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/279442/original/file-20190613-32335-10rbga9.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=221&fit=crop&dpr=1 600w, https://images.theconversation.com/files/279442/original/file-20190613-32335-10rbga9.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=221&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/279442/original/file-20190613-32335-10rbga9.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=221&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/279442/original/file-20190613-32335-10rbga9.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=278&fit=crop&dpr=1 754w, https://images.theconversation.com/files/279442/original/file-20190613-32335-10rbga9.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=278&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/279442/original/file-20190613-32335-10rbga9.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=278&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">For years now, inflation has mostly been below the band.</span>
<span class="attribution"><a class="source" href="https://www.abs.gov.au/AUSSTATS/abs@.nsf/mf/6401.0">ABS 6401.0</a></span>
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<p>Mark Crosby, Warren Hogan and Adrian Blundell-Wignall suggest broadening the target band to 1-3%. Tony Makin and Nigel Stapledon suggest cutting it to 1-2%. </p>
<p>Richard Holden and Warwick McKibbin suggest ditching it altogether and replacing it with a target for nominal GDP growth. McKibbin suggests a nominal GDP target of 6%, which given the present forecast for weaker nominal GDP growth would mean interest rate cuts. In better times it would mean rate rises.</p>
<p>Chris Edmond and Craig Emerson defend the 2-3% inflation target saying that what is really concerning is the bank’s preparedness to stay beneath the target band for extended periods.</p>
<h2>Home prices</h2>
<p>The panel expects only modest falls in Sydney and Melbourne house prices of 2-3% in each city after falls of 10% over the past year. It is more optimistic on home building than is the Treasury, expecting housing investment to fall by 4.9% rather than the budget forecast of 7%.</p>
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<h2>Business</h2>
<p>None of the panellists expects household spending to grow by the 2.75% forecast in the budget. On average, the panel expects spending growth of just 1.9% in 2019-20, which is little better than the present 1.8% and only few points above population growth.</p>
<p>Janine Dixon blames continuing weak growth in wages and incomes. Nigel Stapledon says much of it flows from the weaker housing market. Household furnishings drive household spending growth. Household spending drives GDP growth, accounting for more than half of it.</p>
<p>In better news, the panel expects mining investment to rebound after sliding for most of the last five years. Its forecasts of growth in mining investment of 4.4%, and growth in non-mining investment of 4%, are in line with budget forecasts.</p>
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<h2>Interest rates and the budget</h2>
<p>Perhaps surprisingly given its forecasts for weak employment growth, weak economic growth and weak inflation, the panel’s average forecast for interest rates is for just one more cut, perhaps as soon as July 2, but some time in the second half of the year. </p>
<p>Only five panellists expect a followup cut in the first half of next year, but among them are Craig Emerson, Richard Holden and Steve Keen, who were the only three to <a href="https://theconversation.com/no-surplus-no-share-market-growth-no-lift-in-wage-growth-economic-survey-points-to-bleaker-times-post-election-110315">correctly</a>) forecast in January that there would be a rate cut at all this year.</p>
<p>Holden expects two further rate cuts in the second half of this year, taking the Reserve Bank cash rate to 0.75%, and then a further two in the first half of next year, taking it to just 0.25%. Keen expects one further cut on the second half of this year and another two in the first half of next year, taking it to 0.5%.</p>
<p>Warwick McKibbin is the only panellist expecting the Reserve Bank to change course, expecting one further cut this year and then a series of increases as ballooning debt makes the Reserve Bank and other central banks realise they cut too far, pushing the cash rate back up to 1.5%.</p>
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<p>The panel expects a government 10-year borrowing rate of just 1.5%, which is about the lowest it has ever been. A year ago the 10-year bond rate was 2.7%. The ultra low rate will both make it easier for the government to borrow and cut the cost of servicing its existing debt as loans are rolled over.</p>
<p>In further good news for the budget, the panel expects a substantially higher spot iron ore price than does the government, of US$95 a tonne by mid next year instead of the fall to US$55 assumed by the Treasury.</p>
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<p>The forecast is somewhat above the Department of Industry’s <a href="https://www.industry.gov.au/">new July forecast</a> of US$95 a tonne by the end of this year trending down to US$61 by the end of 2020, but are way in excess what was forecast in the budget. A <a href="https://budget.gov.au/2019-20/content/bp1/download/bp1_bs7.pdf">sensitivity analysis</a> included in the budget said that for every US$10 that the iron ore price was higher than budgeted, the government’s tax take would be A$1.1 billion higher in 2019-20 and A$3.7 billion higher in 2020-21.</p>
<p>The panel expects the Australian dollar to remain broadly where it is at just below 70 US cents as the upward push from strong commodity prices offsets the downward push from domestic economic weakness.</p>
<p>Yet despite the iron ore price and lower borrowing costs the panel expects a much weaker budget outcome than the A$7.1 billion surplus forecast in April.</p>
<p>Its average forecast is for a surplus of only $1.7 billion, which is a mere sliver of GDP (0.1%), practically indistinguishable from a deficit of the same amount.</p>
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<p>The forecasts come after <a href="https://www.finance.gov.au/publications/commonwealth-monthly-financial-statements/2019/mfs-may/">Finance Department figures</a> for May released on Friday raised the possibility of an early return to surplus in 2018-19. They suggest that surplus is at risk in 2019-20 and beyond, both because of economic weakness and an because of an increasingly urgent need to respond to that weakness through spending or further tax cuts.</p>
<p>Asked whether should the government strive to continue to deliver its promise of a surplus if economic growth remains weak or weakens further, former OECD director Adrian Blundell-Wignall replied bluntly, “of course not”.</p>
<p>The only panellists prepared to defend the continued pursuit of a surplus in the economy remained weak or weakened were Ross Guest, who said it was a worthwhile aim given the steady rise in government debt to GDP ratio, and Tony Makin, who qualified his reply by saying the surplus should be achieved by pruning unproductive expenditure such as industry assistance rather than deferring tax cuts. </p>
<p>Former government minister Craig Emerson regretfully forecast that the government would deliver a surplus whatever the economic circumstances, for political reasons.</p>
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<h2>The Conversation 2019-20 Forecasting Panel</h2>
<p><em>Click on economist to see full profile. Forecasts as of June 24, 2019.</em></p>
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<p><a href="https://cdn.theconversation.com/static_files/files/841/2019_-2020_CONVERSATION_ECONOMIC_SURVEY.pdf?1579484023">PDF OF RESULTS</a></p><img src="https://counter.theconversation.com/content/119455/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Peter Martin does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The Conversation’s distinguished panel predicts unusually weak growth, dismal spending, no improvement in either unemployment or wage growth, and an increased chance of recession.Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/650322016-09-07T06:24:32Z2016-09-07T06:24:32ZBusiness Briefing: disrupted companies will need to think global to survive<p>Australian companies should better manage the expectations of shareholders who increasingly expect dividends and focus more on meeting the needs of global consumers, says UNSW Adjunct Professor Paul X. McCarthy.</p>
<p>That’s his advice for companies dealing with the disruption brought on by digital platforms. Aside from the price of iron ore affecting the big end of town in this year’s results, the major disrupter is the movement of advertising dollars to online global channels and marketplaces, such as multinationals like Uber, Google and Facebook.</p>
<p>He explains that sectors that were previously thought to be sheltered from the forces of digital disruption, such as legal services and real estate, are now facing the same challenges as other sectors.</p>
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<p><em>Read more analysis on the bigger picture of what is happening in Australia’s business sectors, in our <a href="https://theconversation.com/au/topics/company-results-2016-30905">company results wrap series</a>.</em></p><img src="https://counter.theconversation.com/content/65032/count.gif" alt="The Conversation" width="1" height="1" />
Australian businesses need to focus more on the global market and less on giving generous dividends to shareholders.Jenni Henderson, Section Editor: Business + EconomyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/565882016-04-19T20:21:01Z2016-04-19T20:21:01ZBudget explainer: commodity prices and the federal budget<p>The first years of the millennium were kind to government finances. A benign economic environment, and a <a href="http://www.theguardian.com/world/2013/nov/26/mining-boom-a-once-in-a-century-lost-economic-opportunity-report-finds">once-in-a-century commodity boom</a> fuelled by Chinese growth, helped the Federal budget to a cumulative surplus of $89.3 billion over the period 1999-2008. </p>
<p>The <a href="http://www.imf.org/external/pubs/ft/survey/so/2015/RES100715A.htm">IMF</a> notes that fiscal policy can either calm or magnify the effects of volatile commodity prices on the domestic economy. While some countries, such as Norway, have set aside the funds resulting from a commodity windfall for a rainy day, Australia has taken a different tack. </p>
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<p>While net debt was paid down from +$53.1 billion (8.4% of GDP) to -$42.9 billion (-3.8% of GDP), the Howard government was among the <a href="https://www.thesaturdaypaper.com.au/news/politics/2014/12/20/how-john-howards-tax-cuts-undid-his-protege-tony-abbott/14189940001389">most profligate in history</a>. The structural integrity of the budget continues to be undermined by the spending commitments, tax cuts, and generous concessions (such as that on superannuation) made at that time. Since the global financial crisis, and ensuing fiscal stimulation, the federal budget has maintained a deficit, to the tune of an estimated $321 billion (cumulatively) by the end of the 2015-16 fiscal year.</p>
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<h2>How do commodity prices impact the budget?</h2>
<p>While the price of crude oil (which liquefied natural gas prices are referenced against) and thermal coal peaked in 2008 (at the time of the global financial crisis), iron ore prices did not peak until February 2011. Each of the commodities so crucial to export revenue and budget stability have since declined in price by over 70%. </p>
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<p>It is <a href="http://www.afr.com/news/policy/budget/heres-why-australias-budget-is-still-so-dependent-on-iron-ore-20151215-globie">estimated</a> that every $10 fall in the price of iron ore results in around $2.5 billion a year in lost tax revenue. A simple calculation suggests that the fall in iron prices from the 2010-11 peak (US$162 average) to an average of US$49.50 in this fiscal year makes a $27.5 billion dent in the budget. </p>
<p>However, royalties from the sale of commodity resources typically accrue to the states, so where is the link to the federal budget?</p>
<p>The most direct association is via the profitability of the resource sector – higher earnings should equate to a higher contribution in the form of corporate tax. There is also a multiplier effect whereby firms in complementary sectors (such as mining services) benefit from the boom and pay more tax. Additional staff are employed (often on higher salaries), contributing more income tax, spreading the wealth to the wider economy, and <a href="http://www.rba.gov.au/publications/bulletin/2015/sep/pdf/bu-0915-4.pdf">boosting economic growth</a>. </p>
<p>The flipside is the detrimental impact on industries, such as manufacturing and tourism, which suffered as the Australian dollar rose in sync with the terms of trade. The budget has become ever more dependent on the resource sector. </p>
<p>Now, the cycle is in reverse. As the investment phase of the cycle ends, expensive cost structures start to be stripped back, fewer staff are required and <a href="http://www.afr.com/news/special-reports/australia-energy-future/mining-services-companies-under-stress-20151129-glap8b">related companies struggle</a>. Lower commodity prices result in huge <a href="http://www.abc.net.au/news/2015-11-10/iron-ore-miners-bear-brunt-of-value-writedowns/6927868">write-downs of existing projects</a> and <a href="https://au.news.yahoo.com/thewest/wa/a/31168938/woodside-shelves-browse-lng-project/">postponement of new projects</a> which reduces both current and future tax revenue. </p>
<p>Treasury Secretary John Fraser <a href="http://www.treasury.gov.au/PublicationsAndMedia/Speeches/2016/The-Australian-Budget">recently stated</a> that below expectation revenue collection is the major cause of deterioration in the budget position.</p>
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<h2>A Treasurer’s windfall?</h2>
<p>Iron ore prices hit a low in December 2015, coinciding closely with the publication of the Mid Year Economic and Fiscal Outlook (<a href="http://www.budget.gov.au/2015-16/content/myefo/download/MYEFO_2015-16_Final.pdf">MYEFO</a>). At that time, Treasurer Scott Morrison painted a bleak picture of both the economic outlook and government finances. Forecast GDP was revised down to 2.75%, while assumptions for thermal coal (US$52 per tonne) and iron ore (US$39 per tonne) prices were lowered. The reduction in the iron ore forecast (from US$48 per tonne previously) reduced expected tax receipts by around $7 billion.</p>
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<p>In the intervening period, commodity prices have generally risen sharply. Thermal coal prices have increased by 18%, while iron ore has bounced over 40%. This helped economic growth to <a href="http://www.abc.net.au/news/2016-03-02/gdp-economic-growth-data-december-quarter-2015/7213540">beat forecasts</a> and should allow for a more upbeat final budget outcome. </p>
<p>Importantly, recent commodity price increases should give Morrison a little more room for manoeuvre in the forthcoming budget. Ahead of a likely early federal election, surely there will be the temptation to use the windfall to entice voter support for a Coalition re-election. </p>
<p>However, with market commentators cautioning that the recent <a href="http://www.smh.com.au/business/markets/goldman-sachs-thinks-miners-could-upgrade-earnings-by-30pc--or-maybe-not-20160322-gnp3it.html">rebound in commodity markets is not sustainable</a> one can only hope that historical mistakes of basing <a href="http://www2.deloitte.com/au/en/pages/media-releases/articles/budget-monitor-temporary-boom-permanent-promises-011214.html">permanent promises on a temporary boom</a> are not repeated. </p>
<h2>A lesson for fiscal prudence?</h2>
<p>There are some important lessons to be had from fiscal management in Australia - at both the state and federal level. Commodity prices are volatile and can result in significant gyrations in government finances and economic activity. </p>
<p>Ideally, fiscal policy should act as a stabiliser, <a href="http://blog-pfm.imf.org/pfmblog/2015/07/your-majesty-rebuild-that-fiscal-buffer-some-fiscal-policy-advice-from-the-eighteenth-century.html">building up a buffer</a> during the boom years that can be drawn upon in the subsequent lean years - and helping to ensure that one generation doesn’t exhaust available resources to the determinant of the future generations. </p>
<p>Basing long-term, structural, policy decisions on a short-term, temporary boost can be a recipe for fiscal disaster. This is also relevant for state governments currently benefiting from a stamp duty windfall as a result of soaring house prices. At a bare minimum, sound fiscal policy should require that conservative assumptions be used in preparing budget forecasts.</p><img src="https://counter.theconversation.com/content/56588/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Lee Smales does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The first years of the millennium were kind to government finances. A benign economic environment, and a once-in-a-century commodity boom fuelled by Chinese growth, helped the Federal budget to a cumulative…Lee Smales, Senior Lecturer, Finance, Curtin UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/544762016-03-20T19:28:11Z2016-03-20T19:28:11ZIron ore still has an important role to play in Australia’s economy<p><em>Australia is pivoting its economy away from resources like coal and iron ore, but are there other commodities we can bank on to take up some of the slack? In this <a href="https://theconversation.com/au/topics/future-commodities">“future commodities”</a> series we explore the economic future for commodities we’ve always relied on, and some we haven’t.</em></p>
<hr>
<p>Despite the recent increase in prices, there is still a sense of gloom and doom around the price of iron ore. However, increasing demand from developing economies for steel will eventually see demand catch up with supply in the future. Australia is well placed to capitalise on this, even if the price remains low for some time, with its large reserves of the resource and current investment in infrastructure.</p>
<p>The World Bank, in its latest <a href="http://pubdocs.worldbank.org/pubdocs/publicdoc/2016/1/991211453766993714/CMO-Jan-2016-Full-Report.pdf">Commodity Market Outlook</a>, has reduced its forecast for 2016 iron ore prices to $42 a metric ton from a forecast price of $59.50 that was made in October 2015. Iron prices in the fourth quarter of 2015 dropped 15%, against a drop of 8% for all metal prices. Prices have recently increased to over $50 a ton, which is still a fraction of its 2011 peak.</p>
<p>According to the World Bank, the plunge in the price is a result of continued oversupply, weak demand from the steel production sector in China, and destocking of iron ore at Chinese Mills. </p>
<p>Despite weaker demand, the <a href="http://www.australianmining.com.au/news/iron-ore-future-appears-grim">major miners continue to expand</a> production. While I have questioned <a href="https://theconversation.com/iron-ore-race-to-the-bottom-not-in-the-interests-of-australians-33685">whether this race to the bottom</a> was in the interest of Australians, this new low-cost ore capacity continues to become available in Australia and Brazil, and it is displacing higher-cost mines in China and elsewhere. </p>
<p>Australia’s share of the seaborne market into China <a href="http://www.industry.gov.au/Office-of-the-Chief-Economist/Publications/Documents/crq/China-Resources-Quarterly-Sourthern-summer-Northern-winter-2016.pdf">increased from 59% to 64% in 2015</a> and Brazil’s share increased from 18% to 20% in the same period. </p>
<p>Iron ore trading has traditionally been the second-largest commodity market after crude oil and Australia has a substantial share of such market, accounting for about half of the seaborne iron ore market. </p>
<p>This is unlikely to change for a number of reasons. Australia’s Pilbara region has one of the most significant iron ore deposits globally and large investments have been made to ensure that extraction and processing costs are low.</p>
<p>Low-cost Australian miners are well positioned to continue to supply in a market characterised by low prices. The World Bank has forecast prices between $42 per metric ton for 2016 to $51 per metric ton for 2020, which would likely see high cost miners continued to be displaced by low-cost miners in Australia and Brazil. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/112065/original/image-20160219-1283-xw5z2n.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/112065/original/image-20160219-1283-xw5z2n.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/112065/original/image-20160219-1283-xw5z2n.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=485&fit=crop&dpr=1 600w, https://images.theconversation.com/files/112065/original/image-20160219-1283-xw5z2n.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=485&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/112065/original/image-20160219-1283-xw5z2n.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=485&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/112065/original/image-20160219-1283-xw5z2n.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=610&fit=crop&dpr=1 754w, https://images.theconversation.com/files/112065/original/image-20160219-1283-xw5z2n.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=610&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/112065/original/image-20160219-1283-xw5z2n.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=610&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="http://www.rba.gov.au/publications/smp/boxes/2015/feb/a.pdf">AME Group/Reserve Bank of Australia</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<p>Unless Chinese demand falls rapidly, the lower price will be partly compensated by higher volumes. This scenario is illustrated in this graph, which shows that value of exports in 2015 remains high despite the iron ore price having peaked in 2011.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/112062/original/image-20160219-1283-1bx3upd.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/112062/original/image-20160219-1283-1bx3upd.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/112062/original/image-20160219-1283-1bx3upd.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=513&fit=crop&dpr=1 600w, https://images.theconversation.com/files/112062/original/image-20160219-1283-1bx3upd.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=513&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/112062/original/image-20160219-1283-1bx3upd.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=513&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/112062/original/image-20160219-1283-1bx3upd.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=645&fit=crop&dpr=1 754w, https://images.theconversation.com/files/112062/original/image-20160219-1283-1bx3upd.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=645&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/112062/original/image-20160219-1283-1bx3upd.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=645&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="http://www.industry.gov.au/Office-of-the-Chief-Economist/Publications/Documents/crq/China-Resources-Quarterly-Sourthern-summer-Northern-winter-2016.pdf">China Resources Quarterly, Department of Industry, Innovation and Science</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<p>It does not seem likely, except if there is a major economic crisis, that the Chinese demand will fall dramatically in the short run. Some analysts argue that while <a href="http://www.platts.com/latest-news/metals/london/china-steel-capital-stocks-need-decades-to-match-26368644">China’s steel consumption has likely peaked</a>, it is still catching up to a stock of steel per capita that characterises developed economies. </p>
<p>Steel is still needed in developing economies to build transport infrastructure, housing, gas and electricity supply networks, water and sanitation and to build factories and machinery. At a certain point, when the essential infrastructure has been built, the demand for consumer goods such as washing machines and refrigerators increases as national income continues to grow.</p>
<p>As the society becomes more urbanised, steel is also needed for urban transport (subways, trains, buses and cars) but also for high-rise apartment blocks that are associated with larger population density. </p>
<p>As shown in the figure below, steel stocks per person tends to plateau as a certain level of wealth is reached and the need for new infrastructure and buildings are met. The exceptions are Japan and Canada. The former because of the shipbuilding, engineering and automotive industries and the later as an exporter of steel. </p>
<p>Steel lasts for a long time, and it can be recycled to meet the need for more steel once its stock reaches a plateau. From that point onwards, the need for steel, to replace appliances, buildings and infrastructure and to account for population growth, can perhaps be met by recycling scrap, rather than by burning coal to smelt iron ore in blast furnaces. </p>
<p>In China a lot of the infrastructure is new and it will not be recycled anytime soon. Moreover, it is also expected that the demand for consumer goods will increase, which mean that it may be a while before the consumption of steel per capita falls significantly. </p>
<p>Chinese per capita consumption level is now about 1.5 times that of the US and so it stands to reason that it will fall. However, it may be a while before the stock (not the flow) of steel reaches a plateau. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/112263/original/image-20160222-25891-dihm5c.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/112263/original/image-20160222-25891-dihm5c.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/112263/original/image-20160222-25891-dihm5c.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=525&fit=crop&dpr=1 600w, https://images.theconversation.com/files/112263/original/image-20160222-25891-dihm5c.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=525&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/112263/original/image-20160222-25891-dihm5c.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=525&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/112263/original/image-20160222-25891-dihm5c.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=660&fit=crop&dpr=1 754w, https://images.theconversation.com/files/112263/original/image-20160222-25891-dihm5c.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=660&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/112263/original/image-20160222-25891-dihm5c.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=660&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.worldsteel.org/steel-by-topic/sustainable-steel/economic.html">WorldSteel Association</a>, <span class="license">Author provided</span></span>
</figcaption>
</figure>
<p>The WorldSteel Association estimated that the world average stock of steel per capital was about 2.7 tonnes in 2005, which suggests that there will also be strong growth in steel production in other areas of the world to support economic development. </p>
<p>This is especially the case as the second most populated country, India, accounting for nearly 20% of the world’s population and with a stock of steel per capita of 0.4 tons (as of 2005), develops economically. </p>
<p>All this suggests iron ore will continue to play an important role in the world economy for decades to come if demand for steel continues to rise to support economic development.</p><img src="https://counter.theconversation.com/content/54476/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Flavio Menezes does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Even if the price of iron ore remains low, Australia is still well placed to benefit from this resource in the future.Flavio Menezes, Professor of Economics, The University of QueenslandLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/418142015-05-18T03:49:44Z2015-05-18T03:49:44ZCompetition the wrong test for iron ore inquiry<p>Fortescue Metals Group Chairman Andrew Forrest has <a href="http://www.afr.com/business/mining/iron-ore/andrew-forrests-iron-ore-campaign-against-bhp-billiton-and-rio-tinto-goes-grassroots-20150517-gh3qzv">stepped up</a> his campaign against competitors Rio and BHP, after gathering the support of independent Senator Nick Xenophon who is pushing for an inquiry into competition in the iron ore sector.</p>
<p>Forrest <a href="http://www.dailytelegraph.com.au/news/opinion/big-miners-bhp-billiton-and-rio-tintos-flood-the-market-tactics-threaten-australias-prosperity/story-fni0cwl5-1227349418669">claims</a> the miners are harming the Australian economy by flooding the market with iron ore, driving lower prices with a <a href="http://www.abc.net.au/news/2015-05-04/andrew-forrest-renews-attack-on-rio-bhp-iron-ore-supply/6444014">“predatory volume strategy”</a>. Australian Competition and Consumer Commission Chairman Rod Sims says it’s hard to make a claim of predatory behaviour given the miners are still making a margin on their product.</p>
<p>Prime Minister Tony Abbott has said an inquiry <a href="http://www.news.com.au/national/breaking-news/decision-on-iron-ore-inquiry-soon-hockey/story-e6frfku9-1227357805095">“could make sense”</a> in order to “get to the bottom on claim and counter-claim about what’s happening inside the iron ore industry at the moment”.</p>
<h2>How we got here</h2>
<p>Most Australians would know by now that the price of iron ore has fallen substantially over the last year. To get a sense of the decline, the benchmark price has fallen by more than 60% from around US$135 per tonne at the beginning of 2014 to below US$50, recovering to above US$60 recently.</p>
<p>This fall has been driven by two main factors. First, iron ore is essentially used for the production of steel. In turn, the demand for steel is typically driven by construction activity. New residential building construction starts in China, the biggest buyer of iron ore, declined by 14.4% in 2014.</p>
<p>Second, there has been an expansion in production by the world’s three largest miners: Rio Tinto, BHP and Brazil’s Vale. Together these three companies represent more than 60% of the international iron ore market. Moreover, all three major mining companies have plans to further increase supply.</p>
<p>Vale, for example, <a href="http://www.vale.com/EN/investors/home-press-releases/Press-Releases/ReleaseDocuments/PREPORT1T15_i.pdf">increased production</a> by nearly 11% or about 12 million tonnes between the first and last quarters of 2014. BHP <a href="http://www.theaustralian.com.au/business/mining-energy/bhp-lifts-wa-iron-ore-forecasts-increases-march-quarter-output/story-e6frg9df-1227314701106">produced 59 million tonnes</a> of iron ore in the first quarter of 2005, representing a 20% increase on quarter 1 2014, and approximately 77% of Vale’s production in the same period. Similarly, Rio Tinto increased iron ore production by 11% in 2014, to a total of over 300 million tonnes.</p>
<p>Collectively, the world’s largest iron ore producers (Vale, Rio Tinto, BHP Billiton, and the smaller Anglo American and FMG), <a href="http://static.ourstatebudget.wa.gov.au/15-16/factsheets/ironore.pdf">increased sales</a> by more than 140 million tonnes, around 10% of the total seaborne market, in 2014.</p>
<h2>The market adjustment</h2>
<p>The demand for iron ore is derived from the demand for steel, which in turn is derived from the demand for construction. This suggests the elasticity of demand ought to be fairly low. <a href="http://econ.duke.edu/uploads/media_items/thesis-zhirui-zhu.original.pdf">One estimate</a> of the world’s elasticity of demand for iron ore suggests that a 1% drop in price leads to an increase in demand of only 0.24%. </p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/81972/original/image-20150518-25422-gp9sio.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/81972/original/image-20150518-25422-gp9sio.png?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/81972/original/image-20150518-25422-gp9sio.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=571&fit=crop&dpr=1 600w, https://images.theconversation.com/files/81972/original/image-20150518-25422-gp9sio.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=571&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/81972/original/image-20150518-25422-gp9sio.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=571&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/81972/original/image-20150518-25422-gp9sio.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=717&fit=crop&dpr=1 754w, https://images.theconversation.com/files/81972/original/image-20150518-25422-gp9sio.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=717&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/81972/original/image-20150518-25422-gp9sio.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=717&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Reserve Bank of Australia.</span>
</figcaption>
</figure>
<p>The low elasticity of demand suggests that the market will primarily adjust through changes in supply, with high cost suppliers being displaced by low cost producers and revenue falling. The chart to the right, reproduced from an <a href="http://www.rba.gov.au/publications/smp/boxes/2015/feb/a.pdf">RBA report</a>, is helpful in understanding which miners will be displaced as a result of the drop in prices.</p>
<p>Indeed, this adjustment is already in motion. For example, China now imports more than 80% of the iron ore it needs compared to 70% two years ago. China’s iron-ore output has <a href="http://www.businessspectator.com.au/news/2015/4/30/china/iron-ore-price-war-has-chinas-miners-reeling">decreased by 9%</a> in the first quarter of 2015. The impact is also being felt by smaller miners in Australia and in other parts of the world.</p>
<p>Moreover, the impact on revenue is also as predicted. While Australia’s exports of iron ore to China increased by 18% on a yearly basis, iron ore export earnings <a href="http://www.industry.gov.au/industry/Office-of-the-Chief-Economist/News/media-releases/Pages/Increasing-supply-and-slowing-economic-growth-in-China-contributes-to-weaker-commodity-prices-14-May-2015.aspx">declined by 31%</a> due to the fall in prices. </p>
<p>In a nutshell, while the larger miners are gaining market share, they are doing so at the expense of high cost miners and it is adversely affecting earnings. The diagram above also helps us understand why the ACCC has said that this process of high cost suppliers being replaced by low cost suppliers simply reflects the workings of a competitive market.</p>
<h2>Where will it end?</h2>
<p>The <a href="https://hbr.org/2000/03/how-to-fight-a-price-war">example of the airline industry price wars</a> in the US following the 1992 deregulation is instructive. As a result of the price war, the industry lost all the profits that had been earned in its entire history.</p>
<p>Why would the large miners engage in a price war?</p>
<p>Andrew Forrest’s central idea seems to be that by increasing production, and causing such a large decrease in prices, large, low cost miners would be able to exclude small, high cost miners from the market. Presumably, once these high cost miners exit the market, the large miners would then recoup any profit sacrifices by using their market power to increase prices and profits.</p>
<p>Given large miners are not pricing below production cost, this is not your standard <a href="https://www.accc.gov.au/business/anti-competitive-behaviour/predatory-pricing">predatory pricing</a> - and why the ACCC apparently has no concerns with the conduct. However, it’s not clear that production/extraction costs are the relevant costs for a predatory pricing test. As resources are finite, a tonne of iron ore sold today is one tonne less of iron ore sold tomorrow at likely a higher price. This is the opportunity cost of the resource and it is not clear why this should not be included in a predatory pricing test. These are complex issues that a parliamentary inquiry could independently look at.</p>
<h2>Why it’s a policy issue</h2>
<p>One may be tempted to think that this is essentially a business issue and that, in the absence of any anti-competitive implications, governments should simply stay out of it. This would be a costly public policy mistake as it would ignore the impact the price war has had, and will have if it continues unabated, on the value of the resources for owners.</p>
<p>The key is that because iron ore resources are finite, a lower price today may result in a reduction in their total value over the lifetime of a mine. The only case when this wouldn’t happen is if future demand for iron ore were to fall. This is unlikely as any decline in the demand from China, as it moves to its next stage of development, will be replaced by new demand derived from development efforts in India, Africa and the less developed countries of South East Asia.</p>
<p>In Australia, the Crown owns the resources and their value is captured both through state royalties, which directly benefit Western Australia where the bulk of iron ore resources are, and through corporate tax, which benefits both Western Australia and the country as a whole. The industry also has a significant impact on the broader economy.</p>
<p>The 2015 federal <a href="http://www.budget.gov.au/2015-16/content/overview/html/overview-04.htm">budget papers estimate</a> that, since the last budget, the value of forecast iron ore exports has been downgraded by around A$90 billion. This has contributed to lower nominal GDP and has reduced forecast tax collections by around A$20 billion. This is roughly 57% of the public deficit in 2015-2016.</p>
<p>In Western Australia, the general government revenue estimates to 2017-2018 have been revised down by an unprecedented A$10.2 billion since the 2014-15 budget, driven by sharp declines in iron ore and crude oil prices. The revenue write-down in 2015-16 alone is A$3.9 billion, equivalent to 13% of the state’s total revenue base.</p>
<p>As the elasticity of demand for iron ore is low, this foregone revenue, or a return on ownership of mineral rights, is unlikely to be recovered in the future. It is essentially a transfer from the owners of the resources to buyers.</p>
<h2>Will the price war end by itself?</h2>
<p>Rio Tinto, Fortescue Metals Group, Arrium Limited, Grange Resources, and Vale’s production and exports of iron ore were <a href="http://www.smh.com.au/business/mining/vales-slower-growth-to-trigger-iron-ore-rally-20150430-1mxenu.html">reportedly lower</a> in the March 2015 quarter than the December 2014 quarter. Vale, for example, decreased its output by 10% from the previous quarter and has announced it could temporarily decrease supply by 30 million tonnes. This, alongside an increase in Chinese demand for iron ore (despite a fall in its demand for steel), can possibly explain the recent partial recovery in the price of iron ore.</p>
<p>Given the expansion plans of the three large miners, and demand conditions, it seems the restraint shown by some of the miners in Quarter 1, 2015 may end, resulting in further downward pressure on iron ore prices. The Western Australian government budget papers, for example, assume a $47.5 price per tonne of iron ore for 2015-2016 and an increase in volume of 4.4%, on top of an increase of 13% in 2014-2015.</p>
<p>So what can a government inquiry accomplish? The inquiry is likely to focus on whether the conduct of the large miners is anti-competitive. The arguments I presented above suggest that the issues goes beyond competition law, or at least the ACCC’s interpretation of it, when examining <a href="https://theconversation.com/iron-ore-race-to-the-bottom-not-in-the-interests-of-australians-33685">finite resources owned by the Crown</a>.</p>
<p>A second possible avenue for investigation, which could be pursued by the parliamentary inquiry, involves considering adding a public benefit test to any new production licence approvals or changing <a href="https://theconversation.com/why-twiggy-forrest-should-have-got-behind-a-super-profits-tax-39422">taxation arrangements</a> to reflect the impact of business conduct on the value of the resources. For example, a tiered royalty regime could be set so that rates increase for very high volumes.</p><img src="https://counter.theconversation.com/content/41814/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Flavio Menezes participated in a press interview organised by the Minderoo Group (<a href="http://www.minderoo.com.au/">http://www.minderoo.com.au/</a>) to support the establishment of a parliamentary inquiry into iron ore prices. Flavio Menezes received no financial benefit from participating in the press interview. </span></em></p>While it’s easy for the large miners to argue increased iron ore production is business as usual, the overall cost to the sector warrants a closer inspection.Flavio Menezes, Professor of Economics, The University of QueenslandLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/400852015-04-13T20:26:57Z2015-04-13T20:26:57ZFederalism the loser as Hockey ransoms GST to push WA reforms<p>Against a backdrop of plummeting <a href="http://www.abc.net.au/news/2015-04-13/joe-hockey-announces-iron-ore-write-off-but-no-new-taxes/6387536">iron ore prices</a> piercing a worrying hole in his government’s bottom line, Western Australian Premier Colin Barnett has been battling to preserve his state’s share of the <a href="https://theconversation.com/grattan-on-friday-the-wild-west-presents-yet-another-taxing-issue-for-hockey-and-abbott-39926">GST carve-up</a>.</p>
<p>Now <a href="http://www.perthnow.com.au/news/opinion/mathias-cormann-was-share-of-gst-is-unfair-unsustainable-and-must-be-fixed/story-fnhocuug-1227299769181">Finance Minister Mathias Cormann</a> and Federal Treasurer <a href="http://www.afr.com/news/politics/joe-hockey-labels-wa-trading-laws-antiquated-as-gst-fight-heats-up-20150412-1mj8as">Joe Hockey </a>have hinted that Western Australia may see a larger slice of the GST pie if only they, as Senator Cormann put it, “show a sense of urgency” around microeconomic reforms such as the sale of the state’s electricity poles and wires.</p>
<p>In other words, do as we say – or else.</p>
<p>This is nothing short of the federal government bossing around the states – and using the distribution of GST to the states as a bargaining chip. Any time the Commonwealth starts dictating policy to the states on ideological grounds without clear benefit to the national interest, then it’s bad for Australia and it’s bad for democracy. </p>
<h2>Trouble in the West</h2>
<p>The GST stoush has been brewing for some time. It’s been clear to the Western Australia government that, under the current system for calculating the GST distribution, things were going to get worse for them over time. </p>
<p>That’s been compounded by the <a href="http://www.abc.net.au/news/2015-04-13/joe-hockey-announces-iron-ore-write-off-but-no-new-taxes/6387536">plunge</a> in the iron ore prices. </p>
<p>The independent Grants Commission has recommended that WA’s share of GST revenue be cut from about 37% of the per capita average of GST collected nationally to around 30% – as part of an effort to redistribute the mining windfall enjoyed by the resource-rich states. It’s been <a href="https://au.news.yahoo.com/thewest/a/27067274/664m-question-gst-figures-disputed/">calculated</a> that Western Australia stands to lose $664 million of GST next year under changes to the GST distribution formula recommended by the Grants Commission. </p>
<p>So as far as Western Australia is concerned, they are being penalised for good conditions that they are no longer enjoying.</p>
<p>Iron ore prices have plunged to below $50 a tonne, with the Treasurer <a href="http://www.abc.net.au/news/2015-04-13/hockey-manages-budget-expectations-amid-iron-ore-plunge/6387592">warning</a> they may even reach as low as $35 a tonne.</p>
<p>This is causing serious distress in the industry, with investment drying up and revenues winding down. So Western Australia is in a difficult position. They have committed themselves to government spending based on the previous state of the economy, not today’s dire outlook. </p>
<p>In such turbulent economic times they’re not likely to give up easily on the fight for a larger share of the GST pie. They need it too much. Fiscal equalisation is a good thing, but Australia’s arrangements are too slow in adjusting to changing circumstances. They are also too reliant on horizontal transfers from state to state and not enough on vertical subsidies from the Commonwealth.</p>
<h2>Carrot or stick</h2>
<p>As part of the <a href="http://en.wikipedia.org/wiki/National_Competition_Policy_%28Australia%29">National Competition Policy</a> reforms of mid 1990s, the federal government rewarded states with payments for liberalising energy markets.</p>
<p>Those payments weren’t coercive. These were reforms that the states were collaborating in, and the payments were to help enact policies that citizens of those states and their representatives wanted. It was more carrot than stick.</p>
<p>This week has seen quite a different approach from the federal government – and this time it’s more stick than carrot.</p>
<p>Now the federal government is effectively saying “We <em>could</em> consider giving you what you regard as your just desserts in terms of your share of the GST… but only on the condition that you implement the reforms that we believe in.”</p>
<p>It makes a mockery of federalism. </p>
<p>When Prime Minister Tony Abbott <a href="https://www.pm.gov.au/media/2014-06-28/white-paper-reform-federation">launched</a> his White Paper on federalism, he said:</p>
<blockquote>
<p>We need to clarify roles and responsibilities for States and Territories so that they are, as far as possible, sovereign in their own sphere. The Commonwealth will continue to take a leadership role on issues of genuine national and strategic importance, but there should be less Commonwealth intervention in areas where States have primary responsibility.</p>
</blockquote>
<p>The federal government’s push for reforms in Western Australia look, to many, like exactly the opposite. It is the Commonwealth bossing around the states.</p>
<p>The benefit of federalism is that people in different parts of the country can choose the mix of policies that they want. There’s a democratic principle at stake here. </p>
<h2>Privatisation push</h2>
<p>The federal government has suggested it sees room for privatisation of a range of assets in Western Australia <a href="http://www.afr.com/news/politics/joe-hockey-labels-wa-trading-laws-antiquated-as-gst-fight-heats-up-20150412-1mj8as">including</a> the poles and wires network and the Port of Fremantle. Joe Hockey also described Western Australia’s trading laws as “antiquated”.</p>
<p>But WA trading laws are none of Joe Hockey’s business. These are all entirely matters for state governments and state citizens to decide, just as we just saw voters decide on electricity network privatisation in the NSW election.</p>
<p>Some may argue that all Australia can do at the moment is to increase the efficiency of its economy through privatisation and many of those perceived obstacles to efficiency on that are under state jurisdiction.</p>
<p>But the point is: surely that’s choice for Western Australia to make. It’s not something they should be bullied into by the federal government while their slice of the GST is held to ransom. And as a country we are much better off if States are free to follow their own paths, allowing us to compare what works best</p>
<p>Even if we do assume there’s a clear cut case and that privatisation creates clear efficiencies for Western Australia, what’s the overall benefit for Australia? The net gain, at a national level, would have to be pretty small. That suggests that the federal government’s push for privatisation of state assets is largely ideological.</p>
<h2>Who’s next?</h2>
<p>This stoush affects all Australians – not just those in the West – because it affects the autonomy of every state. Everyone has a stake in how the GST is distributed and everyone has a stake in ensuring their state is free to make policies supported by the people of that state. </p>
<p>All states have a vested interest in their ability to negotiate strongly, whether it is collectively or individually, with the federal government any time a state is being bullied.</p><img src="https://counter.theconversation.com/content/40085/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alan Fenna receives funding from the ARC.</span></em></p>Western Australia should not be bullied into microeconomic reform and privatisation by the federal government while their slice of the GST is held to ransom.Alan Fenna, Professor of Politics, Curtin UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/394222015-04-07T01:55:01Z2015-04-07T01:55:01ZWhy Twiggy Forrest should have got behind a super profits tax<p>Coinciding with the government’s tax discussion paper last week was a <a href="http://www.minerals.org.au/file_upload/files/publications/RichardsonC_Mining_tax_ratios_FINAL.pdf">report</a> from the Minerals Council of Australia evaluating the industry’s tax burden (tax paid divided by profits).</p>
<p>The report, written by Deloitte economist Chris Richardson, aimed to dispel the public view that the mining industry does not pay its fair share of tax. </p>
<p>A key point is that while the proportion of mining company profit paid in tax had decreased in 2008/2009 leading up to the debate on the introduction of the Resource Super Profits Tax (RSPT), it is now at or above historical levels. </p>
<p>As pointed out in Richardson’s report, the nature of taxation of mining plays a big part in explaining why the ratio of tax paid to profits has increased amidst a significant drop in the price of minerals such as iron and coal.</p>
<p>In a nutshell, mining companies pay royalties and company tax. Up until recently, mining companies also paid the Minerals Resource Rent Tax (MRRT), which was a compromised rent tax introduced by the Gillard government to circumvent the industry opposition to the RSPT. For a variety of reasons, related mostly to its design, the MRRT did not raise a great deal of revenue and so the focus here is on the other two taxes.</p>
<p>While royalties are typically levied on revenue, company tax is levied on profits. So, faced with a reduction in prices, production becomes less profitable. Firms, however, will still pay 30% of their profits in company tax, so any increase in the ratio of total tax paid to profits has to be explained by royalties. </p>
<p>As Richardson points out, not only has the ratio of royalties to profits increased because profits decreased, some States have also increased the royalty rates. They were likely incentivised by the MRRT design, under which companies received a credit for the royalties they paid on coal and iron ore projects with annual resource profits above A$50 million. For these projects, an increase in the royalty would have no impact on the bottom line.</p>
<p>Here is the rub, as pointed out by the Henry Review, the Minerals Council itself and a <a href="http://www.scribd.com/doc/31959942/Economists-Statement">group of 20 economists</a>; royalties distort production decisions. For example, a company that would exploit a mine for which revenue is just greater than costs in the absence of royalties, would not exploit a mine in the presence of royalties. </p>
<p>While royalties do capture some of the rents – the super profit associated with the exploitation of a finite resource that is owned by Australians – they are inefficient. In contrast, a tax on super profits does not distort production decisions. As long as revenue exceeds costs, the company will exploit the mine. This was the key rationale for the proposal of the RSPT to replace royalties.</p>
<h2>How times have changed</h2>
<p>Fortescue Metal Group’s Andrew “Twiggy” Forrest was one of the most <a href="http://www.smh.com.au/business/axe-the-tax--mining-magnates-see-red-20100609-xvqj.html">vocal opponents</a> of the super profits tax. Fortescue’s financial position is currently under significant pressure due to falling iron ore prices caused by <a href="http://theconversation.com/iron-ore-race-to-the-bottom-not-in-the-interests-of-australians-336850">oversupply</a>, and the slowing Chinese economy. Ironically, it would likely be better off today under a well-designed RSPT than under a royalties regime. </p>
<p>A well-designed RSPT would have impacted Fortescue in two different ways. First, a super profits tax is designed so companies pay more tax when times are good and less tax when times are bad.</p>
<p>Second, an RSPT would also have increased the cost of increasing production for the major iron ore producers. This is because the price at which smaller, higher cost producers would shut down production would have increased, necessitating even larger increases in production for the major producers’ strategy of displacing small producers to pay off. This would depend on how world prices responded to increases in supply by the large companies.</p>
<p>All worth considering in light of Andrew Forrest’s recent <a href="http://www.theaustralian.com.au/business/mining-energy/accc-investigates-andrew-forrest-call-for-cap-on-iron-ore-production/story-e6frg9df-1227277776667">controversial call</a> for a cap on iron ore production.</p>
<p>The RSPT proposed by the Rudd government had some flaws, as discussed in Richardson’s report. But had the industry been successful in engaging with the policy process, securing the replacement of royalties with a super profits tax, it would be in a better position today. </p>
<p>Nevertheless, mining companies have invested a trillion dollars in new mines and infrastructure and the boom and bust nature of the industry is unlikely to change. While profits are lower now, the need for a better taxation system for minerals remains. It is not a good omen for tax reform in this country when the only reference in the recently released tax discussion paper to a mining tax is in the foreword, and it refers to the abolishment of the MRRT.</p>
<hr>
<p><em>Flavio will be on hand for an Author Q&A session between 10:45 and 11:45am AEST on Wednesday April 8. Post your questions about the article in the comments section below.</em></p><img src="https://counter.theconversation.com/content/39422/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Flavio Menezes does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Had the mining industry engaged differently on the proposed mining super profits tax, it would be in a better position today.Flavio Menezes, Professor of Economics, The University of QueenslandLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/352432014-12-09T19:38:20Z2014-12-09T19:38:20ZChina-Australia doomsayers overlook strong fundamentals<p>Pop quiz: in 2014 the quantity of Australian iron ore demanded by China has: a) fallen sharply, b) fallen modestly, c) remained the same, d) increased modestly, e) increased sharply?</p>
<p>The answer in just a moment.</p>
<p>Last week the Australian Bureau of Statistics (ABS) told us that the economy is suffering from an <a href="http://www.abs.gov.au/AUSSTATS/abs@.nsf/ProductsbyReleaseDate/52AFA5FD696482CACA25768D0021E2C7?OpenDocument">income recession</a>. Our exports aren’t fetching the prices they used to – the terms of trade are down by around 9% for the year - and that means we can’t afford to buy as much from overseas as before.</p>
<p>Growth in China has also <a href="http://www.afr.com/p/world/china_growth_slows_from_rail_to_GPWU3X58iAOG5SvvMgNi9L">slowed</a> and the construction industry there is in the middle of a major funk. Moreover, China’s economy is rebalancing away from growth led by resources-hungry investment.</p>
<p><a href="http://www.smh.com.au/world/chinas-slump-will-hurt-australian-incomes-and-the-pain-is-likely-to-linger-20141205-11zy1z.html">Joining the dots</a> is proving irresistible. But there’s a problem with this story, and it’s a big one.</p>
<p>The answer to the above question is unambiguously option e. In the September quarter – that’s the same quarter Australia shifted into an income recession - exports of iron ore to China were <a href="http://www.bree.gov.au/files/files//publications/crq/westpacbree-crq-201411.pdf">up 33% from a year earlier</a>, according to Westpac and the Bureau of Energy and Resources Economics (BREE). This followed a 32% jump the first quarter and a 36% leap in the second. </p>
<p>These are extraordinary numbers and we should not be at all surprised when they start to slow. But, for now, Chinese demand continues unabated.</p>
<p>In a sense this is not difficult to understand. The law of demand says that when the price falls, the quantity demanded will increase. The price of iron ore is down nearly 50% since the beginning of the year. </p>
<p>And while growth in China is now 7.3%, the slowest pace in five years, that’s coming off an ever-larger base. In terms of the number of dollars being added to the economy each year, 7.3% growth now is more than a match for 8% a couple years ago.</p>
<h2>Watch the miners</h2>
<p>If the price has fallen and the quantity traded has increased, there can be only one culprit – a dramatic increase in supply. And so there has been: BHP Billiton alone is in the midst of a 65 million tonne per annum <a href="http://www.bhpbilliton.com/home/investors/reports/Documents/2014/141006_IronOreBriefingandWesternAustraliaIronOreSiteTour.pdf">expansion</a> of its Western Australian iron ore operations.</p>
<p>Treasurer Joe Hockey may be worried about falling iron ore prices but BHP Billiton certainly isn’t. Even with iron ore prices sitting as they are between A$70 and $80 per tonne, the business remains hugely profitable. Its current cost of supply is around A$27 per tonne and the target is less than $20 in the medium term. Producers in other sectors of the economy would kill for those sorts of margins.</p>
<p>While it’s become popular to dismiss the projections for Chinese demand from the miners themselves as being overly optimistic – why exactly is not clear. Remember, it’s their billions of investment dollars on the line - and <a href="http://www.treasury.gov.au/%7E/media/Treasury/Publications%20and%20Media/Publications/2014/Long%20run%20forecasts%20of%20Australias%20terms%20of%20trade/Documents/PDF/long_run_tot.ashx">forecasts</a> offered by the Commonwealth Treasury in May based on an analysis of demand and supply fundamentals are proving remarkably accurate. In reference to iron ore they concluded that “… supply will increase at a much faster rate than demand…” and that “The shift of production to the flatter section of the supply curve is expected to cause a rapid fall in the real price…”</p>
<p>These dynamics will play out until 2017-2018. From then on, the price will stabilise at a touch above $70 per tonne. There’s little to worry about here.</p>
<p>The bottom line in all of this is that the impact of China on the Australian economy remains a tremendously good news story. According to the latest <a href="http://www.abs.gov.au/ausstats/abs@.nsf/mf/5368.0">trade data</a> from the ABS, the value of our exports to China is more than double that to our second-largest customer, Japan. This ratio holds true across the board - agriculture, fuels and minerals, services and even manufactured goods.</p>
<p>None of this is expected to change any time soon. China is the world’s second-largest economy and the International Monetary Fund continues to <a href="http://www.imf.org/external/pubs/ft/weo/2014/02/">forecast</a> that it will grow by 7.4% this year and 7.1% next year. That growth in 2015 is more than double that predicted for the US and nearly nine times that for Japan. There’s always room to quibble about the exact numbers but few would disagree that China will continue to outperform other major economies.</p>
<p>For the Australian economy it doesn’t get much better than that.</p><img src="https://counter.theconversation.com/content/35243/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>James Laurenceson does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Pop quiz: in 2014 the quantity of Australian iron ore demanded by China has: a) fallen sharply, b) fallen modestly, c) remained the same, d) increased modestly, e) increased sharply? The answer in just…James Laurenceson, Deputy Director and Professor, Australia-China Relations Institute (ACRI), University of Technology SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/336852014-11-09T23:23:13Z2014-11-09T23:23:13ZIron ore race to the bottom not in the interests of Australians<p>The world’s biggest iron ore producer, Vale, has announced its <a href="http://www.smh.com.au/business/mining-and-resources/brazilian-miner-vale-to-expand-iron-ore-despite-low-price-20141031-11eorj.html">intention</a> to expand production despite a falling price. This follows similar announcements by Rio Tinto and BHP. </p>
<p>This expansion in production by the three largest iron ore exporters in the world, accounting for over 60% of the <a href="http://www.reuters.com/article/2009/11/04/iron-ore-idUSSP53161420091104">market</a>, is puzzling and it may not be in the best interests of the resource owners in Western Australia and Australian taxpayers generally. </p>
<p>Why would firms pursue such a strategy? Western Australian Premier Colin Barnett <a href="http://www.parliament.wa.gov.au/Hansard/hansard.nsf/0/5FC562D402C4A82948257D78002D4320/$File/A39%20S1%2020141016%20All.pdf">has suggested</a> the big miners may be flooding the market to reduce the price and drive higher-cost suppliers from the market. </p>
<p>Indeed, Vale’s CEO has indicated the objective is to displace competitors’ quantities. This is plausible as there are many producers that are marginally profitable at current world <a href="http://www.macrobusiness.com.au/wp-content/uploads/2012/09/cost-curve.png">prices</a>. They will likely exit the market if prices are reduced further.</p>
<p>Given the big miners’ market share, it stands to reason that higher production volume will have a negative impact on iron ore prices. Perhaps the big miners hope that once higher cost producers exit the market, prices may rise again. </p>
<p>However, there many reasons to suggest such a view is too simplistic and this strategy will not work.</p>
<p>Crucially, iron ore production is by and large a mining and extraction activity. This means underground resources do not disappear if a high-cost miner exits the market. Equally, once resources are mined, extracted and sold at a potentially low price, the resources are gone and its owners will not be able to enjoy future higher prices. </p>
<p>It may make sense for the big miners to ramp up production now, despite causing a reduction in prices, if there are particular reasons to believe the demand for iron ore will decrease in the future. If this were the case, then it might be better to sell now, even if at reduced prices, vis-à-vis selling in the future at even lower prices. But this is unlikely given that many countries in Asia, Africa and South America will still need steel to catch up to the level of development of richer countries. </p>
<p>Is this just supply and demand at work? Is it a case of lower-cost producers vying for larger market shares even if this happens at the expenses of these companies’ shareholders? Unfortunately this ignores the interests of those who own the resources.</p>
<p>Iron ore resources are owned by the state (that is, by the people). The economic rents – the income derived from the ownership of a resource that exists in fixed supply – are captured in two different ways in Australia. </p>
<p>The Western Australian government charges (ad valorem) royalties on the value of iron ore sales. By increasing production, causing prices to fall, the big miners’ action will affect the value of the royalties captured by the government. Even if the big miner’s revenue rises due to quantities rather than prices, royalties may still fall if other Western Australian producers exit the market.</p>
<p>Similarly, Australians at large benefit from the tax revenue collected by the federal government. As the corporate tax is levied on accounting profits, lower iron ore prices may mean lower tax revenue as well. </p>
<p>Again, even if prices increase in the future, Australian governments will not be able to fully capture additional revenue as many high-cost producers are located in other jurisdictions.</p>
<p>Mining companies own capital that can be driven harder, as well as owning the mining rights. Managers may be tempted to increase production and enjoy a higher return on capital even at the expense of not maximising the value of the resource over the life of the mine. </p>
<p>The public, however, captures the value of the resources through ad valorem royalties and the corporate tax system. This means the public would benefit from actions that maximise the value of the resources over the life of the mine. </p>
<p>The challenge for the big miners is how to overcome this temptation of any short-term gains from increasing production to capture market share, at the expense of reducing prices further, resulting in a reduced value for the resources over the life of the mine. The challenge for governments, on behalf of the resource owners, is to continue to challenge the big miners’ thinking as Premier Barnett has done.</p><img src="https://counter.theconversation.com/content/33685/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Flavio Menezes does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The world’s biggest iron ore producer, Vale, has announced its intention to expand production despite a falling price. This follows similar announcements by Rio Tinto and BHP. This expansion in production…Flavio Menezes, Professor of Economics, The University of QueenslandLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/263012014-05-09T04:44:19Z2014-05-09T04:44:19ZDigging beneath China’s interest in Australian iron ore projects<p>The Australian iron ore industry is no place for the faint hearted. On April 11, Padbury Mining spectacularly announced billions in funding (reportedly backed by Chinese investors) to develop the Oakajee Port north of Geraldton in Western Australia’s mid-west. This infrastructure would open up development of massive magnetite iron ore deposits in the State’s mid-west, bypassing the bottleneck at existing port and rail facilities at Geraldton. Even more spectacularly, by April 30 Padbury announced it was <a href="http://www.abc.net.au/news/2014-05-02/padbury-mining-stocks-plunge-on-oakajee-announcement/5425856">all off</a>.</p>
<p>Clive Palmer’s Sino Iron Chinese partners (CITIC) were no doubt miffed by his suggestions in February that he was defending Australian firms from being <a href="http://www.miningaustralia.com.au/news/palmer-says-chinese-companies-are-raping-australia">“raped and disrespected by foreign-owned companies”</a>. His joint venture relationship with Chinese State owned CITIC has been strained by cost overruns associated with the processing of low-grade magnetite into shippable ores at the mine site in the Pilbara.</p>
<p>These events have been unfolding in the context of some big moves in the price of iron ore. The price for 62% Fe iron ore delivered to the Port of Tianjin peaked at more than US$180 per tonne in late 2010 – during a Chinese Government economic stimulus program that required large amounts of steel. Since then the iron ore price has declined to around US$103 per tonne. While speculating on the future of commodity prices is little more than guesswork, the trend is clearly downward.</p>
<h2>China’s agenda</h2>
<p>Last week Chinese state-owned Baosteel announced a surprise <a href="http://www.smh.com.au/business/chinas-baosteel-moves-for-new-pilbara-resources-20140505-37skl.html">takeover offer</a> for Aquila Resources (in conjunction with Aurizon as a junior partner). It is the latest of many investments in Australian iron ore by Chinese investors, most with close ties to the Chinese government. These investments are welcome, as the Australian economy’s structural shortage of capital requires such foreign investment. However, it’s worth pondering why there is such interest in Australia’s iron ore industry by China, and what this might mean for the future.</p>
<p>China’s steel mills – mostly state owned - purchase around 70% of the world’s traded iron ore. China is expected to import 850 million tonnes of iron ore in 2014. To put this into context, Australia is expected to produce 610 million tonnes in 2013-14. The vast majority of Australia’s production is from the Pilbara region of Western Australia, and most is “direct shipping ore” (DSO) – able to be dug up and shipped without processing.</p>
<p>In essence, the Pilbara has plenty of high quality ores that are cheap to mine and require little processing. Many of the large new projects - for example Padbury’s - however are based on low grade magnetite ores that require significant and costly processing. </p>
<p>China is keen to see production grow, both from new DSO deposits and from processed (or beneficiated) magnetite. The reason for this is simple. For every US$10 per tonne drop in the iron ore price, the Chinese economy saves US$8.5 billion. The US$70 ore price decline since 2010 is thus saving China more than US$40 billion per year on current import quantities.</p>
<p>Is it too far-fetched to link these issues? Are Chinese state investors investing in new production primarily to lower prices, rather than to develop profitable mining operations?</p>
<h2>Prices matter</h2>
<p>The demand for iron ore is highly inelastic – at current prices iron ore accounts for around one quarter of the final value of steel, but the demand for steel is determined primarily by demand from the construction, infrastructure and manufacturing sectors. As a material with few substitutes, the consumers of steel tend to demand steel based on their need, rather than its price.</p>
<p>One aspect of free market economics that even nominal Communists understand is that increasing supply in markets with inelastic demand can in fact reduce overall revenues – in fact can lead to a situation where buyers get more of the product for less of their money. As such, upstream investment in unprofitable production can make economic sense in a convoluted manner.</p>
<p>A signal that this might be occurring would be new production being developed that would never be considered by rational investors, where the expected returns just don’t justify the risks. One such investment was Clive Palmer’s Sino Iron joint venture development. Original estimates suggested that this operation would require US$2.5 billion to bring to operation, although costs ended up being closer to US$10 billion.</p>
<p>As Palmer’s ores require on-site processing prior to dispatch to China, ongoing operational costs are far higher than other Pilbara DSO operations. These costs, as well as transport and logistics, are perhaps as high as or higher than prevailing market prices. Even ignoring the requirement to repay the billions in “sunk’"capital investment, this project looks problematic. It would be very unlikely to be developed today.</p>
<p>The Sino Iron project, however, is old news, and problems there have been a long time coming. Is there evidence of more recent investments, with high operational and investment risks, that just don’t make economic sense?</p>
<h2>Watch what happens at Oakajee</h2>
<p>To answer this, we can look to what happens next in Western Australia’s mid-west. While the region east of Geraldton has plenty of direct shipping ores, it has vastly more lower quality magnetite. One big mid-west producer, Gindalbie Mining, has been making whopping losses mining and processing its vast deposit of low quality magnetite at Karara. Western Australia has even granted the company royalty relief - a sure sign of dire financial problems. </p>
<p>At current low world prices, mining and processing magnetite doesn’t make a lot of sense. This will become even more true as massive new deposits come on stream, including Simandou in Guinea (West Africa), which could one day rival the Pilbara.</p>
<p>So if the Oakajee Port does get the go ahead in the near future, backed with Chinese funding as Premier Colin Barnett has <a href="https://au.news.yahoo.com/thewest/latest/a/22645988/new-hope-for-oakajee-port/">predicted</a>, that will be an ominous sign.</p>
<p>Should Australia care if Chinese state-owned enterprises undertake such investments? The Western Australian government will get their royalties and jobs will be created. Surely all development is good development?</p>
<p>Australia should almost certainly care. Governments need to build infrastructure that may become idle in future as supplies of ores from new regions come on stream. Australians will be dislocated as they relocate for jobs that are mothballed as high cost operations are closed. In short - there will be costs, and these costs will be borne widely.</p><img src="https://counter.theconversation.com/content/26301/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Nil.</span></em></p><p class="fine-print"><em><span>John Rice does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The Australian iron ore industry is no place for the faint hearted. On April 11, Padbury Mining spectacularly announced billions in funding (reportedly backed by Chinese investors) to develop the Oakajee…John Rice, Associate Professor in Strategic Management, Griffith UniversityNigel Martin, Lecturer, College of Business and Economics, Australian National UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/116272013-01-15T23:16:53Z2013-01-15T23:16:53ZA rebound in iron ore prices? Who knows?<figure><img src="https://images.theconversation.com/files/19238/original/r87k94cx-1358290689.jpg?ixlib=rb-1.1.0&rect=11%2C10%2C982%2C646&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Iron ore prices have rebounded: but forecasting prices is a tricky business.</span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>Forecasting commodity prices is like buying a second hand car. Only the car’s previous owner and perhaps the dealer really know what the car is actually like. In contrast you, the buyer, are an outsider with very limited insight and can only judge the car’s true value by what you see in the car yard. Second hand cars, and iron ore, are classic cases of asymmetric information at work, pioneered by <a href="http://elsa.berkeley.edu/%7Eakerlof/">George Akelof</a>’s 1970 study on <a href="https://www.iei.liu.se/nek/730g83/artiklar/1.328833/AkerlofMarketforLemons.pdf">the market for lemons</a>.</p>
<p>In 2008 BHP Billiton grew tired of the practice of selling iron ore to China at an annually negotiated and hard fought fixed price of around $120 per tonne only to see its competitors in India selling iron ore in the spot market at prices of $300 per tonne. </p>
<p>The company was selling iron ore directly to many of the large and some smaller steel makers in China at annually agreed benchmark prices, only to see them sell it on to other producers at much higher spot prices. Steel producers could now make more money from trading iron ore than making steel. Many smaller steel producers simply shut down their blast furnaces, traded iron ore and retreated to the local tea house to watch the money rolling in.</p>
<p>Iron ore was one of the last of the heavily traded commodities that could not be readily bought and sold by intermediaries. So BHP Billiton got serious. BHP Billiton jump-started the market started by donating around two million tonnes of iron ore to form a spot market to entice a limited number of “informed” (sanctioned) intermediaries (not speculators) to provide liquidity and establish a floating price index against which their contracts could be priced.</p>
<p>The dominant iron ore producers desire a floating price index for iron ore that reflects global steel demand. But they also want to sell iron ore directly to steel producers, and avoid pesky brokers, traders and speculators in between. These intermediaries are regarded by the producers as market parasites latching on to their hugger-mugger marketplace to undercut prices and destroy value. </p>
<p>A floating index is only effective if such intermediaries are present and are freely allowed to trade. Traded volumes of iron ore barely reach 80% of the total global volume of iron ore produced. This is better than zero, as it was prior to 2008. But compared with copper and other metals, whose traded volumes in futures and other derivatives often exceed 100 times their production volume, the iron ore market is stale. The iron ore price index relies upon buyers and sellers to report their transactions to a data compiler, and only a few transactions are ever reported. This is unlikely to improve.</p>
<p>An efficient market is regarded as one where prices reflect prevailing demand and supply conditions. There will naturally be price volatility. Prices for copper or bananas are generally seen as the squiggly line of a random walk and contain inherent volatility, with some price jumps. In contrast, iron ore prices exhibit a volatility all of their own and are capricious in a different way. Instead of a large number of minor price changes with a few large price jumps reflective of normal market activity, iron ore prices are not continuous and mostly only jump up or down. Sometimes the prices changes are quite extreme, taking the market by surprise even though this type of behaviour is expected in a market with limited trades.</p>
<p>This is largely a function of the commodity itself. Iron ore is sold in large parcels to buyers and supply interruptions can trigger price changes as demand spikes. But critically, the fact that the dominant producers have elbowed speculators out of the market, while reluctantly acknowledging their necessity to maintain market liquidity, has created a volatile iron ore price index of questionable relevance to market observers.</p>
<p>This does two things. First, forecasting iron ore prices becomes tricky. Most of the forecasts will be wildly wrong because of the jumpy and largely opaque nature of how the price series is generated. And second, because forecasts are difficult, the Federal Treasurer and his Treasury have no idea how much tax revenue is due to them from iron ore sales, either through normal corporate tax receipts or via the MMRT because the forecasts will be wrong.</p>
<p>Squeezing speculators from the iron ore market has allowed the dominant producers to maintain market secrecy under the guise of price discovery. Until speculators penetrate the iron ore trade, forecasting prices in the market for lemons (and iron ore) will remain a mystery.</p><img src="https://counter.theconversation.com/content/11627/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jason West does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Forecasting commodity prices is like buying a second hand car. Only the car’s previous owner and perhaps the dealer really know what the car is actually like. In contrast you, the buyer, are an outsider…Jason West, Associate Professor, Griffith Business School, Griffith UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/93922012-09-12T04:27:59Z2012-09-12T04:27:59ZThe floating fortunes of our iron ore barons<figure><img src="https://images.theconversation.com/files/15326/original/h4b6j384-1347339144.jpg?ixlib=rb-1.1.0&rect=17%2C56%2C1979%2C1194&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Australian iron ore producers have had a torrid time in recent months - but how they quickly they can respond to such fluctuations will be critical to their continued success.</span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>Despite the recent fluctuations of the iron ore price, producers such as mining billionaires Andrew Forrest and Gina Rinehart entered the iron ore market with eyes wide open and understand the long-term risks, but also the short-term opportunity. </p>
<p>This dynamic plays out by those who take great delight each time the iron ore price tanks and encourage us to eat the rich each time it spikes. </p>
<p>Rinehart and Forrest as well as their rivals in the industry, are captive to the fortunes of the Asian steel producers and must continually turn the iron ore tap on and off when demand fluctuates. </p>
<p>Unanticipated mine closures and job cuts as well as rapid expansions will be a feature of this industry for at least another 30 years.</p>
<p>Australians are hesitant to celebrate wealth creation. We all expect the rich to behave in a certain way such that the privileges that accompany wealth are counterbalanced by its attendant responsibilities. An <a href="http://www.youtube.com/watch?v=B3CcxRbFiLg">immodest display of wealth</a> is a swift and sure method of estranging oneself. </p>
<p>But do present day mining magnates really behave in this way? Much of the wealth of Mr Forrest and Ms Rinehart is heavily concentrated in the relative fortunes of their companies. </p>
<p>Indeed half of Ms Rinehart’s wealth is embedded in the worth of a single mine, Roy Hill. Profitable iron ore mining demands a level of output that achieves a critical mass of a scale sufficient enough to cover the fixed costs of production. In modern times there is no such thing as a small mining entrepreneur and gold prospectors seeking their fortune somewhere in the Klondike do not count.</p>
<p>Unlike other wealthy individuals, Australia’s mining magnates are <a href="http://www.themonthly.com.au/wayne-swan">heavily criticised</a>. This contrasts to the US, where rich individuals like Warren Buffet are able to maintain a certain perspective and are philanthropic because they have already crystallised much of their wealth and their business empires are to a large degree self-sustaining. </p>
<p>The real wealth of Australia’s mining entrepreneurs is embedded in the fortunes of their companies and success is almost entirely dependent on the global demand for steel. </p>
<p>This is not assured. Obviously, their wealth is not immune from volatility and will continue to fluctuate with iron ore prices. </p>
<p>To date, their fortunes have been greatly assisted by the index pricing of iron ore, which has reshaped the production landscape.</p>
<p>Unlike commodities, where the availability of liquid spot and forward markets allows prices to quickly respond to changes in demand, iron ore price agreements were dominated by an annually agreed benchmark price up until 2008.</p>
<p>The benchmark price was always agreed between the large producers and the large consumers, leaving the second and third tier producers at the mercy of a select number of negotiators. The large producers could leverage their own economies of scale which left the smaller producers at a significant disadvantage because they could never compete on price.</p>
<p>While benchmarked prices offered cost certainty to Chinese, Japanese and Korean steel producers, many smaller smelters took advantage of the opportunity to buy iron ore at annually fixed prices and on-sell it to other steel producers who were short of supply in the spot market. </p>
<p>The spot market in China traded large volumes of iron ore imported from India and elsewhere. Smaller smelters were able to buy iron ore at $100 a tonne from the large producers and then sell the same parcel for over $300 a tonne on the spot market. For many smelters, it was more profitable to cease steel production altogether and simply trade iron ore.</p>
<p>One of the largest producers of iron ore, BHP Billiton, took the initiative to eliminate this practice and ensure that upstream producers, rather than intermediaries, captured the full margin. With the help of two investment banks, BHP Billiton initially took a loss-making short position of one million tonnes of iron ore to inject sufficient liquidity to create a market with reliable index prices. </p>
<p>This was followed by another short position several months later to sustain the market’s development. It was reckoned that sacrificing a short-term loss was a small price to pay for the benefits of capturing the full margin that producers were entitled to receive. </p>
<p>While buyers greatly resisted the new price regime they were powerless to stop it. For the first time, prices would not be determined by the dealings of a select number of producers and consumers at the negotiation table. The market for coking coal, also essential for steel production, experienced a similar transition. </p>
<p>This market is now largely self-sustaining and is reasonably liquid to reflect short and long-term supply and demand. </p>
<p>This has offered newer entrants to the iron ore market like Fortescue and Hancock a unique opportunity to earn a fair margin on their product without the inefficiencies created through price negotiation that previously characterised the market. </p>
<p>Index prices are now observed with relative transparency, allowing for a more refined picture of expected long-term dynamics. The price transition has allowed mining companies to better manage capital expansion planning and future cost control. Along with the recent increased use of contract mining, iron ore producers can easily cut production when prices recede and ramp up production again when they rally.</p>
<p>Historically, margins earned on iron ore are very low and booms have always experienced much shorter duration than busts. The index pricing of iron ore has thus greatly changed the production landscape since junior players can more easily adjust output to changes in price.</p>
<p>For Mr Forrest and Ms Rinehart, among others, the rapid accumulation of wealth is to some degree, a matter of being in the right place at the right time. They both have the requisite appetite for risk that is essential for such ventures. But they must be prepared to quickly alter direction if conditions dictate. </p>
<p>History is replete with entrepreneurs who saw opportunity and invested their personal wealth and reputation at a critical period but failed to adjust when the global economy shifted. </p>
<p>The huge empires of railroad entrepreneur Samuel Insull and steel producer Charles Schwab collapsed when global conditions changed faster than they could respond. </p>
<p>Twiggy and Gina could learn from the lessons of these and other failed empires while keeping a close eye on the iron ore index.</p><img src="https://counter.theconversation.com/content/9392/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jason West does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Despite the recent fluctuations of the iron ore price, producers such as mining billionaires Andrew Forrest and Gina Rinehart entered the iron ore market with eyes wide open and understand the long-term…Jason West, Associate Professor, Griffith Business School, Griffith UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/93392012-09-06T20:21:08Z2012-09-06T20:21:08ZIron ore prices continue to fall, but is it really time to panic about China?<figure><img src="https://images.theconversation.com/files/15113/original/hm2xgmtb-1346898337.jpg?ixlib=rb-1.1.0&rect=26%2C44%2C1955%2C1209&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Iron ore miner Fortescue Metals announced this week it was delaying $1.6 billion in investments as iron ore spot prices continued to fall: but is it really time to panic about China's manufacturing sector?</span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>This week we learnt that Australia’s GDP growth fell significantly in the second quarter compared with the first. The fact that GDP growth is a lagging indicator raises serious questions about the current state of the economy.</p>
<p>Exacerbating such concerns is that <a href="http://www.foreignpolicy.com/articles/2012/08/29/everything_you_think_you_know_about_china_is_wrong">China’s economy appears in a precarious state</a>. </p>
<p>Facing a cyclical downturn overseas and structural reform problems at home, China’s growth has also slowed, and is e<a href="http://www.lowyinterpreter.org/post/2012/09/03/China-hype-is-giving-way-to-realism.aspx">xpected to slow further</a>.</p>
<p>As growth in China has slowed, the price of iron ore, our most important export commodity, has fallen sharply. Iron ore is currently trading below $90 per tonne, around half that of a year ago.</p>
<p>Some have called the mining boom to be over, or at the very least to have peaked, and mining companies such as Fortescue Metals have <a href="http://au.news.yahoo.com/thewest/a/-/breaking/14746758/fmg-to-cut-jobs-defer-projects-as-iron-price-fall-bites/">announced</a> they are deferring investment and laying off workers.</p>
<p>Whereas the terms of trade were once fuelling sharp increases in national income, which boosted government tax revenues and ran up housing prices, the party is now over. </p>
<p>As <a href="http://www.smh.com.au/business/the-economy/a-tipping-point-for-the-australian-economy-20120904-25baw.html">one commentator</a> put it, “Australia has gone in a short space of time from the lucky country to the country whose luck is running out”.</p>
<p>Or so the story goes.</p>
<p>Let me begin by stating that I have no special insight into what the next growth figure for China’s industrial output will be. Nor what will happen to commodity prices, this month or next.</p>
<p>Fortunately, I am not alone. To use the language of an econometrician, the data generating process for these variables is, statistically, a random walk. That is, the best predictor of next period’s figure is this period’s figure plus a random error. The lesson for readers is that they should not take too seriously the many “forecasts” of these variables that appear in the press.</p>
<p>I’ll also leave aside speculation about whether the Chinese government will launch a stimulus package should the rate of growth slow too dramatically.</p>
<p>Instead, let’s stick to a commentary based on what we do know, and ultimately what is more important.</p>
<p>China’s trend growth rate, as opposed to next quarter’s, will fall in the coming decade compared with the last. This is for many reasons: rebalancing the economy away from investment toward consumption is difficult, not least of all on a political level, and easy sources of productivity gains, such as the demographic dividend and borrowing technology from overseas, have largely been exhausted.</p>
<p>Iron ore prices will also fall from their stratospheric levels in recent years. This is not only because China’s trend rate of growth will slow, but also because additional supply will come on line as a result of massive investment by mining companies in recent years.</p>
<p>While these observations may sound dire for the Australian economy, the reality is far more sanguine.</p>
<p>First, some perspective is required. To say that iron ore prices have fallen by around half in the past year still leaves them at the same level they were toward the end of 2009. </p>
<p>At this time, they were <a href="http://www.indexmundi.com/commodities/?commodity=iron-ore&months=120">many times higher</a> than they were in 2005. </p>
<p>The trend level of iron ore prices since the mid-2000s, and commodity prices more generally, has changed in Australia’s favour, and there is no reason to think that it will revert to the historical average any time soon. China will remain a net buyer in world markets. The Reserve Bank of Australia’s <a href="http://www.rba.gov.au/statistics/frequency/commodity-prices.html">Commodity Price Index</a> is extremely clear in making this point.</p>
<p>Similarly, as RBA Governor Glenn Stevens <a href="http://www.rba.gov.au/speeches/2012/sp-gov-240712.html">has noted</a>, while growth in China is slowing, so too is growth in other parts of the world; far better to be exposed to China where the trend rate remains much higher.</p>
<p>Secondly, to the extent that the terms of trade will fall, historical experience suggests that this will be cushioned by a depreciation in the Australian dollar. A depreciation in the dollar is not a catastrophe. </p>
<p>Far from it: the very reason that Australia has a floating exchange rate is to offset shocks from abroad. A fall in iron ore prices may well be bad news for miners, but via a depreciation in the Australian dollar, it would be welcome news for other sectors such as manufacturing, tourism and education.</p>
<p>Thirdly, while China may drive world iron ore prices, the extent to which such fluctuations drive Australia’s macroeconomic performance should not be overstated. This should be obvious. Even prior to the terms of trade rising sharply in the mid-2000s, the Australian economy had experienced one of the longest continuous periods of expansion since World War 2.</p>
<p>The terms of trade are simply a measure of relative prices - export prices divided by import prices. While a rising terms of trade provides an unambiguous shot in the arm to national purchasing power, it has no direct impact on real GDP.</p>
<p>Indeed, the point of calculating the terms of trade as part of the national accounts is to strip out the effect of price movements on the value of traded goods and so better focus on developments with respect to real economic activity.</p>
<p>Of course, if export prices are high, then this can indirectly spur output growth via investment, amongst other channels. But given long lead times, mining companies make investment decisions based on forecasts of the long run price level of goods such as iron ore, and these remain positive.</p>
<p>The decision by some miners recently to delay investment in large part reflects cost pressures as they have all sought to open the investment tap at the same time, not a fall in long run expected prices.</p><img src="https://counter.theconversation.com/content/9339/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>James Laurenceson does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>This week we learnt that Australia’s GDP growth fell significantly in the second quarter compared with the first. The fact that GDP growth is a lagging indicator raises serious questions about the current…James Laurenceson, Senior Lecturer, School of Economics, The University of QueenslandLicensed as Creative Commons – attribution, no derivatives.