Columnists Australia

Business/Robbery etc

Big oil, coal and iron ore producers are flooding the market to knock out rival - and China-friendly - suppliers

3 January 2015

9:00 AM

3 January 2015

9:00 AM

Wow! Not a pretty sight, these wounds Australia is beginning to suffer in the word’s current cut-throat competitive commodities killing campaign. Before long, corporate victims will join the ‘disappeared’ off the stock exchange lists. Their former employees will join the rising numbers of Australian unemployed as the carnage hobbles our economic growth, destroys government revenues and forcefully reverses the long trend of rising real incomes. It will not be better by the time of the next federal election in 2016.

Collapsing prices for our major export earners, natural gas, iron ore and coal, make up a perfect storm for the Australian economy at a time when proposed fiscal restraint in being blocked by an irresponsible Senate. The massive expansion in mining and oil/gas capacity is now hitting the market as the end approaches of the economic stimulus caused by work on these huge projects, financed mostly from borrowed foreign funds. Further billions of dollars of developments have now been cancelled or held over indefinitely; all would have contributed to providing the solid base for Australia’s future export income – and the prosperity underpinning the Abbott government’s ability to pay down its huge inherited debt.

The recent halving of world oil prices involves a direct hit on Australia’s natural gas export industry; the same goes for iron ore and coal which have been hurt by China’s slowdown and worsened by local competitive killer instincts. Share prices for all of them have dived; raising capital for further expansion does not look a likely option, as Santos has shown. There is now no way these commodities will be the fiscal saviours we need. The country is not looking so lucky after all. The dramatic end of the terms-of-trade boom (largely wasted by Rudd/Gillard) is potentially more serious than the 1973-74 oil shock that disrupted the Whitlam government’s over-zealous spending agenda; but while Whitlam faced a hostile Senate that tried to check his spending excesses, Abbott’s Senate is blocking his spending cuts.

The current crisis is largely due to the economic rules having changed since the days when, if demand fell and took prices with it, producers would cut production. But not now: when falling demand pushes prices down, big producers significantly expand production. Apart from seeking to maintain their own revenues by selling more at the lower price, this also serves to keep prices below the break-even levels of vulnerable competitors in the hope of knocking them out. Others may seek merely to maintain output, but hold profitability by cutting out expenditure on development, or even upgrading their output at the expense of their average ore grades and future profits. In both cases, marginal competitors end up in serious trouble. That is what is happening in Australia across the spectrum of our major mining commodities. So much so that one industry leader is calling for the Australian Competition and Consumer Commission to review the ‘flooding’ of the iron ore export market by BHP-Billiton and Rio Tinto. This has worsened the impact of the China economic slowdown on the price of ore, which has almost halved this year, to a level where most of Australia’s smaller producers are unprofitable. The same goes for coal, where prices for steel-making coal has been almost cut in half from the peak of a couple of years ago and coal used for electricity generation is down about 30% – but where the outlook is a bit more favourable.

Ramping up production by the two biggest Australian players in iron ore and coal, BHP-Billiton and Rio Tinto, from their newly expanded capacity, which must earn its keep, also serves to undermine China’s long-standing consumer strategy of encouraging the development of multiple competing iron ore and coal suppliers, some of whom appear unlikely to be able to withstand a lengthy siege without what could be controversial Chinese intervention.

In oil, Australia’s natural gas producers are suffering collateral damage, extending into the stockmarket, from November’s decision of OPEC, led by Saudi Arabia, to maintain production quotas in the face of recent price falls to below $US70 a barrel – well under the break-even point for several members of OPEC. The Saudis have both political and economic agendas aimed at damaging not only fellow OPEC members (but potential enemies) like Iran and ISIS, by insisting on keeping output high to worsen the supply/demand imbalance that keeps prices low. The Saudis also seek to hit non-OPEC members like Russia (causing, with the West’s Ukraine sanctions, significant falls in the rouble) and, as a bonus, damaging marginal producers in the ‘Shale Revolution’ that is helping to rid the US of fuel dependence on the fractious Middle east. As one Australian commentator noted: ‘Saudi Arabia might simply be forcing a production purge that is similar to the one BHP and Rio Tinto are creating in the iron ore market’. Any Saudi success in denting the US shale boom may be welcomed by some Australian LNG exporters worried that the US could become a major export competitor in the Pacific basin. Whatever the objective, it will be quite a while before prices recover.

But all is not lost: every fall of $US20 a barrel in the oil price adds about 0.25% to world GDP, so someone is benefitting at our expense – including even some of us. Lower commodity prices can be a bonanza for consumers; in the US, the lower price of energy, particularly oil, is leading to a resurgence of manufacturing and a strengthening of the US dollar, which should bring world-wide economic benefits. This should rub-off directly on some Australian industries and indirectly on Australian suppliers to countries like China that are potential exporters to a revived US. And Australian exporters (and the Reserve bank) will welcome the inevitable consequential fall in the Australian dollar, especially for gas, iron ore and coal, while the increase in the cost of our imports is being softened by falling petrol prices.

So Australian motorists are laughing all the way to the bowser. But overall, these disruptive falls in commodity prices for Australia’s major exports pose such a serious threat to Australians’ living standards, government debt and jobs that it is no laughing matter. In the words of the iconic 1933 Stan Cross black-and-white cartoon: ‘Stop laughing – this is serious.’

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