Saturday, July 7, 2012

Resources boom will lead to much bigger mining sector

A widespread fear - or maybe for some, a hope - is that the resources boom will evaporate someday soon. What will we do once it's over, a lot of people ask. Well, this week we got an answer: export at least twice the minerals and energy we do today.

You can divide the resources boom into three overlapping phases. The first phase is where the prices we receive for our exports of coal and iron ore shoot up to unprecedented levels because the world's exporters of those commodities are unprepared for the surge in demand from China and India as they rapidly industrialise.

The second phase is where our (and the world's) commodity producers seek to take advantage of those remarkable prices by expanding their production capacity as quickly as possible. At first the mining companies expand their existing mines, then they and others begin building new mines.

Much of the financial capital they require to fund this expansion comes from the retained after-tax earnings of the mining companies' shareholders (many of whom are foreigners). Much of the rest of the financial capital will be acquired from abroad. Much of the physical capital (mainly equipment) the miners install will be imported.

As part of the expansion, steps must be taken to ensure sufficient infrastructure exists to transport the minerals or natural gas to the nearest port by road or rail or pipeline, then loaded onto bulk carriers. Often this infrastructure is provided privately, sometimes it's provided by government.

The third phase is where the new production capacity comes on line and the volume of our exports starts to surge. But it won't just be us who are now exporting a lot more. The countries we compete with will also have been expanding their production capacity.

So even if you assume the demand for mineral and energy continues unabated - which is a reasonable expectation in this case - the global surge in supply can be expected to bring down the earlier sky-high prices.

Thus the prices we've been receiving for our exports are certain to fall back. Fortunately, however, this will occur as the volume of those exports is growing, thereby limiting the effect on the total value of our exports.

So, where do we stand in this process?

We've reached the point where, after a lot of global investment in new capacity, global supply has begun to expand and global prices have passed their peak and begun falling.

Thus our terms of trade - the prices we receive for our exports relative to the prices we pay for our imports - peaked in the September quarter and fell back in the two subsequent quarters. The terms-of-trade index (where 2009-10 equals 100) got to 130, but has since fallen by 10 per cent to 117.

Since it was the big improvement in our terms of trade that did most to explain the rise in our exchange rate, this deterioration in our terms of trade might explain why the dollar has fallen closer to parity with the US dollar. We can't be sure, however, because - as you might have noticed - a lot of other worries have been affecting global currency markets lately.

Similarly, although we can't be sure, most economists are confident global coal and iron ore prices won't fall back to where they were before the boom started, meaning our terms of trade will stay above their long-term average.

And, assisted by continuing strong capital inflow to Australia, the dollar will stay well above its post-float average of about US75?. (Meaning, of course, that life will stay uncomfortable for our other export and import-competing industries.)

This doesn't mean the second, investment phase of the boom is nearing its end, however. According to a Bureau of Statistics survey, the industry is expecting to spend a record $120 billion this financial year, up from $95 billion in the year just past.

Much mining investment comes under the heading of "engineering construction". It's expected to grow in real terms by more than 20 per cent in 2012-13 and by 9 per cent in 2013-14. The industry has committed to, or commenced construction on, more than half the fabled $456 billion resources-investment pipeline.

Note that much of the spending in recent times is on the development of liquefied natural gas facilities.

As for the third, export expansion phase, this week we got some new estimates from the Bureau of Resources and Energy Economics. It's expecting the volume of our total minerals and energy exports of about 700 million tonnes a year to more than double by 2025. And that's just the low-range estimate.

We now export about 400 million tonnes of iron ore a year. By 2025, this could grow to between 885 million and 1082 million tonnes. If so, our share of the world export market would go from its previous 30 per cent to between 45 and 55 per cent. Our main competitors are Brazil and West Africa.

At present we export about 20 million tonnes of natural gas a year, giving us just 2 per cent of the world export market. This could increase to between 86 million and 130 million tonnes by 2025, taking our market share to between 10 and 15 per cent. Our main competitors are Qatar, Russia and, in future, North America.

We are now exporting roughly 150 million tonnes of steaming (thermal) coal, giving us less than 20 per cent of the export market. This could rise to between 267 million and 383 million tonnes by 2025, taking our market share to between 23 and 33 per cent. Our competitors include Indonesia and, in future, Mongolia.

Our exports of coking (metallurgical) coal are roughly 150 million tonnes a year, but they could rise to between 260 million and 306 million tonnes. This would take our market share from 60 per cent to between 56 and 66 per cent. So there's a risk we lose market share to rivals such as Colombia.

All this growth isn't expected to much change the states' share of bulk commodity exports by volume. Western Australia has 60 per cent and Queensland has 22 per cent. But NSW has 15 per cent, leaving other states and territories with 3 per cent.

We'll be left with a mining sector whose share of national production (gross domestic product) well exceeds 10 per cent, making it bigger than manufacturing.