The recent sharp slump in commodity prices could finally herald the end of a mining boom that has fuelled the Australian economy for years.
While the country’s mines will continue to be developed for some years, and export volumes will surge, the windfall price phase of the mining boom – with record prices of coal and iron ore – appears to be over.
BHP Billiton and Woodside Petroleum have already scrapped or scaled back major projects; former billionaire miners such as Nathan Tinkler have seen their fortunes depleted or have hit financial difficulty; and government revenue from the mining sector has slumped.
Slipping commodity prices should have led the Australian dollar lower. Yet the currency has remained stubbornly high.
Leading economists warn that Australia’s salad days are over. Worse, Australians face an extended period of lower living standards if the country doesn’t move quickly to improve competitiveness, particularly through reforms to boost waning productivity.
“It’s like having a hangover,” says Stephen Anthony, the Canberra-based director of budgeting and forecasting at Macroeconomics, an economic modelling and forecasting agency. “We’ve partied hard and now we’re hung over.”
The government, which recently released a white paper entitled ‘Australia in the Asian Century’, is now pinning its hopes on positioning the country to exploit Asia’s ongoing ascent. Its new strategy includes an ambitious programme to boost productivity.
But companies warn that hard steps must be taken, such as labour-market reforms, if Australia is to be competitive in the Asia Pacific region and avoid a post-mining-boom slump.
“The best thing the Australian government can do is pursue productivity and microeconomic reform more aggressively than it’s done for two decades,” Anthony says.
End of an era
For the past 10 years anyone visiting a five-star Australian resort would have noticed something different. The guests have not all been typical well-groomed wealthy clientele; many were workers with sun-damaged skin, and big hands and forearms.
These holidaymakers were from Australia’s mines. They were paid huge money to build and work in mines that were tapping into the China-led mining boom, and like the rest of the nation they were living it up.
Mining booms have long been a feature of Australia’s economic and social history, dating back to the gold rush of the 1850s. But the mining boom that began in 2003 has been unprecedented in its scope and power.
Over the past five years alone, commodity prices in Australian-dollar terms have surged 60%. Australia’s terms of trade (the ratio of export to import prices) rose 56% from 2005 to 2011.
Economists Bob Gregory and Peter Sheehan describe the terms of trade increase as a “free income gift to Australians”. The boom has also triggered a huge increase in mining and resource investment, including coal mines and liquefied natural gas (LNG) plants.
The boom made miners, and Australians, rich. It threw up a list of colourful mining billionaires, including the world’s richest woman Gina Rinehart, Fortescue Metals founder Andrew ‘Twiggy’ Forrest, and Tinkler, a former apprentice and electrician who turned an AUD1 million (US$1.04 million) investment in central Queensland mining leases into a billion-dollar fortune.
Tinkler’s 19% stake in Whitehaven Coal made him the richest young person in Australia, and he spent big on horses and sports teams, including his local Newcastle Knights rugby league team and the Newcastle Jets soccer team.
Average Australian income levels rose by about 25% over the past decade, outpacing Europe and the US, according to Gregory and Sheehan. But the impact hasn’t been all positive: the boom-fuelled Australian dollar’s value has hurt the country’s manufacturing and service export sectors, particularly education and tourism. It has also masked a slump in labour and capital productivity.
Dearth of demand
Recent sharp falls in commodity prices, however, have threatened to reverse Australia’s terms of trade income windfall, the mining boom and the fortunes of the billionaire miners.
Prices for commodities such as iron ore and coal have crashed on the back of the ongoing European recession and waning demand from China, the country that has accounted for more than half the world’s demand for both commodities.
Macroeconomics’ Anthony says the Chinese are reluctant to adopt measures to drive up domestic investment, which would boost demand for Australian resources; instead they’re more likely to stimulate domestic consumption.
So is the mining boom over? Most economists agree we have witnessed the end of the ‘price’ phase of the mining boom, with commodity prices having peaked in August and September last year.
“It does appear initially the price phase is over,” Anthony says. “It’s very unlikely commodity prices will spike again back to the record levels. It seems more likely they will fall somewhat over the next 18 months.”
He expects commodity prices to fall 8% during 2012 – which has essentially already occurred – and perhaps another 8% next year.
Falling demand has had an impact on Australia’s terms of trade, which peaked along with commodity prices in the September quarter last year, and has fallen 9.5% in the past three quarters.
Treasurer Wayne Swan said in his mid-year economic and fiscal outlook speech that the government expects Australia’s terms of trade to fall by 8% in 2012-2013; larger than the 5.75% decline factored into the budget. Sheehan and Gregory believe the terms of trade could more than halve in the next few years.
The reversal of demand for commodities has affected Australia’s newly made mining billionaires too. Rinehart and Forrest’s fortunes have plummeted, while Tinkler has struck financial difficulty after his aborted AUD5.2 billion bid for Whitehaven Coal. The value of his holding in Whitehaven has now halved to AUD500 million. He has also been embroiled in five court cases with creditors and has had to offload horses and luxury cars.
Productivity problems
The mining boom has longer-term ramifications than just record prices, and some of these could end up hurting the country.
Saul Eslake, chief economist at Bank of America-Merrill Lynch, says the boom is “multi-faceted” – he believes the surge in prices is being followed by a peak in investment, which will lead to a rush in production. Eslake agrees the price phase is over, but thinks that the investment boom that began in 2002 only got into full swing in 2009 or 2010.
“That’s probably not going to peak until some time in 2013-2014,” he says. When it does, more ore will hit the market, which could potentially depress prices further if global demand remains muted.
The big miners have reacted to the price falls by slowing or halting mining projects. BHP Billiton has decided not to proceed with the AUD30 billion expansion of its Olympic Dam mine in South Australia, and a planned AUD20 billion expansion of Western Australia’s Port Headland. Woodside Petroleum has also put its AUD15 billion Pluto LNG project on hold.
But Sheehan and Gregory say those projects were not particularly advanced, either undergoing feasibility studies or awaiting final approvals. There is no evidence that projects under construction or committed are being cancelled.
Still, a recent report by ANZ and Port Jackson Partners said that while most first-generation projects will be built, of the 950 projects identified as currently under way or proposed, up to two-thirds may not proceed in the planned timeframe. That means capital expenditure between 2013 and 2020 would fall from an expected AUD759 billion to AUD450 billion. The jobs to build and operate these planned projects would fall from 310,000 to 160,000.
Sheehan and Gregory expect capital expenditure on projects to peak in 2013-2014, but then slump by 80% to about AUD17 billion by 2016-2017.
The investment boom will still trigger an expansion of production and export of minerals and commodities, which will ramp up as projects are finalised – particularly LNG, with nine plants under construction.
“That [production boom] could well continue until the early 2020s,” Eslake says.
But as Sheehan and Gregory note, while exports will rise rapidly in the decade from 2010-2020 – and probably more than double in real terms – the commodities that comprise this growth require low employment and have low linkages into the domestic economy.
Despite the ongoing capital investment and a surge in export volumes, the best days of the mining boom are over for Australia.
Trouble ahead
In normal circumstances, the decline of mining prices wouldn’t be so bad for the country. The Australian dollar typically falls along with commodity prices, providing an economic shock absorber as it makes exports from other industries more competitive.
Additionally, the Reserve Bank of Australia (RBA) has been lowering interest rates, in part to weaken the Australian dollar. It most recently cut the official cash rate by 25 basis points on October 2 to 3.25%, only just above the low of 3% reached during the height of the global financial crisis in 2009.
Yet the Australian dollar isn’t weakening this time around. In fact it has strengthened this year, from AUD0.979 to the US dollar on January 1 to AUD0.967 on November 2.
Ironically, the country’s past economic success is preventing the currency from weakening now. Australia hasn’t had a recession in 21 years, and has generally enjoyed healthy growth over the past decade. That’s attracted international investors whose capital has been bolstered by large quantitative easing programmes in the US and Europe. They believe Australia’s currency and its paper assets are a safe haven. Added to this, mining-boom capital is still flowing in.
“The normal dynamics of adjustment aren’t occurring, and because of that we’re stuck in this low-income period,” Anthony says.
To help get Australia’s economy moving, the authorities need to promote investment and spending in areas that are not commodity-sector related. It’s not hard to find options.
Economists Sheehan and Gregory argue that Australia has a massive infrastructure backlog – amounting by some estimates to 40% to 50% of GDP. They believe that state governments could stimulate large-scale infrastructure investment to replace resources investment.
The trouble is that such investments will cost a lot. And the federal government in particular does not have the money to pay.
“This government and the previous government didn’t save enough of the revenue,” says Eslake, adding that Canberra gave a lot away in tax cuts and untargeted welfare handouts. “The hay was never put in the barn.”
The commodities price crash has already hit revenue. The controversial minerals resource rent tax (MRRT), which was introduced on July 1, raised no tax in the first three months of this financial year; the government has been forced to slash its forecast of MRRT revenues in 2012-2013 from AUD3.7 billion to AUD2 billion. But influential economic forecaster Deloitte Access Economics says the real figure could be as low as AUD500 million.
Another way to help the economy would be to improve productivity, something that most economists think is necessary to take up the slack left by the end of phase one of the mining boom. “Government needs to inspire the nation to hold up the banner of microeconomic reform in the same way [former prime minister] Paul Keating did in 1987,” Anthony says.
In an August 2012 report, ‘Beyond the Boom: Australia’s Productivity Imperative’, management consultancy McKinsey notes that Australia saw productivity decline by 0.7% annually between 2005 and 2011, compared to a 2.4% increase from 1993 to 1999.
Anthony believes that the country will experience “income recession” unless Australia can turn this decline around. He notes that while nominal GDP grew on average at 8.1% annually since the mining boom began, this is likely to fall to just 3% to 4% a year over the next three to four years. That is barely enough to absorb the natural increase in the labour force of around 1.5%, which means that real wages will fall if inflation is around 2.5%.
Lacking labour reform
There are ways that Canberra can help bolster Australia’s economy.
One urgently needed reform is the industrial-relations system. Anthony wants the government to introduce a more flexible Fair Work Act to allow workers to enter into individual contacts. Under the act, individual contracts allow employers to strike individual agreements with workers, which some economists argue helps flexibility and workforce productivity. He also advocates that the government should lower the corporate tax rate and introduce a moratorium on new regulations and taxes.
The federal government is reacting. Its recently released 300-page white paper, ‘Australia in the Asian Century’, outlines 25 national objectives to prepare Australia for the rise of Asia. This includes an ambitious programme to boost Australia’s diplomatic presence in the region and increase Asian-language teaching in schools.
Economists note that not much is new in the paper, but they are at least happy that it lays out “a coherent narrative and framework for many of the things that the government is seeking to do anyway”, according to Eslake.
Boosting Australia’s productivity and innovation is at the heart of the document, and industry groups have praised the government’s move to increase competitiveness through innovation and productivity enhancements.
But they also think the paper ignores key reform areas, particularly the labour market. Australian Industry Group chief executive Innes Willox, for example, said it was disappointing that workplace relations reform, a key ingredient of productivity, is absent in the white paper.
“More flexible workplace relations are critical to the realisation of productivity gains from other sources, including education and training and innovation,” he says.
The Labor government is unlikely to promote greater workforce flexibility given that its campaign against the opposition coalition’s controversial pro-employer Work Choices legislation helped it win the 2007 election. It subsequently scrapped Work Choices and introduced the Fair Work Act. That election loss has made the opposition coalition wary of labour-market reform too (opposition leader Tony Abbott has ruled out reintroducing statutory individual contracts).
Belt-tightening time
It’s not all gloom, however. When it comes to the terms of trade, in a research report released in September, HSBC expects a total cumulative fall of 20% from its peak by early 2013. “This would still leave the terms of trade 65% higher than it was in 2000. This decline is not expected to see a recession in Australia – far from it,” the bank says.
The billionaires are also fighting back. Tinkler, who has moved to Singapore, has denied he is on the brink of financial collapse, and has settled a number of disputes.
“All I will say is that tough people last, tough times don’t,” he told the Australian Financial Review. “There’s been a massive media campaign to try and ruin me...They wanted to treat me like [failed 1980s tycoon] Christopher Skase; like I was sitting in a wheelchair puffing in a bag and owed US$250 million. It is just not the case.”
Tinkler is also pressuring Whitehaven’s board to improve the company’s performance and there are rumours he will make a fresh bid. One supporter says: “Tinkler is on the comeback trail – don’t write him off yet.”
But even if this is true, the fact remains that the passing of the peak of Australia’s mining boom has forced Tinkler to lower his living standards, at the very least.
The rest of Australia will shortly follow, if the country cannot boost its productivity soon.
“For most of the last decade, rising terms of trade [based on increasing commodity exports] have obscured [the fact] that other traditional drivers of growth such as productivity have been declining,” Eslake says. “The easy days for both national income and revenue are drawing to a close; in some respects they have finished already.”