Australia and the Millennium Mining Boom

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1 Remarks made by Professor Quentin Grafton Executive Director/Chief Economist of the Bureau of Resources and Energy Economics (BREE) made at the Australian National Conference on Resources and Energy (ANCRE) September 2012 Canberra, Australia Australia and the Millennium Mining Boom Opening Remarks The first day of the inaugural Australian National Conference on Resources and Energy provides an opportunity to consider where Australia has come over the past decade of the current resources boom, and where we might be going in the years to come. Price Forecasting in the Best and Worst of Times I would like to preface my comments by borrowing some words from Charles Dickens when he wrote about turbulent times in Europe in a different age. As forecasters, it is the best of times for BREE in that our work is receiving a great deal of attention with the commonly asked question: Is the boom over? It is also the worst of times because the past five years have been highly volatile in terms of the difference between peaks and troughs of commodity prices (See Table 1). This makes short-term price forecasts particularly difficult to do. Table 1: Selected commodity price swings (nominal US dollars) Pre-GFC Peak GFC Trough Post GFC Peak Current Copper US$/t 8,985 2,770 10,148 7,561 Aluminium US$/t 3,292 1,254 2,772 1,870 Zinc US$/t 4,620 1,042 2,635 1,831 Nickel US$/t 54,200 8,810 29,030 16,240 Uranium US$/lb Notes: prices are from the following dates (in chronological order) Copper: 3-Jul Dec Feb Aug-2012 Aluminium: 11-Jul Feb Apr Aug-2012 Zinc: 24-Nov Dec Jan Aug-2012 Nickel: 16-May Oct Feb Aug-2012 Uranium: Jun-2007 Mar-2009 Jan-2011 Aug-2012 Source: BREE

2 To illustrate this volatility there have been three episodes where the iron ore spot price has fallen by more than 20 per cent within a three month period, followed by a rebound, but to a lower peak (See Figure 1). Figure 1: Tianjin Iron Ore Spot Prices (CFR) Peak: US$186 Peak : US$192 Trough: US$163 Peak: US$181 Peak: US$ Trough US$118 Trough: US$ Peak: US$ Trough: US$87 60 Trough: US$ US$/t Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 62% Fe CFR Tianjin Source: Bloomberg. BREE forecasts that this will happen again with a rise in the iron ore spot price from its recent trough reached early September. Indeed, prices have already started to rebound, but we expect the new high to be at a lower level than the $148 a tonne reached in March 2012 at the height of the last cycle. Our long-term forecast is for this zig zag pattern to continue, but with an overall trend of decline in iron ore prices from their historical highs in 2011 (See Figure 2). 2

3 Figure 2: Historical Iron Ore Prices index Jun-66= Source: BREE. A key issue for forecasters, the miners and the Australian economy is the relationship between commodity prices and our exchange rate. Typically, Australia s exchange rate has closely tracked the changes in the spot iron ore price with a partial correlation coefficient of In the past couple of months this relationship appears to have altered (see Figure 3). Should there be substantial declines in key commodity prices and should Australia s exchange rate remain at high levels, this would impose a burden on all exporters, and especially commodities exporters that have had sharp reductions in their US dollar price. 3

4 Figure 3: Iron ore prices and USD/AUD exchange rate US$/t US$/A$ 0.60 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 iron ore spot price, 62% CFR China US$/A$ (right axis) Source: Bloomberg. The implications of an unresponsive exchange rate and fluctuations in the US dollar price of iron ore on the value of Australia s exports of resources and energy are illustrated in Table 2. It shows that a 10 per cent reduction in the US/A dollar exchange rate would raise the forecast Australian dollar value of resource and energy exports by A$19 billion from A$189 to $A208 billion. Table 2: Comparisons of exchange rate and iron ore prices Iron ore price Exchange rate Change A$b Change A$b / 5% +/ 10% +/ 5% +/ 10% Total R&E export earnings $189 b Exchange rate assumption 0.99 US$ / A$ Forecast iron ore price 104 US$/t Source: BREE. Macroeconomic Outlook I would now like to highlight some of the forecasts from the latest issue of BREE s Resources and Energy Quarterly that was released earlier this morning. 4

5 The world economy is in a challenging period. Increased downside risks over the past quarter include heightened concerns over the euro zone debt crisis; a moderation in Chinese economic growth and a sharp fall in its export growth; weakness in investment, jobs and manufacturing in Europe; and reduced growth in India. Overall, weak economic growth is assumed in large advanced economies over the next 15 months. Annual world GDP growth in 2012 of 3.5% is expected to be about two-thirds of what it was in China s economy will grow rapidly in 2012, but faces substantial downward pressures, especially in terms of its exports. China s exports are still growing, but at a very much reduced rate compared to one year ago. Concerns over debts in the euro zone are not just Made in Greece, but include an unfolding banking crisis in Spain. As a direct result of the debt difficulties, and the uncertainties it engenders, the euro zone is projected to be in a mild recession in 2012 with contractions in GDP recorded for Italy, Belgium and Spain and in the euro zone as a whole in the second quarter While the German economy grew in the past two quarters the OECD forecasts a contraction over the next two quarters. The French economy has experienced no growth in the past three quarters. There have been multiple solutions to the on-going debt crisis. The latest intervention by the European Central Bank (ECB) is the Outright Monetary Transactions (OMT) program. This requires that indebted euro zone governments first apply for assistance from either the European Financial Stability Fund (EFSF) or the European Stability Mechanism (ESM). Subsequent to an agreement on a country meeting agreed-to-conditions, the ECB would undertake market operations to purchase sovereign bonds in secondary markets of up to three years maturity so as to lower interest rates in debt-affected countries. While this latest intervention has been welcomed by markets it is not, and cannot be, a solution to the multiple economic challenges facing the euro zone. In Australia, high levels of mining investment are expected to continue for some time to come. Significant expansions to iron ore and coal production capacity are underway, and will contribute to solid growth in resource export volumes over the foreseeable future. In , Australian mine production is forecast to increase by 8 per cent, largely attributed to an increase in the volume of energy commodity production by 13 per cent. The production of metals and other minerals is forecast to increase by 4 per cent in (See Figure 4). 5

6 Figure 4: Changes in Volume, Price and Value of Australian Commodities Source: BREE. In , high commodity prices resulted in export earnings from resources and energy growing 8 per cent relative to to total A$193 billion. Export earnings in are expected to decrease due to lower commodity prices relative to assuming the Australian dollar holds its parity with the US dollar. Asian demand for Australian exports, and market expectations about resources and energy commodity prices, are key factors that will influence the value of the Australian dollar over the short to medium term. Australian dollar denominated assets are also increasingly viewed as a safe haven for short-term financial flows in response to the on-going sovereign debt crisis in Europe. This status has provided recent support for the Australian dollar despite falling commodity prices. While some commodity prices are forecast to recover later in the financial year from their recent troughs, they are expected to remain well below the historically high prices seen in 6

7 2011. Thus, Australia s export earnings are forecast to total $189 billion in , down 2 per cent from the record high of $193 billion in , but 5 per cent greater than the value of resources and energy exports in Table 3: Decomposition of the Value of Australian Exports Value of exports (A$m) Resources and energy 117, , , , , ,189 energy 45,591 77,892 57,478 70,143 77,398 80,788 metals and other minerals 71,771 83,903 81, , , ,401 Sources: BREE; ABS. The Millennium Mining Boom To differentiate the current boom from previous booms, it is better named the Millennium Mining Boom and shortened to the Millennium Boom. This is because it began around and coincided with when resource commodity prices started to rise as a result of surging demand in emerging economies, especially China. Past and current mining investments stimulated by high commodity prices could result in a tripling of Australia s resource and energy exports, by volume, from the start of the Boom to the 2020s. Volume increases in exports of bulk commodities will help offset declines in commodity prices from their historic highs in 2011, and will help sustain the benefits of the boom many years into the future. The increase in Australia s terms of trade during the Millennium Boom has been both the largest and longest since the gold rush of the 1850s (see Figure 5). Over the period to an improvement in the terms of trade contributed to about half of the overall annual increase in Australia s real gross national income. The primary driver for the increase in the terms of trade has been the large surge in hard commodity prices. Despite a decline over the past year, Australia s current terms of trade remain at historically high levels. 7

8 Figure 5: Australia s Terms of Trade year centred moving average index 2010= Source: RBA with BREE calculations. The primary cause and key driver of the rapid and substantial rise in resource prices has been a demand surge for these commodities in emerging economies. China s super fast economic growth that has allowed its economy to double every decade along with an urbanisation rate that increased from 20 per cent of the population in the early 1980s to over 50 per cent in 2012, and also China s rapid industrialisation, have all contributed to a very large increase in demand for resources and energy over the past decade. As a consequence of China s demand for resource commodities there has been a ten-fold increase in the real value of mineral exports to China from Australia rising from $5 billion to around $50 billion in (Figure 6). 8

9 Figure 6: Australian Merchandise Exports to China ($ ) A$b mineral resources merchandised goods Source: ABS. The economic impacts of the Millennium Boom are shown in Table 4. A comparison of the eight years immediately preceding the Boom ( ) to the eight years within the Boom ( ), shows that in terms of key economic variables (employment, interest rates and income) Australia has performed much better during the Boom. Table 4: Key Economic Variables: Before and During the Millennium Boom Economic variable Unit Period average to to Employment in Australia index Employment in mining sector index Unemployment rate % Average household income index Nominal interest rate % Real interest rate % Source: ABS with BREE calculations. While Western Australia (66 per cent) and the Northern Territory (56 per cent) enjoyed the highest increases in real weekly household income during the Millennium Boom, households in all jurisdictions had increases in weekly earnings of about 30 per cent or more over the period to Overall, average weekly real household income in Australia rose 39 per cent over the past decade (Table 5). 9

10 Table 5: Average Weekly Household Income ($ ) NSW VIC QLD SA TAS WA NT ACT Australia Ratio of to Source: ABS with BREE calculations. Much of the increase in employment, export volumes and investments in major mining projects and infrastructure has occurred in the key mining states of Western Australia and Queensland (see Figure 7). Since the start of the boom Western Australia has increased the volume of its bulk commodity exports by 155 per cent, its employment in the mining sector by 192 per cent and the value of investments in advanced major mining projects by a stunning 1335 per cent. Queensland experienced even larger percentage increases than Western Australia in terms of mining employment (242 per cent) and the value of advanced major mining projects (1799 per cent), but lower growth in the volume of its bulk exports (44 per cent) over the past decade. 10

11 Figure 7: State Effects of the Millennium Boom (% Change) Sources: BREE; ABS. The effects of the Millennium Boom on the resources sector have been profound. Direct employment in the mining sector almost tripled from about in to around in The value of minerals and energy exports has increased in real terms ( dollars) from $73 billion in to $193 billion in (see Figure 8). 11

12 Figure 8: Value of Exports ($ ) and Mining Employment A$b '000 people employment in resources and energy (including services to mining) (right axis) total resources and energy export earnings Source: BREE (employment data from ABS). While the first price phase of the Millennium Boom is much longer and the price surge much higher than in other booms, it is qualitatively the same as other demand-led commodity booms. The real price of iron ore rose over six-fold, the real metallurgical coal price over five-fold from 2002 to a peak at the end of 2011, and from trough to peak the real price of thermal coal has risen more than three-fold with a substantial dip in as a result of the Global Financial Crisis (GFC). Prices fell sharply in 2012, but they remain high compared to their levels before the start of the Boom (see Figure 9). 12

13 Figure 9: Real Commodity Prices ( =100) index = iron ore metallurgical coal thermal coal Source: BREE The downward pressure in hard commodity prices in 2011 and 2012 is, in part, due to a moderation in economic growth in China and concerns over the fallout of the current euro zone recession and its sovereign debt crises. In addition, and unlike the earlier years of the Millennium Boom, supply response increases for some minerals, especially iron ore, have begun to exceed the increase in demand. Further rises in the production and exports of resources are expected over the coming decade and these supply responses will further moderate prices relative to their 2011 peaks. How far, and how fast, resources prices will decline from their historic highs will depend on the growth in supply and demand factors, especially in emerging economies like India and China. The second investment-volume phase of the Millennium Boom began before the 2011 price peak and has yet to reach its maximum. This investment can be measured by annual capital expenditures (CAPEX) in the mining sector and also by the total value of completed advanced major minerals projects (see Figure 10). The real CAPEX (in dollars) in the mining sector has increased by about 600 per cent from some $12 billion in to over $82 billion in The real value of completed advanced mineral projects has increased from less than $3 billion in to over $30 billion in Both series have yet to peak, but will do so within the near future if resource prices continue to moderate. 13

14 Figure 10: Australian Capital Expenditures in Mining and Completed Major Mining Projects A$b mining CAPEX value of completed projects Source: BREE (CAPEX data from ABS) Cumulative expenditures on Major Mining projects over the past 5 years come to around $100 billion (See Figure 11). Projects that have passed final approvals and final investment decisions currently amount to about $260 billion. Thus, even if there were to be no new additions to the Major Mining projects list, Australia is still only about a third of the way, in value terms, through the investment phase of the boom. Figure 11: Cumulative Expenditures on Major Mining Projects cumulative $b Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Source: BREE 14

15 The largest share by value of advanced mineral projects is in the energy sector and primarily in the construction of liquefied natural gas (LNG) facilities collectively worth over $170 billion. Most of these projects still have several years before they will be completed. As a result, even if there were no new additions to Australia s planned advanced major mineral projects list, the total value of all projects at the beginning of 2016 would be about $90 billion, or some three times larger than it was before the start of the Millennium Boom (see Figure 12). Figure 12: Value ( $) of Advanced Major Mining Projects Source: BREE. The very large investments in the mining sector have started to have a positive effect on Australian production volumes. Iron ore production has increased steadily from the start of the Millennium Boom and has more than doubled over the past decade. Smaller volume increases are shown for metallurgical and thermal coal, but both have increased production substantially over the past 10 years (see Figure 13). 15

16 Figure 13: Bulk Commodities Production ( =100) index = Source: BREE. iron Ore metallurgical coal LNG thermal coal Past and current investments will likely result in a tripling of Australia s resource and energy exports, by volume, from the start of the Millennium Boom to the 2020s. These volume increases in resources and energy exports will be long lasting and will help sustain the benefits of the Millennium Boom well beyond the price peaks of The phases of the boom are shown in Figure 14. The first, price phase of ever increasing prices ended in The second, investment phase began in earnest around 2008 and has yet to peak. The third, volume phase has many years to run and, unlike the price and investment phases, it is unlikely to result in a peak and decline, but rather a levelling out of volumes (see Figure 15). 16

17 Figure 14: Phases of the Millennium Boom 1500 phase I phase II & phase III index =100 Mt indicative figures only iron ore export volumes thermal coal export volumes met coal export volumes capex A$b Source: BREE. LNG export volumes bulk commodity real price index (right axis) value of advanced projects (capex, right axis) Figure 15: Bulk Commodities Volumes (Actual and Projected) Source: BREE. 17

18 Sustaining Australia s Future The decline in Australia s terms of trade from its peak level in 2011 means that the easy gains of the Millennium Boom are over for both the miners and the Australian economy. Over the nougties the terms of trade effect contributed 1.2 percentage points per year to growth in average gross national income (see Figure 16). By contrast, in the nineties when terms of trade were declining they reduced gross national income. Figure 16: Contributions to Gross National Income Per Capita Contributions to growth in average incomes by decade (percentage points, annual average) 4 3 GNI per person 2 ] Contributed 1.2% per year growth in average incomes 1 0 Labour productivity Terms of trade Labour utilisation Foreign income flows s 2000s Source: Adapted from Australian Treasury, 2012, Productivity and Structural Change, Chart 1, p.2. As Australia s terms of trade decline with projected falls in key commodity prices from historic 2011 highs, we will need to make up this shortfall to be able to maintain the income growth we have enjoyed over the past decade. In the absence of any gains from terms of trade, and in per capita terms, the key driver of growth in future Australian incomes will be improvements in productivity. According to the Reserve Bank of Australia, multifactor productivity between 1993/94 and 2003/04 increased at an annual rate of 1.8 per cent in the market sector of the economy, but declined by 0.4 per year between and Labour productivity between 1993/94 and 2003/04 increased at an annual rate of 3.1 per cent, but increased by only 1.4 per cent per year between and (Figure 17). 18

19 Figure 17: Decomposition of Changes in Real Gross National Income Population Income 12% 16% Participation Terms of Trade 1% 3% 49% 46% 4% 86% Productivity 18% - 3% Source: ABS with BREE calculations. Income: Real gross national income: Chain volume measures Productivity: Multifactor productivity, quality hours adjusted hours worked The high productivity growth in the nineties and low growth in the noughties poses an immediate dilemma for Australia if the terms of trade declines as forecast. Productivity growth is supported by the efficient allocation of inputs, improved management practices, on-going technical change and the accumulation of physical and human capital. Public policies that can assist in productivity growth include openness to trade and competition and a sound and consistent policy framework. Productivity growth is supported by the public and private sectors working together to: (1) Avoid infrastructure bottlenecks, especially important in the export important mining sector; (2) Ensure a taxation system that rewards and supports productive activities; and (3) Develop a skills and innovation framework that supports learning and development for Australian students and workers, and encourages research and development and on-the-job innovation. This productivity imperative and its importance for Australia over the coming decade are illustrated in Figure 17. The goldilocks era of every increasing real prices of commodities is over. To avoid the bad news bears of falling terms of trade and on-going low productivity growth that will result in the stagnation of incomes, Australia must move forward with a productivity agenda that supports higher productivity growth (See Figure 18). 19

20 Terms of Trade Figure 18: Terms of Trade and Productivity Growth Maintain Goldilocks 3.7% Productivity Agenda Decline Source: BREE. Bears Bad News Low Productivity Growth (2000s) High (1990s) Closing Remarks In closing, let me restate the following. First, the Millennium Boom has been unambiguously good for the Australian economy and has allowed us to weather the storms of the GFC better than almost any other developed economy and allowed for real income growth of about 40% over the past decade. Second, the easy gains of ever increasing real prices for hard commodities are over. A forecast declining terms of trade requires that Australia substantially increase its productivity growth to be able to maintain the rate of increase in real incomes enjoyed over the past decade. Third, the investment phase of the boom has not yet peaked, but will soon if prices continue to moderate. Past and current mining investments could eventually lead to a tripling of Australia s export volumes from the start of the Millennium Boom to the 2020s. 20

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