The Beginning of the End for Iron Ore…

The big trucks transport iron ore

Is everyone starting to get it now?

In Tuesday’s Daily Reckoning, I quoted from an article written by Ross Garnaut. It suggested that Chinese steel production could decline by more than 25% over the next 15 years. The implications for Australia’s iron ore industry would be disastrous.

Now, more confirmation that Garnaut’s prediction isn’t all that crazy. From the Financial Review:

Li Xinchuang, President of the China Metallurgical Industry Planning Association, said he has just completed research on this very issue.

Li is forecasting Chinese steel consumption to fall by a little over 20 per cent to 560 million tonnes by 2030.

Add in a projected 50 million tonnes of exports, and you are very close to the 600 million tonnes Garnaut cited.

That is a truly horrendous figure for the iron ore industry and for Australia. Adding insult to a near fatal injury, the Chinese government just announced that it will subsidise its iron ore miners by giving them a tax break on production.

This just delays the supply response to falling prices. In the same way, the WA government’s decision to give royalty relief to junior miner BC Iron keeps it in production for longer than it should be.

The bigger issue here is how this will flow through to the broader economy. The iron ore boom drove a historic boom in Australia’s terms of trade, which is shorthand for saying it increased the purchasing power of our currency…which in turn helped to increase living standards.

Now the terms of trade are in free fall, and this fall will likely keep on going for years to come. That means our standard of living will fall as the value of our exports buy much less in terms of imports.

What can we do about it?

Well, successive governments have pretty much spent the windfall delivered by the terms of trade boom. That is, they have provided things like extensive superannuation concessions, middle class welfare and generous pension allowances to buy votes along the way.

Once benefits become entrenched, they are very difficult to take away. You’re seeing this now with debate about how to repair the budget deficit. No one wants to get off the gravy train.

Well, like it or not, the gravy train is slowing. It will take a while to become apparent to most but the good times are well and truly over. The question is how long this iron ore/terms of trade bust takes to flow through into the heart of the Aussie economy — and the religion of the Aussie population — property.

This is where the RBA comes into it. Their interest rates cuts have created a mini housing construction boom (and a massive house price boom in Sydney and Melbourne), which has had a flow on effect on consumption.

Consumption is actually pretty strong right now. It might not be showing up in the figures of traditional retailers like Myer [ASX:MYR], but the likes of Harvery Norman [ASX:HVN] and JB Hi Fi [ASX:JBH] are doing well out of this boom. After all, newly built houses and apartments need whitegoods and electronics.

Perhaps this is partly why the RBA held off cutting rates on Tuesday. They are clearly concerned about inciting more property speculation, but they also must realise that cutting rates isn’t going to increase the iron ore price or bring back falling capital expenditure.

That is, monetary policy only has so much of an effect on the economy. Consumption is healthy as is housing construction. But it just isn’t enough to offset the fall in mining investment, a trend that still has years to play out.


Lowering interest rates to push the currency down is clearly one of the RBA’s aims. While a weaker currency does help exporters, let’s not forget years of a strong currency decimated the manufacturing sector in Australia and pushed most of it offshore.

So now, with the currency falling, it will push up the cost of the imported manufactured goods we used to produce ourselves.

What a mess we’ve gotten ourselves into.

As the saying goes, you reap what you sow…

It’s not all doom and gloom though. In slightly better news for Australia, oil company Royal Dutch Shell announced yesterday a takeover offer for BG Group, a British oil and gas company.

Shell offered a massive 50% premium to BG’s share price, indicating Shell believes the current oil price weakness will not persist. The market didn’t like the price Shell paid, and it’s share price fell about 8% yesterday. That’s standard though when the acquiring company offers such a large premium.

The acquisition gives Shell market leadership in liquefied natural gas, and it will become the owner of BG’s massive LNG project on Curtis Island in Queensland, which is why the deal is important for Australia.

Right now the economics of Australia’s large LNG projects are quite dubious. The multi-billion dollar investment decisions were all made years ago on the assumption that US$100-plus oil prices would be the norm.

Now, with prices 50% lower, the projected return on investment in some cases doesn’t even cover the cost of capital.

So it’s a bold move by Shell to pay a big premium to get these assets now while the oil price is so low. They will probably do it tough for a few years. But looked at from a 10 year plus time horizon, the deal is probably quite a shrewd one.

While it gives confidence that Australia hasn’t built a bunch of LNG white elephants, it really doesn’t make a huge amount of difference to the economy. In the next 12 months, the LNG construction phase will mostly be over, meaning a huge reduction in jobs as these projects transition to the production phase.

And with projects like BG/Shell’s Curtis Island being foreign owned, any profits will accrue to foreign shareholders. States will get production royalties, but apart from that, everything else leaves Australia.

As I said, you reap what you sow. When the nation collectively decides to own property at the expense of everything else, this is what happens. You sell off your productive assets to finance property speculation.

With the RBA lowering interest rates, state governments withholding land supply and a tax structure incentivising property speculation, building ‘wealth’ through property looks like a genius move for a lot longer than it really should.

But the madness will eventually end. Perhaps the realisation of what’s coming in the iron ore market is the beginning of the end for property.

Greg Canavan+,
for The Daily Reckoning Australia

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Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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2 Comments on "The Beginning of the End for Iron Ore…"

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slewie the pi-rat
slewie the pi-rat
1 year 6 months ago

perhaps the West is going from a “production-service-governance” economic engine
to a “GOVERNANCE-service-production” design.

MIT is the NASCAR of moolah: they can show the banksters how to cheat on anything, and even swap paint with the Rooskie car {#V} coming out of the Sanctions curve and into the Grandstand straight-away.

plus! they are EXPECTED to blow up every engine they test.

1 year 6 months ago
with the end of the iron ore boom and the profits after production at a worrying point, with employers cutting costs like staff etc. I think we’ll have to forget about mining saving us from any future decline in our living standards. People aren’t going to buy houses when we’re in a recession. so we’ll have a big housing bust, and it’ll ripple through families, the cost of food will increase, jobs will be few and far between, blended families will become several to one house. It stands to reason with Global blending the standard of living will have to… Read more »
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