Rising Energy Prices Could Bust Australia’s Resources Boom

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The resource boom gets more complicated this week. We know demand is strong. So strong, in fact, that some analysts are now suggesting BHP (ASX:BHP) may rise by as much as 40% as the market re-evaluates the strength of the cycle. But there’s a new wrinkle to the story. Are rising energy costs and actual energy scarcity going to derail the boom before it kicks into an even higher gear?

“One of the great failings of modern so-called ‘economics,’” writes our colleague Byron King in the States, “is its essential dismissal of the material-energy limits of the physical world. OK, in a micro-sense a small number of individuals and firms can disregard the concept of limits. Even at the macro-level, you can also disregard material limits for a while because the world is a big place. Big, but not infinite.”

Energy is its own kind of capital in the modern world. Money is cheap. And although labour is getting more expensive in the mining industry, strong cash flows mean rising wages aren’t going to bust the boom. But energy might.

A scintillating report from the Economic Regulation Authority in Western Australia titled “Discussion Paper: Gas Issues in Western Australia” laid out all of the industry’s energy concerns. The issue is simple: supplies are tight and costs are rising.

After surveying up-stream suppliers and downstream users (retail and industry), the report summarises the major issues. “These concerns were that the gas supply market is very tight and that gas supply contracts are difficult to secure and that long term contracts are no longer available.

In some cases, companies noted that they have been unable to obtain gas supply contracts because the gas producers are not interested in small contracts. If users or energy retailers cannot obtain appropriate gas supplies from gas producers then the ability to develop a competitive market for gas is significantly impeded.”

What does it mean when “a competitive market for gas is significantly impeded”? It means gas – the preferred, relatively clean-burning fuel of choice for future mining projects – will be neither cheap nor abundant.

The cost of energy changes the economics of a project. Many mining upstarts in WA have been lured into projects that were uneconomic at lower commodity prices. Do those projects return to “uneconomic” status with higher energy prices, even if you assume commodity prices will stay high? Hmm.

More from the report. “It appears that the supply of gas to the Western Australian market is likely to depend largely on NWSG (North West Shelf Gas) for the next few years, until additional gas fields are discovered, and brought to production.”

And just how soon will new and cheap gas be brought into production? Not as soon as everyone thought. “Three known potential new sources of gas which may come into the WA market at some stage in the future are the Macedon, Gorgon and Pluto gas fields. However, there is no definitive domestic gas production development timetable for these projects.”

There is a timetable. It’s just not going to make a difference any time soon. “Gorgon’s construction timetable is uncertain with recent approval delays and cost blowouts affecting the planning for this project. It is doubtful that the earliest timeframe for domestic gas production of end 2012, as outlined in the State Agreement (and subject to a positive economic evaluation by Gorgon in 2010), is now achievable.”

Uh oh.

What does it all mean? “There could be potential problems looming in the supply of domestic gas to the WA market at various periods over the next five to seven years.”

Who wins and who loses in this scenario? Well, cashed-up big mining companies with long-term energy contracts should be okay. The trouble is gas suppliers are entering shorter contracts which give them more upside to the rising gas price. This squeezes out all but the biggest players. It leaves the big boys with the energy and capital to undertake projects…even if they don’t have the land. The land can be acquired. So watch for the land grab.

On the energy side of the equation, it’s possible to replace natural gas with coal. It’s just that coal is, well, so unpopular these days. It’s dirty. It’s old fashioned. It’s killing the planet, we are told. We don’t expect a boom in coal-fired power. But we wouldn’t be surprised to see a consolidation in coal stocks as coal assets enjoy a new-found appeal.

Nuclear? Well sure, it makes sense as a long-term solution to industrial power needs. But nuclear power is years away from making any meaningful contribution to current economic needs, and that’s assuming lame-brained politicians ever move forward with it.

Dan Denning
The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Big Gav
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Just a thought – if nuclear power is so great then why do politicians need to do anything to make it move forward ?

Doesn’t the market sitting on its hands (or actively mocking the idea, in AGL’s case) tell us all we need to know about the economic viability of nuclear in Australia, without any political meddling in the form of attempting to pick the “correct” solution ?

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