What projects are going to be "economic" in the energy and resources sector for the next ten years? The answer to that question depends on your forecasts for energy and metals prices. That's a function of demand (from China and India) and supply (which includes issues like political risk and peak oil production.)
High energy and metals prices make many projects commercially viable and therefore of interest to investors. It's also worth looking at substitutes. Many of these newly commercially viable products or substitutes can be found in smaller Australian resource and energy stocks.
Take Fortescue (ASX:FMG) as an example, although it's rapidly becoming a very large Australian stock. High prices for iron ore are making previously un-economic grades of iron ore worth pursuing. The high-grade iron ore of the Pilbara is the hematite. On the surface, hematite is the rust colored ore that's already 70% iron. Just below hematite is magnetite, about 72% iron. The lowest grade iron ore is taconite, which is 30% iron ore and takes some upgrading to be useful in producing steel.
We wouldn't normally indulge in a reading from the book of iron ore. But just as tight global energy supplies have forced more careful analysis of the economics of energy exploration and development projects, so too is the "longer and stronger" resource boom forcing analysts to reconsider what ore bodies can be developed at a profit in the next ten years. This takes a little better understanding of the geology and geography of Western Australia, hence our indulgence.
Fortescue is dealing with two main issues: lower-grade ores and further distance to the infrastructure for transporting the ore to a port, where it can be shipped off to China to build the empire of the Middle Kingdom. Ten years ago, those issues would be business killers. In a normal commodity cycle, you'd expect high prices to reduce demand. You wouldn't make multi- billion dollar plans, then, based on what you thought was just a cyclical upturn in prices.
Only this cycle is not an ordinary cycle. It's not a motorcycle, a unicycle, or a tricycle either. It's a super cycle! China doesn't seem to care where the iron ore comes from or how long it took to get there, as long as it gets it. And what that means is that the demand for resources is forcing a fundamental rethink of the economics of resource projects AND the valuations on resource stocks.
Now that we have actually typed such vaguely new-era sounding stuff, it wouldn't surprise is if global financial markets collapse next week when private equity firm Blackstone goes public in New York. That's the danger of getting caught up in any new era. Once even the hard core skeptics accept the new gospel - and the lot here at the Old Hat Factory are pretty skeptical - the top must surely be in.
Still, we think it's a scarcity issue as much as it is a demand issue. All the low hanging fruit in the energy and raw materials sectors has been picked in the last 100 years. High grade ore bodies are being exhausted faster than they can be found, just as the White Elephant oil fields face declining production...while no new ones are being discovered at all.
Dan Denning
The Daily Reckoning Australia
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About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.
