Australia’s terms of trade are 65 per cent above the average twentieth-century level and 85 per cent above the trend seen in the twentieth century, had that continued. As a result, Australian gross domestic product in nominal terms is about 13 per cent higher than it would have been without these relative price changes.
What goes up, of course, must also come down. A gigantic global supply response to booming resource prices is already under way.
Take the case of iron ore, Australia’s largest export commodity, the price of which leapt from just over $12.68 per tonne in 2001 to $187.18 per tonne in February 2011. Forecasts for growth of Chinese iron ore demand (and India’s attempt to switch from exporting iron ore to supplying growing domestic demand from its own steel industry) have led to a scramble to expand and capitalise on current high prices. Suppliers all around the world are trying to cash in on these high ore prices. The established suppliers in Australia and Brazil have big expansion plans just to keep up with continuing growth in the demand from China’s steel mills, and new suppliers are now scrambling to enter the market.
The big new entrant in global iron ore supply is Africa. Africa has reserves of high-quality iron ore that are estimated to match those in Australia. Over 200 iron ore projects are being contemplated across the African continent.
In the past Africa has not been a significant competitor in the iron ore market. African projects typically require huge infrastructure investments to bring them to market. Western banks have been reluctant to finance these project because of high political and economic risks in most African countries. That, it seems, is all about to change significantly. For one thing, much of Africa has been doing better in economic terms over the past decade. For another, Chinese capital is willing to take the risks in Africa.
In this week’s lead essay Luke Hurst reviews 17 key iron projects across West and Central Africa and provides new estimates of additional iron ore export capacity that are likely to come on stream by 2018.
By 2018, Hurst calculates, China is expected to increase its demand at a steady but slowing rate as its growth becomes less resource intensive. Australia’s Bureau of Resources and Energy Economics (BREE) forecasts that Chinese iron ore demand will grow 2.8 per cent per annum through to 2018. Other estimates, from the Raw Materials Group, put growth at 3.8 per cent per annum, a percentage point higher than BREE’s projection. Hurst compares global import demand on the higher Chinese demand forecasts with projected global export capacity, including new African capacity five years out, to assess what the impact of new supplies might be on iron ore prices over this period.
Hurst examines projects according to the risk of their falling over — identifying capacity that is very likely to come on stream according to schedule, capacity that has a fair chance, and capacity that is less likely to be operational in the next five years. Hurst’s analysis suggests that Africa will begin to put pressure on prices in the next three to five years. He reckons that iron ore prices are likely to fall back to around $80 per tonne quickly. If more of the planned African capacity comes on stream prices could tumble to $60 per tonne in the next five years.
A price fall of this magnitude, Hurst points out, would still provide intra-marginal producers with healthy profits but it would have serious knock-on effects for the iron ore exporters and their investments in countries such as Australia and Brazil. For one thing it would dry up internally generated investment capital in the major iron ore firms. Iron ore is expected to represent 2.6 per cent of Australia’s GDP in 2011-12, and a drop in iron prices would affect Australia’s terms of trade, exchange rate and income. The falling price would especially constrain the development of Australia’s budding magnetite industry.
In short, any fall in the price of iron ore such as Hurst foreshadows would have significant knock-on effects for the iron ore-centric economies of Australia and Brazil.
Despite the expectation of strong Chinese demand for iron and other resources for some years, the exceptionally tight commodity markets and high resource prices in the past decade seem very likely to ease over the next half decade as supply responds in global markets to the investment opportunities that high prices have generated.
These outcomes are the result of the response in incredibly tight global markets to bringing on stream new sources of international iron ore supply to service the boom in Chinese demand. They take no account of an unanticipated dip in Chinese demand, which in this analysis is assumed to continue to grow steadily.
Nobody has long-term monopoly in resource markets, neither sellers nor buyers. Discouraged from investment in Australia, there’s no question that Chinese and other investment (including by the majors) has gone to Africa and elsewhere to fill the gap, as the Japanese went to Brazil to fill the Australian gap more than thirty years ago.
Peter Drysdale is Editor of the East Asia Forum.