World Mining Exploration News

Stevens says terms of trade set to fall

JUST by exporting as usual, Australia has been showered with money from sharply higher prices for commodities such as iron ore and coal. That’s been the easy part of the resources boom.

From now, we can’t rely on export prices going higher. Most of the extra gains from the resources boom will have to come from digging up more and shipping it offshore. Rather than price, the action will need to come on volume.

That’s the bottom line from Reserve Bank governor Glenn Stevens, who this week suggested that Australia’s terms of trade was peaking and even set to fall a bit after “five phenomenal years”. Even though this would still leave the terms of trade at nose-bleed heights, it marks a new phase of the resources boom.

The “terms of trade” has been the economic term of this decade, much like “low inflation targeting” in the 1990s, the “current account deficit” in the 1980s and “stagflation” in the 1970s.

If the rest of the world suddenly starts paying more for what Australia exports, then our terms of trade rises. The same improvement comes if the rest of the world starts charging less for what it sells us.

Both the numerator (export prices) and denominator (import prices) have worked spectacularly in Australia’s favour in the past five years. Prices for iron ore, coal, copper, gas and so on have soared because of the unexpected surge in demand from China’s industrialisation. In turn, China’s factories have churned out cheaper electronic goods, clothes and toys imported by Australia. One hundred tonnes of iron ore exported from Australia today can buy at least four times the amount of foreign-made computers or big-screen TVs than five years ago. The terms of trade has strengthened for Australia. Conversely it has weakened for China.

Expressed as an index, Australia’s terms of trade has strengthened by 60 per cent over the past five years, by 15 per cent over the past year and by 13 per cent in the latest June quarter alone. It’s the biggest export price bonanza since at least the early 1950s Korean War boom and perhaps the nation’s biggest overall resources boom ever.

That has injected billions of extra dollars into the economy, showing up in higher company profits, jobs, government revenue and tax cuts. The federal Treasury estimated in the May budget that nominal gross domestic product this year would be 9 per cent, or $100 billion, higher than if the terms of trade had not increased over the past five years. That includes an extra 200,000 jobs. The cumulative GDP gain over the half decade is $260 billion.

But Stevens this week reaffirmed the Reserve Bank’s forecast that the terms of trade has peaked and will fall by 5 per cent in the coming year. Prices for base metals such as nickel and zinc have been falling for a year or more. This peaking reflects less urgent demand from China, where economic growth is coming off the boil as its exports to the US and Europe slow. Market speculators are selling out. And real-world supply is responding to the demand signal from higher commodity prices.

In turn, this sign that we’re looking over the other side of the terms of trade mountain has sparked the sharp sell off in the Australian dollar, which slid from close to parity with the greenback to US80c in less than two months.

This will cushion the impact of lower commodity prices but does not change the need for volumes to drive the story from now.

So far, Australian output of minerals and energy has increased only modestly in response. The Australian Bureau of Agricultural and Resource Economics this week reported that the volume of mineral output actually fell slightly in 2007-08, even though a 25 per cent increase in prices meant that overall export revenue jumped 11 per cent to $116 billion. The biggest increases were in higher iron ore production by BHP Billiton, Rio Tinto and new entrant Fortescue. Gold output fell and coal was flat.

Now we’re waiting for the huge expansion in business capacity now under way, particularly by mining companies, to ratchet up output and exports to markedly higher levels.

The Australian Bureau of Statistics provides regular readings of planned business new fixed capital expenditure for each financial year. The July-August “capex” survey was the third of what will end up being seven such readings for 2008-09. Analysts use “realisation ratios” to convert stated plans with what businesses actually end up spending.

On the average realisation ratio for the past five years, the July-August plans for mining capital expenditure would produce a stunning $16.6 billion nominal rise to $43.9 billion.

ABARE’s latest list of 97 advanced resource projects adds up to $70.4 billion in capex spending. These include Woodside’s $12 billion Pluto LNG project, located offshore in Western Australia’s North West Shelf, which will produce an annual 4.3 million tonnes of liquefied natural gas for the Japanese market. Rio is behind the biggest coal mine development, the $1.1 billion Kestrel project in Queensland, which will produce 12.2 million tonnes of thermal coal a year.

Then there’s the new boom in coal seam methane, with Queensland Gas Co and Britain’s BG Group proposing to spend $8 billion on a 3-4 million tonne LNG plant and associated 380km pipeline, again to supply the Asian market.

And there’s a long list of iron ore, copper, gold, petroleum, aluminium smelting and port developments, mostly in WA.

“The resource sector has had capacity constraints because nobody predicted the extent to which demand from China and so on would pick up,” the Reserve Bank’s Stevens said this week in explaining how export volume growth was set to take over as the terms of trade softens.

“That is why the resource prices went so high — because there was not enough capacity anywhere. They have a lot of investment coming on stream … We will see a pick-up in resource export volumes.”