abare.gov.au - Australian commodities – September quarter . volume 15 . number 3 2008

Minerals and Energy overview

Kate Penney

Prices for energy and mineral commodities are forecast to remain relatively high being supported by continued demand growth and supply-side constraints.

Seasonal declines in demand were witnessed during the September quarter. However, short to medium-term prospects remain positive.

The depreciation of the Australian dollar will support increased earnings from energy and mineral commodities.

Australian export earnings from energy and mineral commodities are forecast to increase by 53 per cent to $180 billion in 2008-09 because of high prices, especially for bulk commodities, and increased export volumes.

Outlook for commodities remains positive

The short-term prospects for energy and mineral commodities remain positive. While prices for a number of energy and mineral commodities have recently declined, prices generally remain well above long-term averages. For example, in August 2008, average copper prices declined by 9 per cent from July to average $7635 a tonne. Despite the fall, prices are still more than 50 per cent higher than the long-term average of around US$4900 a tonne (in 2008 dollars).

The decline in energy and mineral commodity prices reflected weaker demand growth associated with a slowdown in global economic growth. Partially offsetting these downward pressures, commodity prices were supported by an increase in investment demand in the first half of 2008. Investors purchased commodities such as gold, oil and copper to hedge against a falling US dollar. However, the US dollar has recently appreciated against major currencies and investment demand for commodities has since weakened. This has resulted in a significant decline in prices for a number of commodities including oil over the past few months.

In contrast, contract prices for bulk commodities, including coal and iron ore, have reached record levels. Contract negotiations for the Japanese financial year 2008-09 ( April 2008 to March 2009) resulted in prices for iron ore, and metallurgical and thermal coal increasing by
85 per cent, 200 per cent and 125 per cent, respectively.

Demand in emerging economies to remain robust

Demand for energy and mineral commodities will continue to be underpinned by economic growth in emerging economies. However, the duration and extent of the assumed global economic slowdown and the period of instability associated with global credit markets present risks to energy and minerals demand over the next 15 months.

Economic growth in western Europe and the United States is assumed to moderate over the remainder of 2008 before recovering in late 2009. Growth in mineral commodity demand in these economies will move with changes in economic growth. Growth in emerging market economies, particularly China, is expected to remain robust. The majority of the demand for minerals in these economies is stemming from rising domestic demand as a result of industrialisation and urbanisation rather than from export markets.

Because of summer holidays in the northern hemisphere, metals consumption is seasonally low during the September quarter. During this period, metal users tend to draw down stocks or close for maintenance, and there is less investment activity.

Energy consumption in the OECD was lower during the first half of 2008 reflecting weaker economic growth and higher energy prices, particularly for oil. Despite lower assumed economic growth for 2008 and 2009, non-OECD demand for energy commodities will continue to be bolstered by rising demand for electricity in emerging economies. Coal remains an important source of new electricity generation capacity because of its low cost, reliability of supply and the wide geographic spread of coal producers. China’s power generating capacity is highly dependent on coal, which accounted for around 77 per cent of generating capacity in 2007.

Supply continues to be constrained

Global supply for most commodities continues to be adversely affected by difficulties in sourcing skilled labour, long lead times for key items of equipment, rising costs and the development of projects in locations with greater sovereign risk.

Competition for resources has increased the costs of a number of key inputs. For example, according to Rio Tinto, the cost of tyres at their Australian operations increased by 19 per cent in the first half of 2008, while heavy mobile equipment and ammonium nitrate increased by 6 per cent. Increasing costs of inputs, combined with lower prices for some commodities, have reduced the profit margins of companies. As a result, a number of companies have been forced to reduce output or cease operations. For example, Perilya announced in August it will significantly reduce production and, hence, the cost of operation of its Broken Hill zinc, lead and silver mine in New South Wales. This has resulted in the company reducing its workforce by 440 people.

Another supply-side constraint is the availability of sufficient power. For example, power shortages in China have affected production of a number of commodities, including aluminium and zinc. Power rationing has been introduced in nearly half of China’s provinces and industrial users are experiencing regular power outages.

Australia’s earnings from energy and minerals to increase in 2008-09

Offsetting the decline in prices for some commodities in the past few months, the recent depreciation of the Australian dollar limited the effect on resource export earnings. Most energy and mineral commodities are traded in US dollar terms. As such, Australian dollar denominated commodity prices are higher when the Australian dollar is weaker, all else being equal. For example, the average price of lead declined by around 1 per cent in US dollar terms between July and August, but increased by 8 per cent in Australian dollar terms.

In 2008-09, mine production in Australia is forecast to increase by 7 per cent as new mines commence operation and recently commissioned projects approach full capacity. The largest expansions to production are forecast to occur in iron ore, copper and coal.

Reflecting increased production and robust demand in major export markets, Australian export volumes are forecast to increase significantly in 2008-09. Strong export prices and higher export volumes are forecast to result in Australia’s export earnings for energy and mineral commodities rising by 53 per cent to $180 billion in 2008-09.

Driving much of the growth in export earnings are iron ore and coal. Rising export volumes and high export prices have increased Australia’s export earnings from these commodities. Earnings from iron ore, coal, oil and LNG are forecast to account for 98 per cent of the growth in total energy and mineral export earnings as higher earnings from these commodities mostly offset lower earnings from uranium, nickel and zinc.