For the past couple of decades the Chinese economy embodied a Dragon. Powerful. Strong. Aggressive. But recently there’s been a shift from building physical infrastructure to a consumption-based economy and this has major implications for Australia’s resources sector.
In 40 years, economic growth has seen China lift the standard of living for large parts of its 1.3 billion population. In the late 70s, 85% of the Chinese population was living in rural poverty. Now it is less than 30%. This level of growth is akin to western society’s industrial revolution and has spawned one of the largest middle class populations in the world.
China’s “open door policy” in the 15 years from 1990 brought with it an average economic growth rate (as measured by GDP) of 8.7%p.a., dwarfing the USA’s 1.8% p.a. Large amounts of money were spent building physical infrastructure by the Chinese state owned enterprises and entrepreneurs alike. The Beijing Olympics and other programs lifted growth over the last 10 years to an even higher 9.4% p.a. However, many analysts now argue that the dragon has gone to sleep, with growth forecasts under 7%.
Building houses, cities, roads and rail not only required labour, but also lots of steel. Steel, in turn requires iron ore & coking coal; something Australia has vast deposits of.
Australia’s close proximity to China and its large iron ore deposits meant we were in a prime position to satisfy China’s insatiable demand. The bulks (iron ore and coal) became our largest exports, with iron ore as number 1. Australia along with Brazil account for more than 3/4s of the world’s iron ore exports. Therefore it is easy to see why a tired dragon is triggering the sharp decline in iron ore prices.
Has the Dragon had its last dance?
The Chinese slowdown can be attributed to a myriad of factors, such as an oversupply of property, large amounts of unsustainable speculative investment and growth in public and private debt. The two year old Chinese government has been keen to stamp out corruption between its officials and property developers, as well as limiting the problem of speculative investment. This is not an arrow to the heart of the dragon, rather a shifting from an investment/building economy to a more sustainable consumption based economy where market forces determine what should be built, rather than the bureaucracy.
This means that China is shifting away building physical infrastructure, and therefore has less demand for steel and iron ore.
The Ore view
The low iron ore price is putting pressure on miners to find solutions. Two of the top 3 producers in the world are Australia’s BHP & RIO (Brazil’s Vale is the third). They are the most efficient, with massive deposits, quality operations and cash costs of around $20 US/t. Compare this to Fortescue’s $46 US/T.
BHP & RIO’s solution to the weakened price is to produce more. Fortescue’s Twiggy Forrest suggested another; a limit on production to stabilise the price. Sounds like a cartel? This suggestion has been met with significant resistance from politicians, members of the Chinese business community as well as other Australian iron ore miners. Aside from the opposition, a cartel arrangement might not necessarily work. Gina Reinhart argued that overseas producers would fill the hole left in Australian production. When looking at existing cartels… OPEC (the oil producer’s cartel) has failed miserably in trying to stabilize the oil price, with non members Russia and the USA shale producers adding supply.
The dragon is having a breather, and it might be time for the Australian economy to do a bit of restructuring itself.
