We can deal with reduced resources exports [opinion]

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The global energy and resources sector is under enormous strain. The Australian Index of Bulk Commodities Prices has fallen more than 20 per cent in the past 12 months. Oil has gone from a peak of $US140 a barrel in 2008 to about $US30 a barrel today, having fallen nearly 20 per cent in the first weeks of 2016.

This downward spiral in prices has led to increased pressure on company balance sheets, leading to significant share price corrections and job losses. Some of our blue-chip resources stocks, core holdings for millions of Australians in their retirement accounts, were down more than 30 per cent over the last year and major multi­nationals such as miner Anglo American are seeking to reduce their global headcount by up to 85,000.

The reasons for these significant falls in resource prices are a complex combination of supply and demand dynamics that differ to some extent according to the commodity in question. For Australia, two of the most important developments have ­occurred around iron ore and oil. Iron ore is Australia’s No 1 export, producing $66 billion worth of ­export income in 2014, and oil is an important benchmark for the price of LNG, Australia’s third-largest resource export, earning $18bn worth of ­export income in 2014. Australian LNG exports are estimated to reach $49bn in 2020, when we overtake Qatar as the world’s largest LNG exporter.

In the case of iron ore, strong global demand has been led by China. Just a few years ago, its ­demand for iron ore was growing at 19 per cent a year, with China representing 50 per cent of the global market. Iron ore prices reacted accordingly, increasing from less than $US20 a tonne to a peak of more than $US180 in the decade to 2011. With China building thousands of skyscrapers, more than 10,000 kilometres of high-speed rail links and producing 14 million vehicles a year, there was a huge demand for iron ore to meet the needs of this remarkable industrial transformation. Conscious of the oppor­tunities, the biggest producers of iron ore, BHP, Rio and Vale, made record investments in their supply chains, ­increasing their production from 581 million tonnes in 2009 to 870 million tonnes by 2014. Major projects under­taken by Andrew Forrest’s Fortescue and Gina Rinehart’s Roy Hill have also come online.

At the same time as higher volumes were hitting the market following these large-scale increases in production, the Chinese economy was transitioning from ­investment to consumption and more sustainable levels of growth.

The pricing of oil has also been dramatically affected by changes in the supply and demand dyna­mic. In 2008 when the oil price hit its peak, global demand for oil was less than it is today. What has changed is supply. The United States has gone from being a net importer of oil to an exporter, ­increasing its oil exports sevenfold over the past three years and having its first LNG cargo ready for export. This is the net effect of the shale gas revolution that has seen thousands of wells drilled in the US over recent years.

The largest producer of oil, Saudi Arabia, has also expanded production by more than 5 per cent this year alone. With an estimated 260 billion barrels of ­reserves and a production cost well of less than $20 a barrel, the Saudis’ ability to drive the higher cost producers in Venezuela, Russia and Iran into the red is real. Add to the mix the geostrategic motive as seen from Riyadh and one can better understand why many commentators believe lower oil prices are here to stay.

So one can be forgiven for thinking it’s not a pretty picture. Lower iron ore, oil and other commodity prices such as coal, copper, nickel and lead have all had an ­impact on export earnings, share prices and employ­ment. But it won’t always be thus. History tells us the commodity cycle moves in peaks and troughs and often there is a major investment in production at times of high demand that leads to price corrections like the ones we have recently seen.

Price volatility is simply part and parcel of the history of the ­resource sector, but most impor­tantly the long-term fundamentals of the sector remain strong.

The combination of global production growth, rising middle classes and rapid urbanisation will require a greater demand for our energy and resources in this decade and beyond. That is why the International Energy Agency estimates that global energy demand will increase by a third between now and 2040, and the US Energy Information Administration says “we are in one of these likely dips that go below what replacement costs really are so we will see a ­recovery”, predicting the oil price to reach close to $US50 next year. And in the iron ore space, these positive global trends have led senior figures like Andrew Harding, Rio Tinto’s chief executive of iron ore, to suggest that emerging markets will drive demand for iron ore, with non-Chinese demand for steel, particularly from ASEAN and India, to be 65 per cent greater in 2030 than it is today.

India is a fascinating story. With nearly 1.3 billion people, its per capita steel consumption is 27 per cent of the global average and just a fraction of that of China. In 2014 China’s steel consumption was 530kg a person, whereas India’s was just 60kg. With plans to triple domestic steel production by 2025, the Modi government is preparing India for rapid urbanisation and domestic growth. This creates great opportunities for Australia to not only export iron ore to India but to supply China whose large-scale integrated steel mills are increasingly exporting to emerging new markets, including Vietnam and India. In the first half of 2015, Chinese steel exports were up 27 per cent with a 70 per cent ­increase to Vietnam and a 62 per cent rise to India. It is this focus in China on the steel export market that has led in part to China buying a record 96.3 million tonnes of iron ore last month. Prices may be down, but volumes are up.

Of all the major resource ­exporting countries, Australia is best placed to capi­talise on future demand. We are viewed as a reli­able, high-quality supplier that is highly innovative, efficient and proximate to key markets. A good example is that Vale has traditionally taken more than 40 days to ship iron ore to China compared with just nine days from Australia.

Australian household names Rio, BHP and Fortescue are leading the world in new technology, operating trucks, trains and drilling equipment at their Pilbara mines remotely from their hi-tech operations centres in Perth, 1500km away. Australians would be proud to know, just as I was, that 60 per cent of the world’s mining software is written here in Australia, and that one in 10 dollars of all business R&D spent in Australia is undertaken by the resources ­sector. The relative size and dominant global market positions that many of our resource producers have built sees them enjoy economies of scale that allow them to weather low points in the pricing cycle. In fact, when it comes to iron ore, more than three quarters of Australia’s production is in the bottom half of the global cost curve. A falling Australian dollar and lower ­energy input costs also help to strengthen our global ­competitiveness.

Australia is also opening up new markets and reducing bar­riers to existing markets through free trade agreements. For example, the China-Australia FTA eliminates the tariffs of 3 per cent and 6 per cent on coking coal and thermal coal respectively. A free trade deal with India also has the potential to reduce tariffs on the export of resources.

The Coalition is committed to cutting the cost of doing business in Australia for resource com­panies with reforms to deregulation, tax, industrial relations and infrastructure all having an ­impact. A standout is the one-stop shop for environmental approvals, helping to streamline federal and state processes and saving companies up to $546m a year.

These and other reforms are important if we are to maintain a strong pipeline of resource investments in the future. It must be understood that despite the challenging global environment, there are still more than $400bn worth of resource investments in Australia that are at the committed or feasibility stage. In just the past two months, Rio Tinto announced a $2.6bn expansion of its Amrun bauxite project in Queensland and Woodside and its partners ­announced a $2.75bn expansion of its North West Shelf project. These two projects alone will create thousands of jobs.

It’s not just Australian com­panies that are at the forefront of global energy and resources markets, it’s Australians who are playing a lead role. Late last year I met with chief executives of Rio, Glencore and Anglo American, all of whom are Australian. Despite the challenges they face, they empha­sised the ­resilience of the local ­resource sector, and pointed out just how impor­tant resources are to the global economy. One CEO made the point that market valuations are out of synch with reality. He said the combined market capitalisation of the five biggest ­resource companies in the world, responsible for a significant proportion of the world’s iron ore, coal, copper and aluminium supply, is less than a third of the market capitalisation of Google. If these companies weren’t in exis­tence, so much of the transport, housing, communications and power infrastructure that we take for granted would simply not exist. But on the other hand, we can ­always find another search engine.

Resources are indispensable to global growth and global progress, and in the words of my department’s chief economist, “the outlook for the Australian resources sector is largely positive”.

Despite the turbulence in today’s markets, volumes are up, prices will invari­ably rebound over time and investment continues ­albeit at a slower pace. What is more, Australia is an innovative global leader in the ­resources and energy industry, with the product, the people and the proximity to growing markets that leaves it well positioned to capture the opportunities that lie ahead.