12/03/2013 - 09:13

Analysis: budget hole from iron ore fall

12/03/2013 - 09:13

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It’s a good thing for the re-elected state government that the property market is rising, because without an increase in stamp duty from extra house sales, the state budget could develop a large hole from falling iron ore royalties.

With luck, one will cancel out the other but if the surge in property demand peters out later in the year there is the potential for a nasty squeeze on state revenue.

No-one was considering that possibility when voting for the return of a coalition government which undoubtedly deserved an extra four years to continue what it started.

But, the question which will become important in the next few months is whether the government will be able to pay for promises made as the price-boom phase of the commodity cycle comes to an end and WA discovers how hard it is to encourage investment when you’re the most expensive destination in the world.

A glimpse of what lies ahead could be seen in the iron ore market last night when the price of premium ore (62 per cent iron) fell to $US144 a tonne, its lowest level this year and taking the price slide over the past four-weeks to around 9 per cent.

All iron ore miners should be profitable at last night’s price, though what will have their management teams worried is the flood of recent forecasts that the long-predicted slide back to a price of less than $US100 a tonne has started.

If the price predictions are correct, and some of the gloomiest come from people who ought to know what they’re talking about, then the outlook for high cost mines, and for companies planning to start new mines, is not encouraging.

The iron ore price tip which will have reverberated loudest in State Treasury was one attributed to a man in the best position to know what he’s talking about, Vivek Tulpule, chief economist of Rio Tinto, the biggest of WA’s iron ore miners.

According to reports of what Tulpule told investment analysts in Sydney last week the iron ore price has started a slide from $US150 a tonne to “about $US100 a tonne”.

It is possible that Tulpule is doing his master’s bidding, trying to talk down expectations in the banking community about the iron ore price just as at least one potentially major new player prepares to enter the business.

Gina Rinehart is that likely new Pilbara producer, but only if conditions are right and that means a strong iron ore price and willing bankers and partners in her Roy Hill development with its $10 billion price tag.

If Tulpule’s $US100 a tonne forecast didn’t catch the eye of bankers to Roy Hill then some of the other price forecasts floating around last week will have, including one from a serial gloom-spreader, Andy Xie, who reckons the price could briefly dip below $US60 a tonne before settling at around $US80 a tonne.

If Xie’s credentials did not include a stint as chief Asia economist for the big U.S. investment bank, Morgan Stanley, then it might be easy to say his $US80 a tonne is just one man’s best guess.

But, to do that you also have to dismiss an forecast of $US88 a tonne from another investment bank, Goldman Sachs and the “subdued outlook” for steel demand in China from the chief executive of that country’s biggest steel maker, Baosteel.

It is possible, as with Tulpule, to argue that He Wenbo from Baosteel was “talking his book” when forecasting that steel demand in China will rise by just 3% this year.

Where the forecasting issue becomes serious is when you lump Tulpule, He, Xie and Goldman together to arrive at a view of the iron ore market for the next few years which is definitely negative, and not just for the state Government which relies heavily on iron ore royalties but also for the Australian Government which continues to assume that its Mineral Resources Rent Tax will one day be a winner.

Investors have also been slow to react to the gloomy price forecasts with the share prices of most producers holding up reasonable well even though a sub-$US100 a tonne price for 62 per cent ore means that some of them will be getting $US80 a tonne, or less, after discounts for the iron content and impurities in their ore.

State Treasury officials will probably be more alert than the average investor to the potential danger of a sustained fall in the iron ore price to less than $US100 a tonne.

Whether the officials have alerted their re-elected political masters to the dangers of a hole appearing in the state’s budget is another question though last night’s price slide to a 10-week low should have rung a warning bell.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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