The production phase of the resources boom is likely to put upward pressure on the dollar and therefore the manufacturing sector.
It sounds a little contradictory to talk about a ‘silent boom’, but if you look at the latest developments in the Australian economy there is fresh evidence of the resources boom shifting from its construction phase into something far more important – the production phase.
The shift from sinking hundreds of billions of dollars into new mines and gasfields into producing more minerals and gas is starting to have its inevitable impact on the country, especially in those states that allow their resources to be developed.
What it means is that the resources boom (of the mark II, production variety) will:
• further widen the gap between Australia’s resource states and its manufacturing states;
• put additional upward (not downward) pressure on the Australian dollar by flipping Australia from a long-term trade deficit into a trade surplus; and
• enshrine Australia’s high domestic costs structures, which could jeopardise future resource developments.
The major difference between the construction and production phases are those of time, cash flows and tax revenue.
During the construction boom of 2003 to 20011 the Australian economy, and those of Western Australia and Queensland in particular, was stretched to the limit, with high demand and poor supply of everything from skilled labour to industrial equipment forcing costs up.
Some costs have declined as the construction boom has faded, but not all. As a result, Australia is in for a fresh outbreak of cost inflation driven this time by a surge in gas exports, which have the potential to make the country even more of a quarry to supply fast-growing Asian markets.
The production boom is disturbing news for the manufacturing states of Victoria, NSW and South Australia – though it could be argued that they ought to have seen it coming.
For WA, Queensland and the Northern Territory the production boom means most future high-value jobs will be created in their resources and resources-services sectors.
Two items of evidence have coincided to support the production boom thesis, which has been explored in this column several times in the past.
First was news that the Australian economy grew faster in the December quarter than most economists had expected. The 2.8 per cent annual rate of expansion is modest by recent standards, but it means that the country has now posted 23 years of continuous expansion – which might not be a world record but it’s not far off.
WA’s performance in the December quarter was sluggish compared with the growth rates during the construction boom, but the first hints of the production boom were seen coming through with exports up by 1.2 in the quarter, meaning that the annual increase in exports was an eye-popping 7.4 per cent, compared with a national 2.4 per cent increase in exports.
The second item was initially portrayed as bad news, but with a good news core. It involved a report that Australia’s oil output had dropped to a 40-year low in 2013 – but that spending on new gas projects hit an all-time high.
The construction versus production analogy is captured in the oil sector data from the Adelaide-based research business EnergyQuest, as is the likely impact of exports on Australia’s trade figures.
According to EnergyQuest, and other research firms, the impending surge of gas exports is likely to turn a petroleum trade deficit valued at $14.1 billion into a petroleum trade surplus.
“Assuming current LNG prices, EnergyQuest estimates that the growth in LNG production will increase the value of LNG exports from $14.7 billion in 2012-13 to $57 billion by 2018, similar to the current value of Australia’s number one export, iron ore,” the research firm said.
Given that a large proportion of LNG will come from WA, its inclusion alongside iron ore will cement the state as Australia’s primary source of international revenue – and primary cause of the dollar rising, which could further damage manufacturing.
The airline business, to most Australians, seems like a good way to lose money, given the domestic price war between Qantas and Virgin and the struggle confronting Qantas to retain passengers on its international routes.
Look north and there’s an airline performing exceptionally well as it streamlines its structure and rides the China boom with assurance.
Cathay Pacific, a regular at Perth International Airport, has just enjoyed strong growth in its passenger business during the second half of 2013, is expanding its freight business, and by the time this column is published should have reported a big profit boost for last year.
In financial terms the difference between Hong Kong-based Cathay Pacific and Qantas could not be greater, with one airline winning investment ‘buy’ tips from investment banks and the other teetering on the brink of a financial crisis as it desperately seeks a helping hand from the Australian government.
The strength of Cathay Pacific’s performance was underlined last week in a research report from the US investment bank Merrill Lynch.
It told clients that Cathay Pacific was the most exposed Asian airline to improving long-haul and premium passenger and cargo volumes.
After reporting what is expected to be a strong result for 2012, “we see earnings almost doubling again in 2014.”
Why Qantas has been unable to catch the same rising tide of business that has lifted Cathay Pacific, given that they essentially operate in the same region, is a question Qantas management might find hard to answer.
I’ll show you ‘overvalued’
Housing price bubbles, or fears of a housing price bubble, is an issue not confined to Australia. The winner in the bubble stakes is a country with a resources-based economy somewhat like Australia’s – Canada.
According to research conducted last year by Deutsche Bank, and using ratios such as home prices to rental values, Australia is fifth in an overvalued housing competition, topped by Canada, Belgium, New Zealand and Norway.
More recently, Pimco, the world’s biggest investor in government and corporate bonds, took decisive action over Canadian property values by sharply reducing exposure to that country because it believes the housing bubble is about to burst.
According to the Deutsche Bank survey, Canadian homes are 60 per cent overvalued whereas Australian homes are “only” 40 per cent overvalued.