Supply-demand cycle to work on commodity prices

Recent multi-million dollar investments in the state’s resources sector have paid off as unprecedented growth in the past four years continues on the back of higher commodity prices.

While some market commentators suggest the current strong prices will be sustained for a longer period, others expect the prices of most resources commodities to fall as the production response leads to an increase in supply.

Whatever happens, all experts agree the resource sector will continue to dominate the landscape of WA’s economy.

According to Chamber of Commerce and Industry of WA economist John Nicolaou, the state’s resources boom started around 2001-2002 and has continued since. This has been clearly reflected in remarkable business investment growth rates and a strengthening of the export sector, he said.

During the past year there has been dramatic commodity price change as well, as demand from China fuels expansion in the sector.

Leading the price charge has been iron ore, with major producers building price increases of 71.5 per cent-plus into their supply contracts with Asian steel mills. The commodity contributed about $6 billion to the value of Australia’s exports in 2004, according to the Department of Foreign Affairs and Trade.

However, the Australian Bureau of Agriculture and Resources Economics (ABARE) is forecasting a rise in iron ore output of around 10 per cent, which should lead to a dampening of prices. Most of this new production reflects commissioning of new production capacity at Rio Tinto and BHP Billiton operations in WA, the independent government research agency says.

ABARE’s prediction of easing prices also extends to oil, but with the proviso that price movements in the commodity will remain volatile.

“A number of factors that mainly relate to disruptions, including geopolitical tensions and a decline in spare production capacity, have contributed to recent higher oil prices,” ABARE said in June.

From a low of less than $US47 a barrel in January, the price of West Texas Intermediate (WTI) crude oil reached more than $US68 a barrel in August, in response to a lapse in production associated with Hurricane Katrina in the US.

Some forecasters have purported that oil prices will continue to increase over concerns that global oil production has peaked and will decline significantly from now on.

But some international agencies, including the International Monetary Fund, the International Energy Association and oil cartel OPEC, disagree with this assessment.

According to the international bodies, proved oil reserves have been increasing over the past decade or so, rather than declining, and this growth is set to continue.

But the question remains as to whether this growth will be sufficient to keep up with growing demand in emerging Asian markets.

In WA the high oil price, while good for the state’s oil producers, is contributing to a number of project delays in the wider resources sector, particularly mining, with the higher price feeding into diesel fuel costs in regional areas.

As well, the iron ore price has led to a 64 per cent rise in steel costs this year, according to AME Mineral Economics.

So while the prices of oil and iron ore sit at historic highs, they remain a thorn in the side of WA’s major projects.

Despite the negative feedback effects of higher commodity prices, WA is certainly better off for the resources boom. Australian company profits before tax increased 72.9 per cent in the March quarter on the previous period to $4.83 billion, a figure to which WA resources companies contributed significantly.

It is also a fact that while economic growth has been lower in other states, WA has been powering ahead on the strength of its resources.

According to the ABS, the annual percentage change in state final demand between June 2004 and June 2005 was 5.7 per cent in WA, with the next best in Tasmania at 4.1 per cent, followed by Queensland at 3.9 per cent.

Australian GDP growth in that period was just 2.3 per cent.

An increase in the number of projects that have become feasible due to higher materials prices has led to higher investment and greater confidence in the sector.

But the accompanying increase in costs has also led to a number of emerging strategies, including consolidation and increased specialisation, with the distinction between explorer and producer never greater.

Alliances have emerged between the producers that own economies of scale in operation and smaller explorers which face barriers to entry because of higher costs and increasing project risks.

As the sector’s contribution to national GDP has risen, government taskforces have been set up to assess issues facing the industry.

Explorers, for instance, have trumpeted the need for greater incentives for exploration through a flow-through shares scheme, while in other states there has been considerable focus on the need for infrastructure investment to address export bottlenecks.

According to exploration expenditure figures from exploration information group Intierra, for the WA Business News quarterly exploration survey, Australian expenditure on minerals exploration by listed explorers was $166 million for the June quarter. This amount has been trending upwards for the past five years and is the highest since 1997, when the greatest level of exploration expenditure was recorded.

In order to simplify the path from exploration to development, miners are calling for improved access to land, speedier environmental approvals and an easier Native Title settlement process.

For all the discussion there has been little talk of how WA can diversify its economy away from the dominant resources industry – notwithstanding considerable diversification within the sector itself – in order to take account of a return to earth that will undoubtedly arrive as the boom reaches its conclusion.

If the super-cycle is not here to stay, how can WA smooth the bump that is coming?

This question may be one for the politicians, but the state’s resources sector will have to grapple with a shortfall in demand, if and when it arrives.