Sent: 17-09-2014 09:18:01
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Iron Ore Price Forecasters in the Firing Line
What is Bill Shorten's iron ore price forecast? Silly question? Not really, when you consider that iron ore prices will have an impact on so many financial or policy making decisions in Australia.
As iron ore prices plumb new cyclical lows, foresters are grappling with how far they will eventually fall and the longer term price trajectory for a commodity which earned Australia $69 billion in export revenue in 2013.
Australia is one of two critical global supply sources. Brazil is the other. Australia is likely to account for over 50% of the 2014 world iron ore trade according to Australia's Bureau of Resources and Energy Economics, the official government forecaster for the sector. Chinese imports account for two thirds of the world trade.
The boom in iron ore prices has been driven by an explosion in Chinese steel production. Chinese steel output rose from 128 million tonnes in 2000 to 772 million tonnes in 2013. Even this year, in the mature phase of the cycle, output is running 5% higher than at the same time last year.
China's burgeoning steel industry caught iron ore producers by surprise. Chinese planners themselves showed a lack of foresight. They failed to cultivate sufficient iron ore productive capacity to meet the needs of their plans. The result was a twelve fold rise in the iron ore price from cyclical trough to peak. Even after subsequently falling 60%, prices are 500% higher than they were in 2003.
Prices have been retracing the earlier rise because of the reversal of the circumstances that caused it in the first instance. Chinese planners have been cultivating more diverse sources. Higher prices, in any event, have enticed new production onto the market with a pipeline of new projects building in response. Larger exploration budgets have resulted in a new iron ore development hub in West Africa to add to the downward pressures on prices.
Former BHP Billiton executive Alberto Calderon addressed some of these dynamics at a seminar for Bloomberg clients last week. His conclusion was that the iron ore price benchmark would fall to $70 a tonne and probably not rise from there for the foreseeable future.
On Calderon's view, there would be ongoing pain for large numbers of smaller iron ore producers, Australian policymakers and the community at large who had unwittingly come to depend on the benefits from the iron ore industry.
Calderon went on to argue that Australia had to restructure its economy to offer alternative sources of growth or face a consequential fall in living standards.
At another conference on the other side of the continent, Westpac economist Bill Evans was addressing the same question and concluded that the iron ore price would recover and rise again to $120 or better over the coming two years.
At the Bloomberg meeting itself, the Morgan Stanley iron ore price forecaster took up some of the middle ground by putting forward an $85-95 price range. The median forecast price in 2015 among those analyst tracked by Bloomberg was $103.
With prices nearing $80, only Calderon was saying that they would go lower. Depending on which view was right, differing investment and policy decisions should ensue.
Calderon's arguments are the most compelling. One reason to put more weight on his analysis is that it has less natural bias. Morgan Stanley, for example, must entice clients to buy equities. This is hard to do if the equity value proposition is being destroyed by a view on the profitability of the companies being promoted. Similarly, the Westpac business will be more profitable if the iron ore price rises. Institutions are typically reluctant to make forecasts that are overtly unfavourable to their well being.
Analytically, industry costs are one of the reasons for a price to settle at a particular level. In an undisturbed market, the price should gravitate toward the marginal costs of production. In iron ore, a large number of Chinese producers have the highest costs in the world requiring prices of $100-120 to remain profitable. Their presence is one reasons prices did remain so much higher than the $50 cost base of the largest Australian producers.
As larger quantities of lower cost iron ore are produced, the industry supply curve drifts to the right and the equilibrium price will tend to decline unless demand can grow by enough to compensate. This is not happening.
Commercial pressures are forcing some Chinese producers out of the market. Government policy is also acting to close some steel plants to help ease some of China's more acute air pollution problems. The removal of some of the highest cost mines will contribute to a levelling of the industry cost curve and the fall in prices.
Over time, too, China will rely more heavily on scrap as the pipeline of aging structures and recyclable products builds. Steel production will need less iron ore.
An objective analysis points to identifiable sources of downward pressure and few reasons to foresee prices rising.
So, what does Bill Shorten think of this? Or, Tony Abbott, for that matter. Their views are important because it would be impossible to properly frame a national fiscal framework without taking a view about the direction of iron ore prices.
Last week, opposition Treasury spokesman Chris Bowen advocated an independent authority to define the forecast parameters against which all policy decisions are made. This erroneously suggests some certainty for planning purposes. Just pick the right body, according to Bowen. This is wrong.
Treasurers do not disclose the iron ore price assumption they are using in framing their budgets. This helps to avoid embarrassment and controversy. It does nothing for sensible policy decisions. Nor does it help voters understand what is achievable or at risk. And yet, it is nearly impossible to judge the policy platform of an Australian leader without knowing his iron ore price assumption.
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