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Race against time: the upside surprise in iron ore

Iron ore prices are a matter of ongoing concern.

Iron ore prices are a matter of ongoing concern. Photo: Getty

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One of the thorniest problems during Australia’s post-boom economic transition is balancing the federal budget.

As I argued in the first two articles in this series, the continued low price of petrol is a boon for consumers and homeowners are enjoying a sustained period of bargain-price interest rates, but neither will last forever.

While the recent string of budget deficits is usually blamed on overspending, it’s actually on the revenue side of the equation where most of the action has taken place due to a collapse on commodity prices.

Our biggest commodity exports, in order, are iron ore, metallurgical coal, gold and thermal coal. When the prices of those commodities soar, the companies producing them make huge profits and pay huge amounts of corporate tax.

That’s what happened during the early stage of the mining boom. Prices shot up and the Howard government had more revenue than it knew what to do with.

In those circumstance, paying off the national debt left by Paul Keating’s government was a doddle.

The ‘debt and deficit’ arguments led by Tony Abbott in opposition tended to play down the fact that tax revenue as a proportion of GDP was 24.2 per cent in 2004/05 and 2005/06, but averaged just 21.3 per cent of GDP under the Rudd/Gillard governments.

The leaky budget

There were two phases of revenue-stress for Labor.

The first was the GFC hangover. Capital gains tax receipts were smashed by falls in the values of shares and commercial property, and company tax fell due to weak profits across the economy.

Wayne Swan 2013 budget speech

Former treasurer Wayne Swan watched $17 billion in revenue evaporate in 2012/13.

The second phase arrived like a slap in the face and the apparently stunned treasurer Wayne Swan fronted journalists at a 2013 budget media conference and said that $17 billion in revenue had disappeared due to crashing commodity prices.

Then-shadow treasurer Joe Hockey enjoyed taunting Mr Swan across the floor of parliament, telling him repeatedly that “everyone knew” commodity prices would tumble.

That smugness wore off pretty quickly though – when Mr Hockey was himself treasurer, prices kept falling and revenue kept evaporating.

The biggest export, iron ore, was assumed in Mr Hockey’s first budget to be set for an extended run at around $96 a tonne, but by the second budget that had been revised down to $48 a tonne.

By May of this year, that had been revised up to $55 a tonne, despite many economists forecasting a further slump below $30 a tonne.

A lucky break

While many sneered at the $55 price, we have indeed seen an increase from $39 in December to $56 at the time of writing.

That’s down to luck more than anything. Economists take sharply different views of what is driving the price of iron, and forecasts for next year’s prices vary from the sub-$30 to the mid-$40s, with super-bull Paul Bloxham at HSBC predicting a long-term price of $52.

So Treasurer Scott Morrison has been given something of a reprieve. The terrible prices forecast have not come to pass, which mean he may hit the ‘not-terrible’ revenue forecasts made in the 2016 budget.

Joe Hockey question time 2013

In opposition, Joe Hockey slammed the Gillard government for not seeing revenue write-downs coming.

The question is how long that will last.

The huge price spikes between 2009 and 2011 were driven by a massive infrastructure stimulus program in China.

Bearish commentators assumed, therefore, that when most of that money was spent the prices would return to little more than the price of ‘dirt’.

However, BHP has a more optimistic view that is not reliant on future stimulus splurges.

Huw McKay, BHP’s vice president, market analysis and economics, wrote this week that: “After almost three decades of uninterrupted growth, Chinese steel output has actually declined of late, prompting many to suggest that production has peaked. We’re not convinced. We expect Chinese demand will rise modestly over the next decade, while the composition of end-use demand for steel will change as the economy evolves.

“As the rate of urbanisation has slowed, and will continue to do so, building rates aren’t going to be what they were. Even so, over the next 20 years, China’s urban population is likely to increase by almost another quarter of a billion people; and the rising middle class will be looking to upgrade to bigger and better apartments, sitting above more extensive underground car parks – meaning what’s built (and renovated) will be more steel intensive.”

A court has dismissed an appeal by BHP Billiton against the $2.2 million payout awarded to Steven Dunning.

BHP is confident about what the future holds for the industry.

Okay, so that’s from an iron ore major talking up its own prospects.

Then again, Mr McKay’s point can usefully be made across many of Australia’s export industries. If the prices China pays for our commodities and other goods and service falls, but volumes rise due to the Middle Kingdom’s huge population growth, then Australia may still ride the China wave.

For now, let’s hope Mr Morrison’s revenue targets are met and the budget can at least tread water during Australia’s transition to a more diverse economy.

Treasury certainly needs the money. If the exceptional stimulus year of 2009/10 is put aside – Labor spent 26 per cent of GDP that year – Mr Morrison is spending more as a proportion of GDP than any treasurer since 1994/5.

That’s appropriate for now, because if he tried to cut his way to a surplus, as the Abbott government did for ideological reasons, we’d be headed for a deep recession.

That fact that we’re not (yet!) is something we should all be grateful for – and something that has more than a little to do with the price of dirt we’re shipping to China.

Read more columns by Rob Burgess here

Read the first two columns in this series below:

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1015race-against-time-2second

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