From the AFR, Forescue’s Nev Power wants government to:
…take “a really hard look at what is happening in the industry and how they want to manage it going forward.
…He said that iron ore price predictions are the single biggest issue in federal and state budgets and were “causing uncertainty and concern” at the highest level of government.
“I’m not sure what they (BHP and Rio) are doing…But the current state of the iron ore industry has been a disaster for everyone. It has ripped the heart out of the industry, the heart out of the suppliers and contractors for the industries, the heart out of communities. There are no winners, only losers.
“It impacts everyone in Australia, whether you work in iron ore or not, because of the massive impact that the iron ore industry has on the economy. So I think there is an absolute issue here of public interest, to try and make sure there is the maximum amount of value (created) that we can in the industry.”
That is what they are doing and there are winners in the long run, both the big miners and Australia.
Owing to the benefits of scale and capital intensity, iron ore extraction is a natural oligopoly business. What’s at stake here is who owns the cartel and whether than benefits Australian welfare. Let’s take a quick look at two scenarios to make the point. The first scenario is the cartel structure favoured by Barnett that seeks to protect and include iron ore juniors by pulling back major miner supply expansions. The second is also a cartel but one that results from swift junior rationalisation enabling the major miners to consolidate their pricing power.
In the junior cartel, Australian iron ore produces 837 million tonnes (mt) of iron ore from 2016 onwards. It does so at a slightly improved price for 2016 as oversupply is reduced in the short term by 43 mt as majors retrench. However, as Sino, Roy Hill, Anglo and Vale continue their expansions and Chinese demand keeps falling, the glut builds from 2017 onwards and the price keeps falling. In due course, smaller members of junior cartel require enormous subsidy to stay afloat as they register huge losses year after year in a price environment stuck at $20 and below. It’s either that or the cartel must negotiate spectacularly implausible shared volume cuts across all Australian producers (at least those in the cartel). Trade rules must be junked, Chinese relations destroyed and the WTO as well as ACCC told to piss off. To operate this would require a virtual nationalisation of all players as total transparency governs quotas, otherwise widespread cheating is inevitable, as in OPEC.
In the alternative model, the major cartel, Australian iron produces 880mt in 2016. It does so at an average $10 lower than the junior cartel in that year given the higher supply glut. However, as the 50mt of junior and 165mt of Fortescue production shuts down by 2017 the iron ore price at first stabilises and then slowly rebounds as some pricing power returns to the major producer’s cartel. Iron ore volumes are down to 715mt but the price is trading at $40 per tonne in a rough market balance.
Juxtaposing these two scenarios gives you the following total revenue chart for the sector (and nation):
Most importantly, in the junior cartel there are no profits for anyone as protected oversupply crushes all margins, including those of the majors. There is also a gigantic Budget drain for WA as it supports the juniors with huge subsidies that completely overwhelm royalties.
In the major cartel, unprofitable iron ore is driven out and solid profits return to the low cost producers as Roy Hill emerges as the marginal producer around $40. There is no budget drain and solid royalties, as well as a Federal tax take (if much lower than the past).
Nev Power is aiming to save his firm at the expense of his country. Rumours are rife that the miner is aiming to secure equity support from Chinese interests, which will destroy the iron ore market permanently.
Government should indeed intervene by ruling out such deals and leaving Fortescue to die when markets deem it appropriate.
