Jennifer Hewitt has wasted no time today in praising the rise of Roy Hill:
Gina Rinehart always prefers to let her actions do the talking. But she will revel in a very personal way in the enthusiastic reaction to the $US7.2 billion ($7.9 billion) funding package for her Roy Hill iron ore project.
It’s not just a vote of international financial confidence in her business and the quality of the project. It’s also a giant rebuff to her many doubters in Australia who persisted in suggesting – to her perpetual fury – that she could never pull it off.
Media headlines regularly reflecting this sort of criticism were part of the backdrop to her big announcement in Singapore last week. This is a revenge moment as much a success story.
Rinehart says she is immensely proud that Hancock, as a wholly owned West Australian company, is taking the lead on such a significant project.
“Roy Hill is a crucible of opportunity during a period of global uncertainty,” she declared last week. “It has already shown it will create new jobs, and benefit the greater mining and construction-related industries, it will add to Australia’s exports, and significantly benefit our West Australian and national economy.”
As well as her own reputation and wealth. So there.
I’ve not been privy to the skepticism that Hewitt describes so can’t really say if it’s a triumph or not in that respect. It certainly hasn’t been the case that the media has been skeptical. On the contrary, it’s mostly been supportive.
But let that go. The question I wish to ask today is whether or not the rush to congratulate Ms Rinehart makes sense in the context of the economy.
Let’s do some quick analysis. It’s a $10 billion project to be completed by the end of 2015. If we’re generous and assume that’s $5 billion per year for two years, it will add 0.3% to GDP over those years. Add in some mutlipliers for the extra employment and production and let’s call it 0.5%. Not bad for one sheila and nicely timed too given the mining capex cliff. So far, so good.
From 2016, Roy Hill begins to pump 55 million tonnes or iron ore per annum. Macquarie Bank once estimated that the removal of India’s $50 million tonnes per annum added $20 to the iron ore price so it’s fair to argue, therefore, that Roy Hill will detract $20 from the price in the obviously oversupplied market. If we take $100 as our base case starting point and conclude that Roy Hill will cause it to fall to $80 then what does that do for the economy?
It will still contribute to GDP via its spending and export volumes. But it will also drop the entire nation’s iron ore income by 20%. That will mean that:
- instead of shipping 750mtpa @ $100 per tonne for a total of $75 billion in income
- we’ll be shipping 805mtpa @ $80 per tonne for a total of $64 billion in income
A stylised example , of course, but you get the picture. The timing of Roy Hill is not especially auspicious for Australia once it begins to ship.
There are counter-factuals. Other countries are moving on iron ore too. Brazil especially has a pipeline of projects nearly 100 million tonnes deep that will come on stream in 2016. There is also expensive Chinese production to be rationalised. And so, it’s entirely fair to argue that Roy Hill represents a grab for market share that we would have been lost to the nation otherwise.
But Roy Hill will also knock out expensive Australian production more quickly, probably half its own volume’s worth at $80 (though I think it will force the price lower) , and it will threaten considerably more, so that still means it’s income downside for the country, even if headline growth is better. This is probably true far into the future as well as the excess production in iron ore drives a secular trend in cost-out deflation.
It’s great that Ms Rinehart has got her dream up and running and there’s no doubt the nation will benefit in the short term but by entering an already saturated market Roy Hill is going to create as much trouble as it does boon. As Capital Economics says pointedly in a bearish iron ore report today, the coming price fall “begs the question of why the mining companies have maintained their commitment to higher production” at all.
That’s capitalism, I guess.
