Independent Senator Nick Xenophon has reignited his push for a senate inquiry into Australia’s iron ore industry, blaming the nation’s major miners for “killing off” last year’s efforts to examine the factors behind the iron ore price collapse.
In Perth to promote his West Australian candidate for the next federal election, Senator Xenophon accused the former Abbott government and the Labor Party of lacking the “courage to stand up to the big end of town”.
…Senator Xenophon reaffirmed his stance that an inquiry would not just test allegations by Fortescue Metals Group chairman Andrew Forrest that BHP Billiton and Rio Tinto had been signalling overproduction to drive down prices and put smaller players out of business but insisted it was also in the national interest to examine the effect of the price fall on government revenue, and consider tightening competition law.
Outside of this being an obvious political stunt, there are two questions being posed here, one sensible and the other stupid. The sensible question is why does the word’s largest exporter of dirt have no idea how the dirt business actually works? That question ought to be applied to Australia’s entire economy, from its bureaucratic macro managers, to its market players and its companies, all of whom have butchered their outlooks. Getting to the bottom of why that is would be fascinating.
The stupid question ironically illustrates the former. Of course iron ore is a cartel. The economics of extraction are dominated by capital-intensity, quality of resource and the benefits of scale. Iron ore will thus always be dominated a small number of large players. The question Xenponzi is really asking without knowing it is what sort of cartel do we want? Do we want one that respects the nature of the business, targets efficiency, margins and maximum profits over the long term, or, do we want one that protects junior producers, inefficiency and lower profits? Ask yourself, what nation aims to inject competition into its export sector to benefit customers when it is the dominant supplier?
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H&H already answered this question emphatically last year:
In a cartel that protects junior producers, 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 the 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).
When you cut through all of the crap it’s really very simple, the juniors and Fortescue must die as soon as possible for the good of the nation. It is the only viable fix for the historic iron ore glut.
