Gubmint: Commodity revenues to plunge on coal

Via the Office of the Chief Economist:


In the June 2020 Resources and Energy Quarterly (REQ) we pointed out that “unlike downturns in previous decades, this downturn was not due to the bursting of excesses built up in the financial system…or in equity markets…. It also differs from the 1970s recessions…which helped contribute to stagflation and forced a wholesale restructure of the world’s energy system.” An inference was that the current downturn would likely be sharp but short relative to those earlier episodes, particularly if COVID-19 containment measures were successful, and large fiscal and monetary stimulus took effect. And, so far, the downturn in output of the world’s industrial sector — the main consumer of energy and resource commodities — has indeed been sharp but relatively short.

Probably the most notable development since the last REQ has been the sharp rebound in the Chinese economy — the world’s biggest consumer of resource and energy commodities. The rebound is the result of the almost complete eradication of COVID-19 in China, the subsequent easing of containment measures, and policy efforts to offset the impacts of the global COVID-19 pandemic.

The other notable development of the past several months has been the spread of COVID-19 in the United States. The high prevalence of COVID-19 in the US compared to other major economies has contributed to recent US dollar weakness; this weakness has boosted the US dollar price of commodities but had an adverse impact on the local currency returns of our exporters as the A$/US$ has risen. The US share market appears to have shrugged the effect on the US economy of the COVID-19 outbreak. But the large US ‘tech’ companies — which dominate the US share market — have benefitted disproportionately from a surge in domestic and offshore investor interest as the pandemic forces people around the world to work, learn, shop and socialise online.

In the outlook period, resource and energy commodity exports are likely to remain a major source of support to the Australian economy as it recovers from the largest global contraction since World War II. In line with IMF forecasts, we assume the world economy contracts by about 5 per cent in 2020, but grows by 5.4 per cent in 2021. Iron ore earnings remain extremely high, after setting an all-time record in 2019–20: strong demand from China has added to the impact of supply problems in Brazil, where COVID-19-related workplace issues have derailed efforts to recover from shutdowns in the wake of the Brumadinho tailings dam collapse. After topping $102 billion in 2019–20, Australian iron ore export earnings are forecast to be $97 billion in 2020–21. Gold has lifted even higher since our last report, and export earnings are on track to set a new record (of about $31 billion) in 2020–21. Base metals have recovered further, and the prices of copper and nickel are now back to pre-COVID-19 levels. Both have relatively constrained long term supply prospects against a backdrop of healthy demand, especially for use in new age technologies.

The prices of energy commodities are steadily recovering, as global demand recovers and supply cuts cause markets to tighten. Data show that China took advantage of low prices to stockpile oil and LNG in the June quarter 2020, helping to put a base under prices. The ‘baseline’ forecast scenario adopted for the oil price in the June 2020 REQ appears likely to be the most accurate of the four scenarios we constructed. As a result of the direct (but lagged) link between oil prices and LNG contract prices, Australian LNG export revenues are still forecast to fall sharply in 2020–21. Spot LNG prices are recovering strongly as (mainly US) supply is cut back and demand picks up. Coal prices have steadied at low levels, and are likely to edge higher through 2020–21 as supply cuts and rising demand depletes inventories.

Resource and energy exports are forecast to be $256 billion in 2020–21, but fall to $252 billion in 2021–22. Resource and energy exports are therefore expected to continue to make an important contribution to the Australian economy during the outlook period. The forecasts have notable risks on both sides: on the downside, a COVID-19-induced, protracted economic slump in the US would hurt Asia (and thus Australia) as its major supplier of manufactures. An upside risk is potential for a successful COVID-19 vaccine and/or treatment that would boost business and consumer confidence, and lift economic activity once a sufficient number of vulnerable people have been inoculated.

A decent hit to national income from coal looks about right. LNG extracts as much as it adds so we should cheer on lower prices. Iron ore is the key:

Iron ore exports have continued to rise in 2020 (see Figure 4.5) despite the global economic downturn associated with the COVID-19 outbreak. Iron ore has largely been insulated from the global recession by ongoing robust steel demand in China, and global demand is expected to remain solid over the outlook period.

Production in Brazil continues to rise slowly, with Vale ramping up some latent capacity in recent months. The company has significant mines and facilities in the north of Brazil, where operations are relatively remote and somewhat protected from the COVID-19 outbreak — which has severely affected towns and cities in the south of the country. Vale remains confident of expanding exports over the rest of 2020, citing a monthly lift in production in June, as well as recent falls in absentee rates (which had spiked due to COVID-19).

However, Vale’s production showed signs of lagging again in July, and the company has repeatedly fallen short of its announced targets. Vale is facing tougher regulatory requirements following the collapse of its Brumadinho dam construction in early 2019. Production plans have also been derailed by the impact of the COVID-19 outbreak, which has led to more than 100,000 deaths across Brazil and severely disrupted transport and labour across the country.

Brazilian production is not expected to return to normal levels until late 2022, and even this schedule faces risks should efforts to contain the COVID-19 pandemic continue to fall short. South African and Canadian production have also been affected by labour and transport problems linked to the COVID-19 outbreak. While the effects on these countries have been less severe, it is unlikely that their production could rise sufficiently to fill the gap created by the downturn in output from Brazil.

Production in Africa is expected to grow over the longer term, with recent rapid progress being made on development of the US$20 billion Simandou deposit in Guinea. China has long sought to diversity its iron ore sources, and Baowu — a large Chinese steelmaker — is now expected to lead the acquisition of Chinalco’s stake in the mine, which amounts to one half of the overall deposit. The other half is held by Rio Tinto. Full production at the site is not expected until after 2025.

Australia is expected to account for a rising share of steel output over the next two years as new mines open in the Pilbara region.

I don’t often agree with the Government forecaster but this looks about right.

The question is about beyond 2022. I expect Brazilian supply to recover by then, China to reinstate lending curbs as the world recovers from COVID, and an ongoing secular fall in Chinese growth until it hits effective zero around 2030 (3% GDP minus dodgy accounting).

So, I doubt the Government would agree with this even though it is baked in:

There is some comfort in that.

David Llewellyn-Smith
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