Western Australia’s Department of Treasury has upgraded its forecast for the state’s 2020-21 Budget surplus to $3.1 billion, compared with expectations in December of just $2.2 billion.
The state’s improved fiscal position has been driven by continued strong demand for iron ore, with Treasury forecasting that the price of the steel input will average US 134.30 a tonne, including freight.
Its December forecasts were based on an iron ore price of $US 103.70 per tonne:
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The State’s fiscal outlook has improved since the 2020-21 Mid-year Review projections were finalised in late November 2020. This primarily reflects additional revenue from a higher than expected iron ore price and stronger than expected activity in Western Australia’s domestic economy – particularly the State’s residential property market, underpinned by substantial Commonwealth and State Government stimulus.
Reflecting the improved revenue outlook, and the impact of Government decisions taken since the Mid-year Review, a $3.1 billion general government operating surplus is now forecast for 2020-21. This is up from the $2.2 billion surplus forecast at the time of the Mid-year Review. Operating surpluses in the range of $1.5 billion to $2.2 billion are forecast over the remainder of the forward estimates period…
Iron Ore Prices
The benchmark iron ore price rose sharply from $US130 per tonne at the 2020-21 Mid-year Review cut off (in late November 2020) to a high of $US175 per tonne on 21 December 2020. It has since eased somewhat, but remains elevated (see chart below).
Rapid movements in the iron ore price are not unprecedented, with prices falling at similar rates to the recent appreciation between mid-March and mid-April 2017 and again in August 2019. The following chart illustrates the inherent volatility of iron ore prices…
In 2020-21, iron ore royalty income is estimated to account for 27% of total general government revenue. This compares to an average of 18% over the preceding decade. With such a large share of the State’s revenue base coming from this source, even relatively
modest differences between the actual and assumed iron ore price will result in significant revenue variations. In this regard, each $US1 per tonne movement in the price of iron ore over a year impacts the State’s annual royalty income by around $81 million…
To its credit, the WA Treasury is not counting on the iron ore boom to last, assuming a sharp retracement to the historical average by year’s end:
The iron ore price is assumed to revert to its long-run average by August 2021. While the iron ore price is expected to fall as stimulus-induced Chinese demand eases and Brazilian supply recovers, Treasury is not necessarily expecting that prices will actually fall to $US64 per tonne within this timeframe. Rather, given the inherent volatility in iron ore prices, and the associated forecasting challenges and risks to the State’s Budget, Treasury considers it a prudent budgeting assumption to base future estimates of iron ore royalty income (beyond the current financial year) on the long-run average price.
Given current prices, this conservative approach suggests there is some upside risk to forecast iron ore royalty income in 2021-22.
As noted above, the WA Budget is heavily revenue dependent on the iron ore market, with iron ore royalty income accounting for a whopping 27% of total general government revenue in 2020-21.
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.
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