THE BOURSE WHISPERER: While not exactly in free fall, global commodity prices have been in a determined slump since around mid-February when they took a sharp fall on concerns about global growth, particularly in the world’s favourite customer, China.
Back that up with a 10 to 15 per cent fall in the price of crude oil, copper, iron ore and gold prices there are, as you would expect to see, some implications for Australia and its investment community, especially if these lower prices are sustained.
Key Commodity Prices: Down 10-15% Since Mid-Feb. Source: Bloomberg, MSWM Research
According to the Portfolio Strategy and Research Group of investment house Morgan Stanley the situation opens major implications for Australia.
The first of these is lower inflation, which Morgan Stanley said was pushing underlying inflation to the low end of the Reserve Bank of Australia’s (RBA) target band.
“Australia’s March quarter Consumer Price Index (CPI) was lower than expected, with core inflation running at 0.4 per cent Quarter on Quarter (QoQ) and 2.4 per cent Year on Year (YoY) (averaging the trimmed mean and weighted median measures),” Morgan Stanley said.
“Lower commodity prices will, other things being equal, lead to a lower CPI. In addition, as the one-off impact from the introduction of the carbon tax drops out in the second half of 2013 (and predominately in 3Q), the headline CPI could slow a further 0.7 per cent and underlying inflation by 0.2 to 0.3 per cent YoY, pushing inflation to the low end of the Reserve Bank’s 2 to 3 per cent YoY target range.”
Morgan Stanley’s second implication for investors is lower capital spending, which it said will be highlighted as resources investment declines in 2014-15.
“Business investment is currently dominated by resources investment, with mining projects representing 60.6 per cent of business investment in the fourth quarter of 2012,” Morgan Stanley said.
The research house used the recent postponement of several key investment projects to highlight the effect the combination of the high Australian Dollar, high local costs and a deteriorating commodity price outlook has already had.
The effect has demonstrated it is not just the junior end of town that is suffering at present with projects scrapped from the drawing boards of major resource companies, with Woodside opting to mothball its James Point Browse LNG project and BHP Billiton pulling the pin on its Olympic Dam and Outer Harbour expansions.
Morgan Stanley analyst Nick Robison has forecast a peak in Engineering and Construction cap-ex in 2013, with cap-ex likely to decline significantly in 2014-15.
“Nick also noted 10 swing projects, including Browse that could alter the outlook,” Morgan Stanley reported.
“In all likelihood, lower commodity prices could pressure more of these projects, further lowering the cap-ex outlook.”
This trend was also outlined in the Chamber of Minerals and Energy of Western Australia’s (CME) recent edition of the WA Resources and Economics Report, prepared in conjunction with KPMG.
The report found the economic contribution of the mining industry in Western Australia is likely to increase as the sector transitions from construction to an operating phase.
The CME said that although there will be an anticipated deceleration in mining investment, this phase will see a significant shift in production levels in coming years – most notably in the bulk commodities and LNG sectors.
This, it said, will result in economic benefit to the State through company profits and additional royalty payments.
“Notwithstanding the softening of prices towards the end of last year, WA and the wider economy continues to benefit from the growth the in resources sector,” CME chief executive Reg Howard-Smith said.
“Ongoing investment and growth is maintaining record levels of employment in WA.”
Morgan Stanley’s third implication for Australian investors was the ramifications of a lower Australian dollar and the effect of further interest rate cuts.
Lower Commodity Prices are Likely to Pressure the Australian Dollar. Source: RBA, MSWM Research
“Commodity prices are one of the key drivers of the Australian dollar,” Morgan Stanley said.
“Whilst the 23 per cent decline in the RBA’s Non-Rural Commodity Price Index (in US dollars) has yet to impact the trade-weighted index (primarily due to weakness in the Japanese Yen), it has begun to impact the AUD/ USD cross-rate.”
Morgan Stanley expressed its concerns a further decline in commodity prices, and an eventual slowdown in capital inflows to fund resources projects, would place more pressure on the Australian Dollar, pushing below parity against the US dollar.
Addressing the Paydirt 2013 South Australian Resources and Energy Investment Conference, the Resources and Engineering Skills Alliance (RESA) chief executive officer Phil de Courcey indicated this was more reality than concern.
De Courcey said the Australian mining sector has lost its cost competitiveness in the past decade due largely to declining cost positions at existing operations, which had combined with capital costs for new projects rising faster than elsewhere.
“In copper and nickel, Australia’s production is now in the most expensive 25 per cent of mines globally, and our iron ore projects are 30 per cent more expensive than the global average based on the capital spend to build a tonne of new capacity,” he told the conference.
“Our skills gaps and labour costs have been key drivers of our deteriorating competitiveness, given that labour is the primary driver of minerals project cost structures.
“Within this environment, it will be critical to generate serious contributions and data as to the debate needed to resolve these confronting issues as the mining industry is the least progressive and least productive industry in Australia.
“It is an industry marked by high capital costs, low commodity prices and a high Australian dollar.”
According to de Courcey it is not too late however, to turn productivity around and for it to contribute significantly to continued growth in Australia’s mining sector long after the current boom in commodity prices and resources investment had peaked.
He went on to say that Australia did have a chance of achieving a future gain in productivity dividend, indicating South Australia particularly could be the state in best position to benefit.
“Mineral exploration expenditure on copper, uranium and iron ore dominate South Australia’s appeal as a major investment destination, accounting for $146 million or 34 per cent of national copper exploration spend and $33 million or almost a quarter at 23 per cent of the national uranium exploration spend,” he said.
“South Australia is also emerging as a major destination for iron ore exploration, attracting the largest share of expenditure for this commodity outside iron ore giant, Western Australia.
“In the energy sector, we have the opportunity to enhance our productivity profile in when and how we deliver on the new shale oil and gas discoveries in the State’s far northeast.
“And we still have Olympic Dam, it is still in production and will be for a very long time. It is still the world’s largest uranium deposit, fourth largest copper deposit and fourth largest gold deposit, and the site of Australia’s largest underground mine.
“It will still employ hundreds of people over the years – but – without some innovative workforce planning, wage and workforce costs will be driven up and that will impact productivity.”
The final concern on Morgan Stanley’s list was a likely rise, albeit a modest one, in real disposable income.
Morgan Stanley said lower commodity prices should flow through into lower consumer goods prices, indicating the ever-confusing price of petrol may be one household staple that punters could end up paying less for, however other materials-intensive product prices could drop as well.
“We estimate that a US$10 per barrel decline in the oil price, if sustained, should lower Australian petrol prices by 4.5 per cent, adding about 0.25 per cent to real disposable income,” Morgan Stanley said.