Resources and Energy Quarterly March quarter 2012

Resources
and Energy
Quarterly

March quarter 2012

BREE 2012, Resources and Energy Quarterly, March Quarter 2012, BREE, Canberra March 2012.

© Commonwealth of Australia 2012

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ISSN 1839-499X (Print)

ISSN 1839-5007 (Online)

Vol. 1, no. 3

From 1 July 2011, responsibility for resources and energy data and research was transferred from ABARES to the Bureau of Resources and Energy Economics (BREE).

Postal address:

Bureau of Resources and Energy Economics

GPO Box 1564

Canberra ACT 2601 Australia

Phone: +61 2 6276 1000

Email: info@bree.gov.au

Web: www.bree.gov.au

Foreword

In the review section of Resources and Energy Quarterly there is a comparison of Australian, OECD and global energy markets; a SWOT analysis of Australia’s LNG industry; and a short history of uranium.

BREE’s forecast for the value of Australian exports of resources and energy for 2011–12 is about $200 billion or about a little less than a 10 per cent increase over 2010–11. This export growth is despite an increase in the value of the Australian dollar in the second half of 2011 and forecasted reduction in global economic growth in 2012.

Over the short term overall metal prices are projected to decline by 6 per cent in 2012 relative to the average price in 2011. The key long-term projection in this issue is that future growth in Australian export earnings from minerals and energy will be generated by higher volumes and, with a few exceptions, will be not be because of rising commodity prices.

Quentin Grafton

Executive Director/Chief Economist

Bureau of Resources and Energy Economics

Contents

Acronyms and abbreviations

ABS Australian Bureau of Statistics

BREE Bureau of Resources and Energy Economics

FOB free on board

GDP gross domestic product

IEA International Energy Agency

IMF International Monetary Fund

LME London Metal Exchange

LNG liquefied natural gas

mb/d millions of barrels per day

MBtu million British thermal units

Mt million tonnes

OECD Organisation for Economic Co-operation and Development

OPEC Organisation of the Petroleum Exporting Countries

PPP purchasing-power parity

RBA Reserve Bank of Australia

TWI trade-weighted index

UNCTAD United Nations Conference on Trade and Development

WTI West Texas Intermediate

Macroeconomic outlook and energy and minerals overview

The world economy has entered a challenging period with increased vulnerabilities and a moderation of global growth in 2012 relative to 2010 and 2011.The updated World Economic Outlook by the International Monetary Fund (IMF) in February 2012 projects global activity decelerating in the year ahead because of the effects of the euro zone debt crisis which have spread beyond Europe. Uncertainties associated with the sovereign debt crisis in Europe have also generated large fluctuations in financial markets and this volatility has had a negative impact on consumer and business confidence.

Global economic growth in 2012 is assumed to be around 3.3 per cent (see Figure 1), which is 0.75 percentage points down from the forecast in the September 2011 World Economic Outlook (WEO) by the IMF. The expected slower growth rate is attributed largely to intensifying strains in the euro zone and economic fragilities in some other large economies. Within most of Western Europe short- to medium-term economic growth prospects have diminished. Despite a strengthening of economic activity in the US, global growth and world trade have slowed (see Table 1).

Europe appears to have entered a mild recession in 2012 caused by the rise in sovereign yields in 2010 and 2011, the effects of bank deleveraging on the real economy, and the impact of on-going fiscal consolidation. The main reason for the diminished outlook in Europe is the escalating euro zone crisis. It is interacting with financial fragilities elsewhere, has sharply reduced capital flows to emerging economies, and led to substantial changes in the relative values of key currencies.

The outlook for the large developed economies in 2012 is assumed to be weaker than in 2010 or 2011. Growth in Western Europe is expected to falter in 2012. Most advanced economies, however, are expected to avoid falling back into a recession and overall economic growth in the advanced economies is projected to average 1.5 per cent during 2012 and 2013.

Emerging economies, particularly those in Asia, contribute to an already important and increasing share of world economic growth. Over the outlook period the prospects for emerging economies are much better than those for advanced economies, but are becoming less certain, especially for those countries that are highly reliant on export-led growth. Annual economic growth in emerging and developing economies is expected to average 5.75 per cent—a significant slowdown from the 6.75 per cent growth experienced from 2010 to 2011, and about 0.5 percentage points lower than forecast in September 2011 by the IMF. These revised growth figures reflect a less optimistic external environment in terms of trade and a slowdown in domestic demand in key emerging economies.

Most of Asia and Latin America experienced robust economic growth in 2011. Growth is expected to moderate in 2012, but to regain strength in 2013 and beyond. Unlike some advanced economies for some of these emerging economies their immediate concern is rising inflation rather than lagging growth.

The Chinese economy continues to record strong growth, although this is projected to moderate in 2012. In part, this expected easing in economic growth is due to domestic economic policies to combat inflation, including the continuing unwinding of the 2008–09 fiscal stimulus, tighter monetary policy and measures to contain price increases in its property market. Additionally, spillovers from problems in the broader global economy and some high internal risks facing the Chinese economy could threaten and slow economic growth. Internally, socioeconomic factors, such as the structural effect of the so-called ‘middle income trap’, if not well managed, and rising inequality could slow economic growth.

Despite some moderation in economic growth, domestic demand remains strong. Retail sales continue to expand and passenger vehicle sales are just below their late 2010 peak level. Although there has been relatively weaker export demand, manufacturing investment continues to grow. Industrial production growth remains robust, but slightly below 2011 levels, and both power generation and automobile production are growing strongly. As a result, over the outlook period China is expected to continue its major role as a growth engine for the world economy.

In 2012, gross domestic product (GDP) growth for the Chinese economy is assumed to be lower than in 2011, although remaining at a robust level of 8.2 per cent. This is 0.8 per cent below that assumed by BREE in December 2011. An annual rate of economic growth of 8.8 per cent (based on purchasing power parity terms (PPP) valuation of GDP) is assumed over the medium term (see Figure 2).

Over the past decade rapid economic growth, growing urbanisation, and structural change within manufacturing have combined to make China the world’s largest energy user, outstripping the US in 2010 although, on a per capita basis, the US still consumes much more energy than China.

For Australia, China is the most important market for mining. Over the medium term, China is expected to remain the most important mining export market for Australia, given a strong trend of continued growth in industrialisation and urbanisation, both of which are resource-intensive.

The rapid expansion of industrial production in China is expected to support growth in energy and minerals consumption over the medium term. The expansion of resource intensive industries such as electricity generation and steel, pig iron and cement production is expected to remain strong. Over the longer term China’s growing technological prowess could drive rapid change in its industrial structure. These changes should create new areas of dynamic comparative advantage. For instance, China’s construction industry is becoming a global leader in international construction projects.

In 1978, less than a fifth of China’s population resided in cities; by 2009, urban residents made up close to half the population; and by 2030, the share is expected to swell to near two-thirds. Most urban growth in the future is expected to result from the expansion of existing cities through migration from rural areas. China’s strong growth of per capita income and an expanding middle class over the medium term outlook will also increase demand for resource-intensive consumer durables, such as motor vehicles and electronics.

Global economic growth is vulnerable to spillovers associated with the European sovereign debt crisis and fiscal consolidation in Western Europe. Too rapid fiscal consolidation during 2012 could exacerbate downside risks. Ideally, fiscal consolidation should occur at a pace that supports adequate growth and employment. From Australia’s perspective too rapid fiscal consolidation in major export markets could have a short-term negative effect on both the price and volume of key resource commodities.

The global financial crisis resulted in a sharp deterioration in the fiscal health of many advanced economies. For example, Spain moved from a budget surplus of 2 per cent of its GDP in 2007 to a deficit of 11 per cent in 2009. For the US and the UK, the budget deficit increased by 10 and 8 percentage points of GDP, respectively. Government fiscal stimulus packages in response to sharp falls in consumer demand during the global financial crisis were primary causes of those increasing deficits. While the stimulus spending has decreased since 2009–10, budget deficits persist and in many countries debt-to-GDP ratios have continued to rise.

In the medium term, lower budget deficits and fiscal consolidation should support economic growth by reducing real interest rates, lowering tax burdens and encouraging increased private sector investment. In the short term, however, fiscal consolidation will likely slow economic activity. This is especially the case for some countries in southern Europe that are already in recession and have an exchange rate determined by economic conditions for the euro zone as a whole, rather than by country-specific conditions. Should there be widespread and rapid fiscal consolidation, this could have a short-run moderating effect on prices of resource commodities used in industrial production.

The IMF assumes that, for the global economy as a whole, fiscal consolidation equivalent to 3 percentage points of GDP will occur in 2013. Over the next two years fiscal consolidation is projected at around 4.6 per cent of GDP for advanced economies. In the euro zone, the IMF projects that fiscal consolidation will be around 3 per cent of GDP in 2012 and 2013. Fiscal consolidation in the US is estimated to represent about 1 per cent of GDP in 2011, and projected to be between 2 to 4 per cent of GDP over the next two years.

Japan is projected to be the only large advanced economy to implement a fiscal expansion in 2012 reflecting, in part, reconstruction costs related to the natural disaster of March 2011. Its fiscal deficit is estimated to have increased by around 0.8 per cent in 2011 and projected to remain at that level in 2012, but to fall by 0.5 per cent of GDP in 2013. Total reconstruction costs are budgeted at about 4 per cent of GDP over 2011 to 2013 and are expected to be financed, on the first instance, via bond sales.

In China, the budget deficit was around 2.5 per cent of GDP in 2010, and 3.1 per cent in 2009. In 2012 an improvement of China’s budget condition is expected with its deficit expected to be around US$126 billion, down from U$142 billion in 2011.

Sources: IMF; RBA; NBS China.

Economic growth in India has moderated due to policies intended to combat rising inflationary pressures. Economic growth is projected to be 7 per cent in 2012, 0.5 percentage points lower than assumed by BREE in December 2011. The slowing in growth follows a significant tightening in monetary policy. Growth in industrial production is projected to remain subdued over the medium term at around 6 per cent a year below its early 2011 peak. In addition to the effect of tighter monetary policy, industrial production has also been affected by problems at a number of coal-mines that have disrupted the fuel supply for thermal coal power stations. Furthermore, the value of merchandise exports fell in the December quarter, reflecting weaker external demand and lower commodity prices, particularly for iron ore. Despite some moderation, inflation in India still remains relatively high as the wholesale price index rose by 7.5 per cent over the year to December 2011.

Near-term growth in ASEAN countries (including Indonesia, Malaysia, Philippines, Thailand, and Vietnam) is assumed to be around 5.6 per cent in 2012 due to robust investment. This investment should offset a possible slowdown in export momentum.

Despite the weak global outlook for 2012, the Republic of Korea’s economy is expected to grow at more than 4 per cent in 2012 and 2013, but to slow from 2014. In Asia as a whole, growth is projected to moderate in 2012. Nevertheless, even with some moderation, growth is expected to be robust at 7.5 per cent, on average, during 2012 and 2013.

Economic growth in OECD economies is assumed to be 1.1 per cent in 2012. The annual growth rate in Japan is assumed to be 1.7 per cent, 0.8 percentage points lower than assumed in December 2011 by BREE. The pace of growth in the 17 countries in the euro zone slowed in 2011, and is expected to deteriorate further in 2012. In Greece, Ireland, Italy, Portugal, and Spain, fiscal tightening, banking system concerns, low consumer confidence and high unemployment are all having a negative impact on domestic demand. An expected slow-down in growth in the core northern euro zone economies, such as Germany, is likely to make economic conditions in the southern economies more difficult in 2012.

The German economy remains the most robust in Western Europe with strong export-led growth of 3.1 per cent in 2011. However, German industrial production has fallen by almost 5 per cent from its peak in July 2011 and growth is expected to be down to 0.3 per cent in 2012. Forward-looking indicators of equipment investment and exports, the two strongest sectors in the German recovery, have moderated. By contrast, construction activity in Germany has remained more or less unchanged in recent months. Over the medium term economic growth is expected to recover to an annual rate of 1.5 per cent by 2013, and rates of around 1.2 per cent to 1.4 per cent over the following two years.

The US economy has been improving in recent months. Its unemployment rate is declining and there are tentative signs of improvement in housing construction activity. The economy is estimated to have grown at a rate of 1.8 per cent in 2011 and is assumed to continue growing at that rate in 2012. Economic growth is expected to be supported by increases in consumption and business investment, with forward-looking indicators of economic activity improving. Assumed very low nominal interest rates over the next two years are expected to provide stimulus to investment. In 2012, the negative spillovers from the euro zone crisis are expected to be offset by stronger underlying domestic demand. Nonetheless, economic activity may slow from the pace reached during the second half of 2011, as higher risk aversion tightens financial conditions and fiscal policy becomes less expansionary.

Commodity prices which increased substantially in 2010 have moderated since mid-2011 as a result of the slowing growth in the global economy in the second half of 2011. Commodity prices were also lower in the December quarter 2011 compared with the previous quarter. Prices for some base metals and bulk commodities fell sharply in the second half of 2011 in response to weaker global demand (see Figure 3). An exception is thermal coal, with its price more or less unchanged over the last quarter of 2011 (see Figure 4). The resilience of the thermal coal spot price, relative to other bulk commodities, reflects different demand conditions. In particular, the shutdown of nuclear power generation capacity in several countries (especially Japan), and below average hydro electricity generation in China, have provided strong underlying support for thermal coal demand.

In 2012, commodity prices are expected to continue to ease given the current lower than expected growth in the global economy. Overall, metal prices are projected to decline 6 per cent in 2012 relative to the average price in 2011. The price of crude oil is expected to average $98 per barrel in 2012, down 6 per cent from the 2011 average; while iron ore prices are expected to ease by about 8 per cent. Commodity prices are expected to remain relatively stable over the remainder of the outlook period.

Uncertainties about future growth prospects associated with the sovereign debt crisis in Europe generated very large fluctuations in financial markets in the second half of 2011 and early 2012. This volatility is expected to depress demand growth for commodities in the short-term as ongoing and sharp fluctuations in financial markets moderate consumer and business confidence.

In Japan, industrial production and exports were severely affected following the March 2011 earthquake and tsunami, but are recovering at a greater-than-expected rate. Demand in Japan is expected to grow in response to the necessary rebuilding of infrastructure. Domestic and external demand in several central Asian countries that have significant financial and trade linkages to the euro zone have also weakened as a result of the ongoing euro crisis. In South Asia, domestic demand is expected to continue to slow in 2012.

Consumption demand in large export-oriented European Union (EU) economies, such as Germany, will depend on efforts to remediate public debt and liquidity concerns in the region as a whole. Growth has slowed due to a combination of weakening domestic and external demand. Several Central European countries are particularly vulnerable to the deepening crisis in the euro zone due to close trade linkages and high levels of maturing debt.

On a positive side, faster convergence to trend economic growth in the US is forecast to support resources and energy commodity demand in that economy. However, the size of this effect on commodity prices will depend on the scale of the recovery in the US housing and labour markets.

In 2012, demand for resources and energy commodities is expected to ease in response to weaker growth in many countries. China is expected to continue its major role in maintaining both the supply and demand side of the global economy. However, a dip in its growth rate in 2012 is expected to moderate demand for some bulk commodities in 2012.

Over the outlook period, the production of most energy and mineral commodities is projected to grow. In 2012, world refined nickel production is projected to grow by 5.6 per cent, relative to 2011, to total of 1.7 million tonnes. This growth is expected to come from increased production at new operations and an increasing use of existing spare capacity. It is forecast that, relative to 2011, there will be a production growth in 2012 for aluminium and alumina (both up 2 per cent), oil (up to 1.2 per cent), steel (up 5.4), uranium (2.8 per cent) and zinc (up 3.2 per cent). Supported by forecast high growth in steel production, primarily in China, world trade of iron ore in 2012 is forecast to increase by 3.6 per cent and metallurgical coal by 3.5 per cent, relative to 2011. By contrast, concerns about geopolitical oil supply risks have risen again. The impact of a sustained oil supply disruption in the Middle East would be substantial. Should this happen it would result in sharply higher petroleum prices as there are limited inventories and spare capacity buffers.

Real GDP in Australia (based on a PPP valuation of GDP) is assumed to grow at annual rate of 3.8 per cent in 2011–12, but to moderate to around 3 per cent over the remainder of the outlook period (see Table 2). According to the ABS, economic growth in the last quarter of 2011 was half of what was expected, and lead to the slowest annual growth since 2008. However, Australia remains among the fastest growing economies in the world.

Recent economic data suggest that the mining sector will continue to perform strongly in terms of both volumes of exports and growth in capital investments. Overall, Australian domestic demand continues to grow at a robust pace, although the high level of the exchange rate, and changes in household spending and borrowing behaviour continue to have a negative affect on some industries. As in many other countries, volatility in global financial markets has resulted in noticeable declines in measures of consumer and business confidence in the latter half of 2011.

Over the remainder of the outlook period (2012–13 to 2016–17), growth in the Australian economy is expected to be supported by mining-related activities. High levels of mining investment are expected to continue. Significant expansions to iron ore and coal production capacity are also underway, and will contribute to solid growth in resource export volumes over the foreseeable future.

The Australian dollar traded in a wide range during 2011. In December, the Australian dollar traded at US102c, TWI 76. This compares with US98c and TWI 72 in September 2011, and US106c and TWI 75 in early June 2011. In mid-March 2012, the Australian dollar traded around of US105c while the trade-weighted index was around 78. The recent fall of the Australian dollar from US108c and TWI79 in late February was a result of speculation that lower economic growth in the December quarter 2011 would increase the likelihood of an interest rate cut by the Reserve Bank.

There are several important drivers of the Australian exchange rate over the medium term. In the next three years factors that may cause the Australian dollar to weaken are: the effect of the expected euro zone recession in 2012; a possible reduction in demand in Europe for China’s exports; a stall in the US economic recovery; and any decline in domestic interest rates.

In the last two years of the outlook period (2016 and 2017), it is assumed that the Australian dollar will slightly increase in value due to: expected stronger economic growth in Australia; recovery in the EU economy; a rebound in demand in Europe for China’s exports; and relatively low ongoing interest rates in the US that should dampen demand for US dollars. The demand in Asia for Australia’s exports, and market expectations about resources and energy commodity prices, are also factors that will influence the value of the Australian dollar over the outlook period.

In 2010–11, the mining sector contributed approximately 7 per cent of Australia’s total GDP. The gross value added produced from mining activities was about $100.7 billion (in 2011–12 dollars), of which $9.5 billion was contributed by exploration and mining support services (see Figure 5).

Resources and energy commodity exports account for a large proportion of Australia’s commodity exports. In 2010–11, the value of energy and minerals commodity exports was about $179.2 billion, some 85 per cent of Australia’s total value of commodity exports.

China is the main export market for Australia’s resources and energy exports, accounting for 26 per cent of Australian total export value of resources and energy commodities in 2010–11, followed by Japan (19 per cent), the Republic of Korea (9 per cent) and the US (4 per cent).

Over the past decade, there has been a significant increase in the value of investment in the Australian mining sector, supported by high commodity prices and strong demand from Asia. In 2010–11, investment in private new capital expenditure in the mining sector was $47.2 billion. This compared with inflation-adjusted figures (in 2011–12 dollars) of $37.5 billion in 2009–10 and $7.9 billion a decade ago. The share of the mining sector as a proportion of new capital expenditure of Australia’s total industries has also increased significantly, rising from 12 per cent in 2000–01 to 39 per cent in 2010–11 (see Figure 6). Much of this growth is underpinned by liquefied natural gas (LNG), coal and iron ore projects.

As a capital-intensive industry, the contribution of the mining industry to total employment is low, and accounted for about 2 per cent of total employment over the past three years. In 2010–11, the sector employed about 205000 people. By sub-industry, the metal ore industry employed the largest number of people (about 69000 people), followed by the coal and oil and gas extraction industry (see Figure 7).

In 2010–11, the overall index of Australian mine production increased by 5 per cent compared with 2009–10. This includes a 13 per cent increase in metals and other minerals production that was offset by a 3 per cent decrease in the production of energy commodities, primarily coal due to flooding in Queensland (see Figure 8).

Total Australian mine production is forecast to increase by 6 per cent in 2011–12, relative to 2010–11, primarily due to a 7 per cent increase in the output of energy commodities, particularly thermal and metallurgical coal. Another contributing factor to this growth will be a forecast 6 per cent increase in the production of metals and other minerals, underpinned by rising nickel and zinc production.

Figure 8: Australian mine production

Please refer to page 19 of the Resources and Energy Quarterly – March quarter 2012 PDF version.

Export earnings from energy and minerals commodity exports increased by 25 per cent in real terms (in 2011–12 dollars) between 2009–10 and 2010–11, reaching $185 billion in 2010–11 (see Figure 9). Of this total, export earnings from minerals commodities contributed $113 billion, accounting for about 61 per cent of the total. Export earnings from energy commodities accounted for a smaller share, 39 per cent, and contributed approximately $72 billion in real terms to the total value of Australian energy and minerals exports.

In 2011–12, the total export earnings for energy and mineral commodities are forecast to increase by 8 per cent to $199 billion supported by increases in the export values for both energy and mineral commodities. Energy commodity export earnings are forecast to grow by 7 per cent to $77 billion (in 2011–12 dollars) as a result of strong increases in export earnings from thermal coal (up 28 per cent to $17.8 billion), LNG (up 13 per cent to $12 billon), oil (up 7 per cent to $12.6 billion), and metallurgical coal (up 4 per cent to $31 billion).

Mineral commodity export earnings are forecast to increase by 8 per cent to $122 million as a result of increases in the export values of gold (up 33 per cent to $17.3 billion), alumina (up 14 per cent to $6 billion), copper (up 7 per cent to $9 billion), and iron ore (up 2 per cent to $59.7 billion). Partially offsetting the increased export earnings for mineral commodities will be lower forecast export earnings for aluminium (down 9 per cent to $3.8 billion), and zinc (down 8 per cent to $2.2 billion).

Over the medium term, the outlook for energy and minerals commodity exports remains robust (see Table 3 and Table 4). Investment in LNG production facilities will drive a surge in LNG exports over the outlook period and the commissioning of the Pluto LNG project is expected to boost exports in 2012. Based on mining, rail and port infrastructure expansions currently under way or in planning, significant growth in coal export capacity is expected over the next three years. The outlook for major energy and minerals commodities in detail is outlined in the following Resources Outlook and Energy Outlook sections.