There is no next China
Australia's economic outlook hinges on shifting global supply chains and iron ore demand, as China's manufacturing dominance faces challenges from emerging competitors and geopolitical tensions.
Iron ore has been in the news a lot lately for all the wrong reasons. Last week, Australia's Treasurer Jim Chalmers warned that softening prices for the key steel-making ingredient could wipe out $3 billion of federal revenue over the next four years.
I'm not entirely sure how he calculated that, because in the Budget Treasury undercooked its iron ore price forecast by assuming it would fall to $US60/tonne by the end of the March quarter 2025 (excluding freight, so really that's around $US70/tonne). In all likelihood, the Budget would have had a price for August 2024 below current spot prices, meaning we'd need prices to fall quite a bit from here to start wiping out projected revenue.
Anyway, the good news is that since Chalmers issued his warning, iron ore prices have rebounded to just above $US100/tonne. Barring a disaster between now and March 2024, iron ore looks like it'll create some upside risk to the next Budget.
The bad news is that some analysts are predicting prices are going to remain a lot weaker than we've seen over the past couple of years:
"Goldman Sachs says 'only 1% of Chinese steel mills are currently profitable. In the absence of a hot metal output recovery, continued strong iron ore supply means that we maintain the view that iron ore needs to remain below $100/t'."
Prices sustained below $100 would be bad news for the federal and WA Budgets, and also some of our higher-cost mining companies:
The above chart shows value-in-use, which adjusts the cost per tonne for the quality of the ore. That's important, because it means lower-grade producers like Fortescue, which claims to be "the world's lowest-cost iron ore producer", has its costs weighted appropriately.
If iron ore prices fall much further the most marginal mines will eventually shut down, helping to stabilise prices. For example, Mineral Resources has already announced that its relatively high-cost Yilgarn iron ore will cease operations at the end of this year, having banked a cheeky couple hundred million in royalty relief from the WA government over the past five years (a perfect case study in why tax incentives for mining are generally a bad idea).
So, barring a catastrophe in China – more than just a winter, but an ice age so bad that even the Chinese government refuses to step in as it almost always does in these "winters" – iron ore prices shouldn't collapse to levels where the federal Budget is too pressured.
Still, lower iron ore prices would mean fewer iron ore 'bonuses' in the Budget every year. So it was no surprise to find out that Chalmers is reportedly preparing for a trip to China in September, because he's likely to "be extremely anxious about the state of the Chinese economy – especially the steel industry – and will be keen to get a first-hand sense of what is going on".
Fair enough; not only is the Chinese economy in a bit of a flux, but globalisation itself looks to be evolving in ways that will have serious implications for Australia's future. Not in one, two or five years – i.e., the Budget forward estimates – but in ten, twenty or thirty years.