One of Australia’s most consistent exports in recent history has substantially fallen in price, posing questions around Australia’s future economic outlook. This week’s article will explore the significance of the export, why the price has fallen and the subsequent impacts on the Australian economy.
1. Iron Ore Prices have dropped from $US230 a tonne to around $US160 a tonne
Demand for iron ore has undoubtedly been a shoulder for Australia to lean on during the face of economic adversity. It was there for us during the Global Financial Crisis (which the rest of the world knows as ‘The Great Recession’) and has certainly been a source of support during the pandemic. This is mainly due to countries such as China (who purchase around 70% of Australia’s iron ore exports) having an inelastic demand for the commodity to engage in activities such as infrastructure expenditure, a common policy response to periods of financial contagion, such as the one caused by the global pandemic. Even during the current tensions between Canberra and Beijing, iron ore has been relatively unscathed from protectionist measures set out against Australia, which have affected commodities such as wine, barley and timber. This is because 60% of the iron ore imported by China is from Australia, due to the high quality of the product. It is important to note that the increasing price of iron ore would normally not be entirely positive for Australia, as theoretically, demand would decrease accordingly. However, as mentioned previously, international demand for Australia’s iron ore was relatively inelastic, meaning demand is not greatly affected by fluctuations in the price of the good, and export revenue has been estimated to increase from $103 billion in 2019-2020 to $149 billion in 2020-2021 by Keith Pitt, the Minister for Resources and Water.
2. So why the sudden decrease in price?
The record high value of $US230 was mainly facilitated by a concurrent increase in demand from China following the aforementioned focus on infrastructure expenditure as well as supply continuing to be relatively constrained as other competitors such as Brazil have been impacted in their ability to meet demand due to the collapse of the Brumadihno dam, as well as the worsening impacts brought about by COVID-19. However, China’s rapid uptake in steel manufacturing has prompted a record high in steel production, with China’s National Bureau of Statistics noting that China had produced 16% more steel compared to the same period last year. Essentially, China has manufactured more steel than desired, and with consideration of their slowing economy and rising iron prices, have lowered their demand accordingly. Additionally, UBS analysts believe that the upcoming Winter Olympics will disincentivize further steel production due to the impacts of air pollution, noting, “We expect China’s steel curtailments to be targeted in Q4 when demand slows seasonally and air pollution is in focus (especially ahead of the Winter Olympics in Feb-22) and as a result we expect prices to stabilise in Sept/Oct before continuing to fall back below $US100/tonne in 2022”. One would think that an upcoming event such as the Winter Olympics would encourage further iron exports to meet the demands of the event, however, the dual impacts of the pandemic and China’s oversupply of steel has subdued this sentiment. It also doesn’t help that Brazil has now begun to increase its supply, with UBS analysts estimating a 12% increase in iron ore exports compared to the previous year. Ultimately, the joint increase in supply and decrease in demand prompted an inevitable decrease in the value of iron exports.
3. So what does this mean for the Australian economy?
It is important to note that while these movements in prices are significant, the price of iron ore at the end of last year was below $US120 a tonne. However, the trend of decreasing prices, especially when the reasons behind these decreases are considered, are what is most concerning. This is supported by Commonwealth Bank commodities analyst Vivek Dhar who notes that “While we still think it’s unlikely for iron ore prices to fall as steeply as the budget forecasts in coming quarters, it’s certainly clear that iron ore prices may not be as positive for the Australian economy as hoped.” Unsurprisingly, the Treasury has made quite conservative estimates on the value of iron ore at the end of March 2022 ( $US55 a tonne), and while Mr Dhar and other analysts believe that it is unlikely for prices to reach this level, they do believe there will be a significant decrease in the price of the commodity by March 2022. This has impacts on several of Australia’s economic indicators.
Iron ore is Australia’s largest source of export revenue, so any decrease will have a major impact on aggregate demand, and subsequently growth. And as we all know, labour is a derived demand of growth, so unemployment is prone to increase accordingly. However, the increasingly problematic issue of external stability will also be greatly impacted. Not only will the Current Account decline with the decreased value on the Balance on Goods and Services, but also tax receipts are expected to take a fall, having an impact on Net Foreign Debt and Net Foreign Liabilities as a % of GDP. During the 2019, financial year, Deloitte has reported that the minerals sector had contributed a total of $39.3 billion both in tax and royalties. While Josh Frydenberg had not readied this year’s budget assuming that iron prices would stay high, there were also no assumptions to account for the impact of lockdowns currently faced by the majority of Australia’s population, placing Australia’s next budget outcome and external stability in an uncertain situation.
