Over the past dozen years, digging holes to keep the economy growing instead of building a clever, diverse and innovative economy has proven to be a short-sighted idea. Australia has seen more than a decade of ‘Dutch Disease’.
A mining investment boom was funded and promoted by overseas interests with little local control. This funds flow overwhelmed the local economy leaving it weaker and less resilient than it had been at the end of the 20th century.
Australia has relied too heavily on leveraging into property investment, while the housing market was turbo-charged by illegal foreign investors.
Too many of Australia’s skill-based manufacturing industries have been or are about to be closed down, off-shored, sold or scaled back. Value adding has suffered under rising domestic costs and a persistently high Aussie dollar, buoyed up by an influx of investment dollars, combined with a lack of innovation and capital spending. All of which led to many local skills-based activities to become uncompetitive on the global stage.
A rapid rise of investment directed towards resource projects, including iron ore and LNG, saw the share of GDP directed to this area rise from around 2% to more than 5%. Activity in resource-based industries starved other areas of the economy of funds and skills, lifting their cost of doing business, while giving government planners a false sense of comfort and optimism.
Now that commodity prices have tanked, Australia is left with an economy that looks very Third World. It has an economy based on building houses to accommodate record population growth and digging holes to export scarce, finite and non-renewable resources to clever economies that transform them into high-value products for Australians to import.
Since 2001, easy money policies globally have also supported multi-billion dollar investments in raw materials projects. Lenders and investors to higher cost iron ore and LNG projects were focused on chasing yield in a low interest rate environment.
The positions of many investors and lenders will be threatened during 2016 as supply-side rationalisation becomes the norm. When interest rates revert to the mean over coming years, counter-party risks will rise as lenders to unsupportable projects and emerging markets fold under that pressure.
The most visible signs of stress so far can be found in the highly leveraged commodities trading book of Glencore and the recent capitulation by Anglogold Ashanti. However, much more pain will be felt by lenders to high cost oil and gas producers in the US and other bulk commodity projects in Australia and emerging markets.
StockAnalysis thinks that this progression of events is highly likely to lead to a recession for Australia during 2016.
So far, the Australian stock market has been held up by the finance sector, big retailers, property investment companies and Telstra. Yield-chasing investment has masked some of the worst market conditions ever seen among energy and other resources stocks.
Prices for most commodities have already fallen well below the marginal cost of production. Supply response by metals that have a diversified supply is likely to be seen during H1 2016, but bulk commodities where supply is dominated by a small number of large suppliers, such as for iron ore and coal, are likely to see prolonged downward pressure on price.
Oil supply at a price of sub-$US40 per barrel is seriously threatened over the longer term. New project investment has collapsed. Globally, oil production will be on a declining curve through 2016, led by an estimated fall of about one million barrels per day out of the US by December 2016.
Some newly commissioned LNG projects may also falter, while others such as offshore East Africa, the Browse Basin and some US LNG projects, will be shelved until more visibility on forward pricing is available.
Woodside is likely to rationalise its North West Shelf LNG operations, combining Pluto and Wheatstone assets in a way that lowers costs and reduces gas delivery risks from reservoirs that may not be as technically well understood as might have been assumed.
Shell may also combine gas from its Prelude project with gas from the nearby Crux gas field to feed its FLNG project.
Santos and ConocoPhillips may also find that their recent Browse Basin gas discoveries could find a home with Inpex’s Ichthys project to ensure that the project has sufficient gas deliverability over time.
According to Brazil’s Vale, about 600 million tonnes or 30% of global iron ore capacity is uncommercial at a CFR iron ore price of $US40/tonne. This includes about 130MMt of ‘social metal’ output from China that will ignore the market price over the short term.
All estimates indicate that if the iron ore price gets to the low $US30s per tonne, Fortescue Metals Group and Vale would be under significant stress, while the smaller players and newly commissioned Roy Hill project will be substantially under water.
The EIA estimates that by January 2016, total shale oil output from the US will have fallen some 650,000bopd from an April 2014 peak of 5.5mmbbls per day.
Some of the US’ shale oil production decline has been offset by new output from conventional, deep water Gulf of Mexico oil projects.
