As the iron ore price continues to head
lower, welcome to the pre-budget season of managing expectations.
Tony Abbott might be hoping for a dull or
"steady as she goes" document to be revealed on May 12, but the
declining state of government revenues will see Treasurer Joe Hockey and other
ministers on the public relations treadmill in the month ahead.
The southward direction of the iron ore price
- today at US$47.30 a tonne - represents a dangerous moving target given that
Mr Hockey had factored in what he thought was a conservative US$60 in
December's midyear budget update.
Now the Treasurer's expectations are being
driven increasingly lower price and with the market far from bottoming out, he
is now warning of $US35 a tonne before it hits a floor.
The treasury alarm bells are ring because
this time last year, revenue from corporate tax and royalties was still in boom
territory at around US$117 a tonne.
As the headwinds get stronger, Joe Hockey is
under pressure to pull a fiscal rabbit out of the hat to replace disappearing
revenue at a time when public acceptance and political will for tough budget
measures appears to have evaporated.
The miscalculation of what looked like a
steady correction a year ago is now damaging the government's election promise
to be a conservative economic manager on a credible path to surplus.
Iron ore price heading twoards US$35? Source: Thomson Reuters |
While there appears to be an element of shock
about the pace of the iron ore decline, the warnings from the Reserve Bank have
been constant for at least the past two years.
Time after time, RBA documents and public
statements have flagged that the investment phase of the resources boom was
ending and that the transition back to traditional parts of the economy is
slower than expected.
Just last week, as interest rates were kept
on hold at 2.25 percent, governor Glenn Stevens was typically understated as he
said "commodity prices have declined over the past year, in some cases
sharply" and "Australa's terms of trade will continue to
decline".
So with iron ore veering into crisis
territory, with futures down 30 percent in the space of a month, how worse
could it get?
The big players - BHP Billiton, Rio Tinto and
Vale - can afford to dramatically ramp up volumes to keep the dollars rolling
in even though flooding the market has done little to put a floor under the
price.
But smaller exporters, unable to withstand
the high cost business of extracting iron ore, are at risk of going to the
wall.
Late last week, the junior miner Atlas Iron
announced it would progressively suspend production at its Pilbara mine sites
because of the plunging iron ore price.
The Atlas share price over the past year
demonstrates the crisis for small miners - down from a year high of $1.08 on 10
April 2014 to a low of 12 cents before the company went into a trading halt.
Fortescue Metals recently pulled out of
efforts to refinance US$2.5 billion of debt after rejecting an unattractive
risk premium from US credit markets.
And last month Fortsecue's chairman Andrew
Forrest highlighted the miner's desperation by suggesting that the world's big
miners should act together to cap iron ore production to keep prices high.
Mr Forrest is now being investigated by the
Australian Competition & Consumer Commission after chairman Rod Sims warned
even the suggestion of cartel behaviour risks civil and criminal penalties.
The big factor out of everyone's control is
China as the world's second biggest economy continues to slow towards a still
strong annual growth target of around seven percent.
While a hard landing is looking less likely,
Chinese steel producers are cutting back to deal with softening construction
demand.
At the same time, stockpiles of iron ore are
not being topped up as frequently given the likelihood that prices will be
lower in the short term.
Analyst Li Wenjing told Reuters late last
week: "the overall market in bearish and only buying on a hand to mouth
basis."
The softer market for iron ore is also an
opportunity for Chinese steel mills to meet tighter regulations on carbon
emissions after a surprise declaration on "blue skies" at the APEC
summit late last year.
So despite a stronger US economy, Australian
remains hostage to an uncertain global outlook given the reality of a weaker
appetite from China and Europe's flatling economy continuing to loom as a
potential shock in the event of a Greek exit from the Eurozone.
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