One of the world’s biggest commodity producers, BHP Billiton, recently got a lot of attention by suggesting that the so far insatiable Chinese demand for commodities may have come to an end. The argument is simple enough: the rate of growth in China is slowing. However, the implications for commodity exporters, such as Australia, who have invested dizzying sums of money in expanding capacity to reflect an ever higher increase in Chinese commodity hunger, may be very big indeed.
This has both cyclical and structural implications.
Cyclically, the sharp Chinese slowdown in the first half of 2012 is likely to strongly affect Australia, but structurally it is likely that Australia may be sitting on substantial overcapacity in commodities relative to future demand from China.
As the case with most commodities, supply of iron ore and steel is likely to be sticky relative to increasing demand. This is because the alternative situation is very painful for the owners of the capital. Writing off production capacity is often done at a considerable discount to cost, as it is difficult to move the capacity to other sectors.
However, Australia could very well be in this situation as China’s growth rate is now structurally declining. So far, the return on invested capital has been substantial. From 2004 to 2011 total net capital expenditure in the mining sector has been around A$220 bn. This compares with a total export value of iron ore and coal of around A$400 bn in the same period.
That is a healthy top line margin of 55% (based on net capital expenditure), but the evidence suggests significant overspending on capacity. Recent reports suggest that Australia may be lining up as much as A$112 bn of investment in ports and mining infrastructure in 2012 to satisfy growing demand in China and India. In the 12 months ending September 2011, gross construction expenditure was a full A$170 bn. Compared to these numbers the likely future export revenues don’t look big enough, and especially not if the trend growth rate of India and China declines even slightly.
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