Commodity boom is not over just yet

Calling an end to the commodity boom is problematic because the definition of what constitutes the boom depends on who you are.

Since BHP Billiton shelved $40bn of mining projects in Australia when announcing lower profits on Wednesday, the nation has been engaged in an exercise of navel-gazing and mud-slinging as to what has or hasn’t gone wrong.

For Reserve Bank of Australia governor Glenn Stevens the boom is far from over, with the economy growing at potential and inflation contained.

It’s not a problem for Stevens that some of the resource projects under consideration won’t go ahead because of cost pressures, as there is still a large pipeline for the next two years.

Even when the capital investment phase of the boom runs out, it will be replaced by the actual export of commodities from the new mines’ liquefied natural gas plants, Stevens reckons.

For Rio Tinto CEO Tom Albanese there never was a commodity boom in the first place.

Australia’s politicians are having a field day, with resources minister Martin Ferguson first proclaiming the resources boom is over, much to the horror of his fellow ministers in the Labour Party-led minority government, who have staked their credibility on using revenues from commodities to pay for generous welfare entitlements.

He later rowed back, saying he meant commodity prices had peaked but investments in multibillion-dollar projects will go on.

Of course, opposition Liberal Party leader Tony Abbott, whom the polls say would oust prime minister Julia Gillard if an election was held today, tried to blame the end of the boom on the government’s new carbon and mineral resource rent taxes.

He’s mainly wrong on that count as the new taxes wouldn’t have made the slightest difference to BHP’s Olympic Dam copper mine expansion, but he was on the right theme in a roundabout way, namely that higher costs are pressuring projects.

So, before we can pronounce on the vital signs of the commodity boom, it’s important to decide exactly what we are talking about.

To my mind there are two main elements to the equation.

Firstly, there is the growth in volumes of commodities being consumed worldwide, led by rapid industrialisation and urbanisation in China and India.

Secondly, there is the increase in prices of commodities as a result of the first factor driving demand harder than supply can keep up.

The first part of the boom saw prices climb far more rapidly than supply, a process abruptly ended by the 2008 global financial crisis.

The second phase is where we are currently, with investors starting to worry that the supply response by resource companies such as BHP and Rio is going to outrun gains in demand, especially in an environment of slower growth in China, recession in Europe, and turgid recovery in the US.

One of the key failings of humans is to assume that the conditions they currently find themselves in will continue to exist indefinitely.

It’s also important to note that no boom is ever a straight line upwards; there are always periods of weakness followed by recovery.

Does anybody seriously believe China and India are about to stop industrialising and urbanising?

No. Therefore there is every chance global demand for key commodities such as crude oil, copper, iron ore, and coal will continue to rise for years to come.

The question then becomes whether the supply response has been overdone. The evidence is debatable.

In the short term most major commodities seem adequately supplied, especially if Chinese demand does ease.

Assuming China and India do continue to grow their economies at an average 8% a year over the next few years, this will result in large increases in commodity demand, and the slowing of investment in new mining and energy projects may result in a shortfall.

It’s this longer-term outlook that is behind the upbeat assessment of Australia’s central bank boss and the CEOs of major resource companies.

But in the current environment companies like BHP and Rio would be punished by investors if they were being seen to be spending too much capital on projects where demand is yet to be 100% assured.


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