September Quarter 2015



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Resources

and Energy

Quarterly

September Quarter 2015

This is a text version of the Resources and Energy Quarterly – September 2015 publication. Figures summarising information in this report have been omitted from this version and are available in the PDF and accompanying Excel files on the Office of the Chief Economist website.

If you have trouble accessing these files please contact chiefeconomist@industry.gov.au.



Further Information

For more information on data or government initiatives please access the report from the Department’s website at:

www.industry.gov.au.

Acknowledgements

Individual commodity notes have identified authors.

Cover image source: Thinkstock

© Commonwealth of Australia 2015

ISSN 1839-5007 [ONLINE]

Vol. 4, no. 4

This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no part may be reproduced or altered by any process without prior written permission from the Australian Government. Requests and inquiries concerning reproduction and rights should be addressed to:

Department of Industry and Science, GPO Box 9839, Canberra ACT 2601 or by emailing chiefeconomist@industry.gov.au



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Foreword

The Resources and Energy Quarterly provides data on the performance of Australia’s resources and energy sectors and analysis of key commodity markets. This release of the Resources and Energy Quarterly contains an update to the Office of the Chief Economist’s medium-term commodity forecasts over the period to 2020.


The combination of weak consumption growth and strong supply growth placed considerable downward pressure on commodity prices in the first eight months of 2015. Between January and August 2015, Brent oil prices declined by 4 per cent, iron ore prices (FOB) by 23 per cent and Newcastle thermal coal by 9 per cent.
Despite the current widespread downturn in commodity prices, the prospects for Australia’s resources and energy sector remain broadly positive. Australia’s resources and energy sector is transitioning from a period of high investment to a period of production growth. The environment of lower commodity prices has curtailed the flow of capital into new projects and also reduced sustaining capital expenditure. In addition, exploration expenditure has declined as companies respond to the need to cut costs and increase productivity by pushing existing operations.
The production phase of the boom, which is yet to peak, and is expected to last a lot longer than the price and investment phases of the boom (which were eight and six years respectively). The production phase is largely underpinned by $400 billion of investment that was channelled into resources and energy projects between 2003 and 2014.
Over the next five years all seven mega-LNG projects that have been developed over the past several years are scheduled to begin operation. When this occurs, Australia will emerge as the world’s largest LNG exporter. In 2014-15, Australia exported 25.5 million tonnes of LNG. By 2019-20, there will be a total of 86.6 million tonnes of LNG production capacity in place with a projected combined export volume of just over 76 million tonnes.
While current market conditions are challenging, over the medium- to long-term demand for Australia’s resources and energy commodities is projected to increase, due to increasing consumption in developing nations, particularly in Asia. This expectation is based largely on increasing urbanisation and the expansion of manufacturing in emerging, highly populated Asian economies. As a result, Australia’s earnings from resources and energy commodities are projected to increase at an average annual rate of 6 per cent a year from 2015-16 to total $235 billion (in 2015-16 dollar terms) in 2019-20.

Mark Cully

Chief Economist

Department of Industry and Science


Macroeconomic outlook

The global economy


The global economy is forecast to grow by 3.4 per cent in 2015, supported by growth in the US, European Union and non-OECD Asia. Emerging economies are forecast to grow by 4.4 per cent and the OECD by 2.3 per cent. Lower energy prices will support growth in most countries but is likely to be offset by weaker growth in key economies, such as China and Japan.

After a decade-long increase in commodity prices, driven by a combination of economic growth in China, a slow global supply response and the depreciation of the US dollar, global commodity prices are now in a downturn and many of the factors that supported the ‘supercycle’ are in reverse. Prices for most commodities declined through the first eight months of 2015, principally due to strong growth in mining and refining capacity, moderating world consumption growth and a shift in US monetary policies.

In 2016, world GDP growth is forecast to increase marginally to 3.7 per cent, supported by higher growth in advanced economies, particularly the US and European Union. However, stronger world economic growth is unlikely to stimulate a demand-driven recovery in commodity prices. As a result, most commodity prices are forecast to remain below their post-GFC peaks. Any price increases are likely to be the result of a cut in supply, rather than an increase in consumption, as higher cost producers exit the market or curtail production.

Over the medium term world economic growth is projected to increase to 4 per cent in 2020, supported by 5.5 per cent growth in emerging economies and 2.6 per cent growth in OECD economies. China and India are expected to contribute most to the growth in emerging economies while growth in the OECD economies is expected to be driven by the US and European Union.

A more detailed discussion on the economic outlook for key economies follows.

Figure 1.1: World economic growth

Please refer to page 4 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Figure 1.2: Economic growth in selected countries

Please refer to page 4 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Table 1.1: Key world macroeconomic assumptions

Please refer to page 5 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Outlook for key economies

United States


The US economy grew by 3.7 per cent in the June quarter, a significant improvement on the 0.6 per cent growth recorded in the March quarter. Growth in the June quarter was supported by an increase in household consumption, business fixed investment and the housing sector. However, net exports were weak as a result of volatility in international markets, including China and Europe, that are key destinations for exports.
Labour market indicators show that the utilisation of labour is improving. In August, unemployment fell to 5.1 per cent, 1 per cent lower than the same time last year.

Inflation has stayed persistently low throughout the year at around 0-0.25 per cent, which is well below the 2 per cent Federal Reserve Bank target. Low prices for energy and non-energy imports have contributed to sustained low inflation. As a result, the Federal Reserve decided to maintain discount rates at their September meeting. A decision to increase interest rates will depend on both the inflation rate moving towards the targets of a 2 per cent and the unemployment rate remaining low.


In 2015 US GDP growth is forecast to be 2.3 per cent, driven by consumer spending, low energy prices and an increase in employment. However, developments in key export markets will continue to have a strong influence over economic prospects in the US.
As the economy continues to gain momentum, GDP growth in 2016 is forecast to be 2.6 per cent. Despite lower energy prices, consumer spending is expected grow and drive economic growth.
Over the outlook period US GDP is projected grow 2 per cent a year to 2020.
Figure 1.3: US GDP growth

Please refer to page 6 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Figure 1.4: US quarterly contribution to GDP

Please refer to page 6 of the Resources and Energy Quarterly – September quarter 2015 PDF version.


China


The Chinese economy grew by 7 per cent in the June quarter 2015, down from 7.4 per cent recorded in 2014 and 7.7 per cent in 2013. Growth was supported by consumer spending and infrastructure investment. However, stock market volatility, devaluation of the yuan and continued weakness in residential construction detracted from this growth.

After 12 months of uninterrupted growth in its share market (share prices doubled in the year to 24 June 2015), China’s benchmark Shanghai Composite fell 7 per cent on 26 June and by a further 20 per cent through early September. However, the Shanghai Composite benchmark is still 40 per cent higher than at the same time last year. The share market accounts for around 5 per cent of China’s corporate financing, and the link between the share price and long-term profitability of companies is weak. As a result, volatility is likely to affect China’s share market over the short term, but the impact on the economy should be limited.

In August 2015 the People’s Bank of China cut the value of the yuan, which led to a large outflow of China’s foreign reserves through the September quarter. In mid-September China’s foreign reserves were down 11 per cent, or around US$436 billion, from the June 2014 peak of US$4 trillion. Although the decline in the value of the yuan was large, it had appreciated by around 30 per cent against the US dollar since the currency peg was lifted in June 2005. Despite the outflow, China still has the largest foreign reserves in the world, leaving it well placed to handle further market volatility.

Although residential construction continued to decline in the June quarter, down 16 per cent year-on-year, and vacancy rates increased 22 per cent year-on-year, housing prices have started to recover. The average price of housing in Tier one cities, such as Beijing and Shanghai, increased by 2 per cent between May and July while prices in other cities increased by 1 per cent. The turnaround in prices indicates that the growth in housing supply, which has weighed down residential values and construction growth, is moderating.

Figure 1.5: China quarterly contribution to GDP

Please refer to page 7 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Figure 1.6: Growth in China fixed asset investment

Please refer to page 7 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Figure 1.7: China’s new credit supply

Please refer to page 8 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Over the medium term China’s GDP growth is assumed to moderate to 6.5 per cent in 2020. While the rate of growth is slowing, it will still support large year-on-year increases in commodity demand.

China’s infrastructure investment is expected to grow strongly over the medium term, supported by government expenditure. This includes recently announced public private partnerships worth US$300 billion to develop infrastructure across China. Further, the Chinese government announced plans to invest US$125 billion in rail through 2015. Only US$50 billion of this allocation had been spent in the first half of 2015, indicating a further US$75 billion in rail investment over the remainder of 2015. The government has also committed around US$235 billion to deliver infrastructure associated with the ‘one belt, one road’ policy which plans to improve transport networks in western China and surrounding countries.

These new initiatives are on top of earlier commitments to redevelop government housing (US$64 billion), water infrastructure (US$14 billion) and the electrical grid (US$315 billion).

Figure 1.8: China’s residential sales and starts

Please refer to page 8 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Figure 1.9: China’s manufacturing PMI

Please refer to page 8 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

India


India’s economy grew by 7 per cent in the June quarter, which was lower than the 7.5 per cent growth rate recorded in the March quarter. Although the growth rate was lower than many analysts’ expectations, India’s growth was the same as China’s during the quarter and stronger than many other emerging economies, including Brazil and Russia.

India’s economic growth was supported by a fall in the value of the rupee and the lower price of key imports, such as oil. However, a second successive poor monsoon season had a significant impact on the agricultural sector. Agriculture accounts for around 17 per cent of India’s economy, and roughly half of India’s population makes a living through farming. For the full year 2015 and 2016, India’s economy is forecast to grow by 7.4 per cent.

Over the medium term India’s GDP growth rate is projected to be 7.0 per cent in 2020, supported by economic reform, infrastructure investment and an expanding manufacturing base. However, there are considerable challenges in achieving this growth, including modernising the tax system.

A key component of India’s proposed tax reform is to replace individual state consumption taxes with a nationwide goods and services tax (GST). India has more than 650 interstate checkpoints that local governments use to enforce regional sales taxes. Around 60 per cent of India’s freight is transported by road and these checkpoints cause considerable delays, increasing the cost of doing business. The introduction of a nationwide GST would replace the check points and is essential if the government is to meet their target of lifting India’s ‘Doing Business’ ranking from 142 (of 189) into the top 50 by 2017. However, tax reform has stalled in the Parliament and the original April 2016 date for implementation has been delayed.

The government’s plan for investing in electricity generation and implementing economic reform, particularly to the tax system, should drive growth in manufacturing and the broader economy over the medium term.

Figure 1.10: Quarterly contributions to India’s GDP

Please refer to page 9 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Figure 1.11: India’s current account

Please refer to page 9 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Japan

Japan’s GDP contracted to an annualised rate of 1.6 per cent in June 2015, underpinned by lower demand for exports and lower private consumption. Private consumption accounts for roughly 60 per cent of economic activity in Japan and fell 0.8 per cent from the March quarter, the first decline since an increase in the sales tax in April 2014. The decline in export demand was largely attributable to slowing economic growth in China, and the rest of the Asian region.

There are growing expectations that the Abe Government could introduce a fiscal stimulus package in response to a continued economic slowdown in China. However, the government is focused on the corporate sector being the key driver of growth, by encouraging them to redirect their profits to increase wages and capital expenditure.

Over the medium term, increased economic growth will rely on large scale investment to stimulate higher productivity and employment. However, growth is likely to remain constrained by an aging population and the need for fiscal consolidation. Over the medium term, Japan’s economic growth is forecast to average around 1.0 per cent a year.

Figure 1.12: Japan’s quarterly GDP, annualised

Please refer to page 10 of the Resources and Energy Quarterly – September quarter 2015 PDF version.



South Korea

South Korea’s economy grew at an annualised rate of 0.3 per cent in the June quarter, down from 0.8 per cent recorded in March. For the year ending June 2015, South Korea’s economy grew 2.2 per cent. In the first half of 2015, the economy was severely affected by the outbreak of Middle East Respiratory Syndrome (MERS), which substantially reduced tourist numbers and reduced consumer and business confidence. The economy is expected to recover in the second half of the year, aided by the government’s stimulus package, introduced to mitigate the effects of the outbreak.

Over the medium term exports are expected to be a key contributor to South Korea’s economic growth, as the South Korean won weakens from current levels against the Japanese yen and Euro.

Figure 1.13: South Korea’s quarterly GDP

Please refer to page 10 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Europe

Gross domestic product in the EU28 increased by 1.9 per cent year-on-year in the June quarter, led by growth in the United Kingdom, Spain, Poland and Sweden.

Growth across the EU28 was supported by 2.2 per cent year-on-year growth in household consumption and an increase in fixed asset investment, up 2.6 per cent year-on-year.

Output in the United Kingdom increased by 2.3 per cent, year-on-year, supported by strong growth in the distribution, hospitality, transport and business services sectors. Gross domestic product in the United Kingdom is now 5.2 per cent higher than the pre-downturn peak of 2008.

In contrast, the Russian economy slipped into recession in the June quarter, contracting 4.6 per cent year-on-year as the decline in the price of oil and the impact of sanctions continued to affect economic growth. The Russian economy is expected to contract further in the near term, led by falling export revenues, inflation (which reduces real household incomes) and a decrease in consumer spending.

Within the EU28, economic recovery is expected to continue in the near term. However growth is projected to remain below levels recorded prior to the financial crisis in 2008. The EU28 is forecast to grow by 1.6 per cent in 2015, considerably lower than the average annual growth rate of 2.7 per cent for the five years to 2007.

Over the medium term, growth within the EU28 remains subject to a number of significant risks, including the extent of the economic downturn in Russia, its effect on member economies, and the Greek sovereign debt crisis.

Greece narrowly avoided a further default in July after securing its third bail-out package in five years. However, there is widespread uncertainty over its resolve to implement the stringent reforms associated with the deal and the risk of default.

Growth within the EU28 is projected to improve modestly towards the end of the outlook period, with output increasing by 2.0 per cent in 2020.

Figure 1.14: Economic growth in Europe

Please refer to page 11 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Figure 1.15: Year-on-year change in Russian CPI

Please refer to page 11 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Economic outlook for Australia’s resources sector


It is clear that the commodity price cycle is in a downturn as the factors that supported the rapid increase in prices over the last decade subside. Growth in China’s commodity demand, once believed to be insatiable, is beginning to slow as the economy transitions away from investment-led growth to consumption-led growth; the substantial investment in new projects over the past several years is beginning to translate into additional supply; and the US dollar is beginning to appreciate against other currencies.
The outlook for Australia’s resources and energy sector will be characteristically different to the price and investment phases observed over the past decade, and will depend on developments over the short- and medium-terms.
In the short-term, the resources and energy sectors are transitioning from the investment phase to the production phase. As commodity prices decline and investment in the sector is reduced, Australia’s resources and energy sector is turning its focus to improving productivity and reducing costs rather than just increasing output. Current operating conditions are not a new phenomenon for the Australian resources sector which has shown considerable resilience in the face of commodity price cycles and changing economic conditions in the past.
Over the medium term there are still factors to support growth in commodities demand, particularly in emerging economies that are investing in housing, infrastructure and manufacturing to support growing populations and industrial bases. The Australian sector is well placed to meet future commodity demand as production starts to increase following a long period of investment. Increased production volumes have been reflected in growth in exports. In 2014-15, exports of iron ore and coal increased by 15 per cent and 5 per cent, respectively.
The resources sector has been a key contributor to the Australian economy through large export earnings and capital investments and the slowdown in activity has had an effect on economic growth. Australia’s GDP growth slowed from 0.9 per cent in the March quarter 2015 to 0.2 per cent (in seasonally adjusted terms) in the June quarter 2015. The slowdown was driven by reduced activity in the resources sector, which declined 3 per cent in the June quarter. However, the sector’s production was still 2.1 per cent higher year-on-year for the first half of 2015. Reduced activity in the resources sector also detracted from export earnings and mining-related construction. The slowdown in these sectors was partially offset by increased domestic consumption and stronger performance in the financial, transport and health sectors.

The Australian dollar has depreciated against the US dollar over the past year, but has been historically high since the mid-1990s. Declining commodity prices and the subsequent deterioration in the terms of trade and relatively low interest rates are likely to result in further downward pressure on the exchange rate. The Australian dollar-US dollar exchange rate is forecast to average 0.74 US dollars in 2015-16 but there is a strong risk that the Australian dollar could depreciate further. Over the medium term, the Australian dollar is assumed to return to its long term average of around 0.75 US dollars by 2019-20.

Figure 1.16: Commodity price index

Please refer to page 12 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Figure 1.17: Australia’s economic growth, seasonally adjusted

Please refer to page 12 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Figure 1.18: Australia’s exchange rate

Please refer to page 13 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Table 1.2: Key macroeconomic assumption for Australia

Please refer to page 13 of the Resources and Energy Quarterly – September quarter 2015 PDF version



Exploration

In 2014-15, the downturn in commodity prices pushed many companies to implement cost cutting programs to remain profitable. As a result, exploration expenditure decreased 23 per cent to $5.4 billion. Minerals exploration declined 25 per cent to $1.6 billion and petroleum exploration declined 21 per cent to $3.8 billion. With generally lower prices forecast, a pick-up in exploration is unlikely in the short term.


Mineral exploration expenditure declined in all states and territories during 2014-15. Most of the decline occurred in Western Australia and Queensland, which decreased by $303 million and $140 million to $917 million and $311 million, respectively.

The decline in minerals exploration expenditure was relatively evenly spread between exploration at existing deposits and new deposits, which were down 24 per cent and 29 per cent, respectively in 2014-15.

Figure 1.19: Australia’s exploration expenditure

Please refer to page 14 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Figure 1.20: State exploration expenditure

Please refer to page 14 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Figure 1.21: Exploration by expenditure, by deposit type

Please refer to page 14 of the Resources and Energy Quarterly – September quarter 2015 PDF version.


Capital expenditure


There was an unprecedented escalation in investment in resources and energy projects in Australia over the past decade, underpinned by rapidly increasing consumption and commodity prices. However, the current state of commodity markets is no longer supportive of further investment in new projects. In 2014-15, mining industry capital expenditure was $76.1 billion, down 16 per cent from 2013-14.

Given the projected softness in commodity prices over the medium term, the outlook for new investment in the Australian resources sector is likely to be subdued. As high-value LNG projects are completed, the stock of investment in the sector will be drawn down. Although investment has slowed, new projects are likely to continue to be developed to maintain output as older projects reach the end of their operating life.

Australia has many high quality mineral and petroleum deposits that can be developed when the economic cycle rebounds. However, Australia will need to compete with other resource-rich countries to secure investment and must ensure it remains a leading destination for attracting capital.

Figure 1.22: Mining industry capital expenditure

Please refer to page 15 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Mining sector employment

Cost cutting activities in response to lower prices have reduced the number of employees at a number of operations. Despite this, mining sector employment was 245 700 people in the September quarter 2015, 4 per cent higher than the September quarter 2014 and 8 per cent higher than the June quarter. Mining sector employment is not expected to rebound substantially in the medium term as a decline in construction labour associated with the large LNG projects is likely to offset any increases in employment associated with rising production.

Figure 1.23: Total mining employment

Please refer to page 15 of the Resources and Energy Quarterly – September quarter 2015 PDF version.



Australia’s resources and energy commodity production and exports

Commodity prices have declined steadily over the past year in response to strong growth in supply, slowing consumption growth and a stronger US dollar. This has created a challenging operating environment that has encouraged Australian producers to implement cost cutting and productivity enhancing initiatives to remain viable. Although these measures have been successful for many producers, a number of mines have been forced to close. Despite the challenges, the investment in new capacity over the past few years is translating into higher production.

The rapid increase in supply that has emerged over the past few years is forecast to persist in the short term and contribute to continued low commodity prices. As growth in supply begins to slow in response to reduced investment and the closure of unprofitable capacity, the projected growth in consumption will begin to put upward pressure on prices over the medium term.

Australia’s earnings from resources and energy commodities decreased by 12 per cent to $172 billion in 2014-15 as growth in export volumes was more than offset by lower prices. Earnings from resource commodities were $105 billion, down 15 per cent from 2013-14, driven primarily by lower earnings from iron ore. Earnings from energy commodities declined 6 per cent to $67 billion because of a decline in earnings from coal exports.

In 2015-16, Australia’s earnings from resource and energy commodities are forecast to increase by 3 per cent to $176 billion as higher export volumes for most commodities and the effect of a depreciating Australian dollar more than offset forecast lower prices.

Over the medium term, the outlook for the Australian resources sector is largely positive. The prices of several commodities, in particular iron ore and coal, are projected to increase moderately towards the end of the outlook period. In addition, production and export volumes are projected to increase as the recent investment in the sector contributes to increased output. The strongest growth in export earnings is projected for LNG, where the development of new projects on the east coast of Australia is projected to contribute to a near tripling of LNG exports.

Australia’s earnings from resources and energy exports are projected to reach $235 billion (in 2015-16 dollars) by 2019-20. Earnings from resources exports are projected to total $138 billion (in 2015-16 dollar terms), while earnings from energy are projected to total $97 billion in 2019-20.

Figure 1.24: Australia’s resources and energy export earnings

Please refer to page 16 of the Resources and Energy Quarterly – September quarter 2015 PDF version.

Table 1.3: Outlook for Australia’s resources and energy commodities

Please refer to page 17 of the Resources and Energy Quarterly – September quarter 2015 PDF version

Table 1.4: Australia’s resources and energy commodity exports, by selected commodities

Please refer to page 17 of the Resources and Energy Quarterly – September quarter 2015 PDF version

Figure 1.25: Australia’s major resources and energy commodity exports

Please refer to page 18 of the Resources and Energy Quarterly – September quarter 2015 PDF version

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