Pete Wargent blogspot

Co-founder & CEO of AllenWargent property buyer's agents, offices in Brisbane (Riverside) & Sydney (Martin Place), and CEO of WargentAdvisory (providing subscription analysis, reports & services to institutional clients).

4 x finance/investment author - 'Get a Financial Grip: a simple plan for financial freedom’ (2012) rated Top 10 finance books by Money Magazine & Dymocks.

"Unfortunately so much commentary is self-serving or sensationalist. Pete Wargent shines through with his clear, sober & dispassionate analysis of the housing market, which is so valuable. Pete drills into the facts & unlocks the details that others gloss over in their rush to get a headline. On housing Pete is a must read, must follow - he is one of the finest property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.

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"The most knowledgeable person on Aussie real estate markets - Pete's work is great, loads of good data and charts, the most comprehensive analyst I follow in Australia. If you follow Australia, follow Pete Wargent" - Jonathan Tepper, Variant Perception, Global Macroeconomic Research, and author of the New York Times bestsellers 'End Game' and 'Code Red'.

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Friday, 26 September 2014

Burning pain ahead for coal mining regions

What next?

If there is one thing I learned from working in the mining industry, it is that forecasting commodity prices is a fool's errand.

Working in the copper/gold/silver sector each year I prepared budgets and forecasts based upon a range of assumptions, but realistically who could have forecast the outrageous swings in fortunes of those commodities through the past decade? Certainly nobody preparing the wildly inaccurate stockbroker reports, that's for sure!

Let us take a 60 second run through what's happening to the bulk commodities right now which is causing a great deal of excitement in the media and a great deal of pain to Western Australia's budgets in particular.

Since it accounts for almost one third of the Reserve Bank's commodity price index, iron ore is attracting most of the headlines, but as we will consider below, it could be the coal mining regions which face the brunt of the pain. 

Part 1 - Price

As I looked at here the respective prices of coking coal and thermal coal have genuinely crashed, and with Australian coal mines at the sharp end of the cost curve we are going to see an ugly shakeout of the high-cost producers and elevated levels of unemployment in coal mining regions.

Coal mining regions are already suffering badly, new coal projects are unlikely to get off he ground in the present environment, and unemployment in coal mining regions has already been rising worryingly.

That turn leads me to be fearful for property markets in coal mining towns and regions of Australia.

As for the iron ore price, well, history shows that commodity prices frequently overshoot on the upside in a speculative frenzy and on the downside as producers flood the market with a glut of supply, and we are currently in the latter phase during this cycle.

How far this has to run is anybody's guess - it's nigh on impossible enough to forecast in markets where the LME provides great transparency on warehouse stocks let alone where assumptions are reliant on rubbery data out of China.

We're still in the midst of a spectacular downtrend at present which will hurt Australian income, is pushing the Australian dollar dramatically lower and is now likely to force marginal producers to the wall and out of the game, until upwards pressure returns on prices, however long that may take (click chart).


Part 2 - Supply

The Reserve Bank has implied hopefully that declining commodity prices could elicit a slowing of supply from the large producers. 

That faint hope seems highly unlikely looking at the latest data out of Port Hedland, which shows that at the current pace of growth iron ore tonnages exported from the Pilbara could soon be double what they were only in October 2012. 

That's a heck of a lot of iron ore cargo bound for China's burgeoning stockpiles!


The RBA's own charts show an incredible boom in iron ore supply from Australian shores - so huge, in fact, that the increase in trade volume has completely offset the collapse in prices...to date at least.

Bulk Commodity Exports graph

There is little point in warning that property prices and rents could crash in the Pilbara, since completely unsurprisingly, they already have.

Part 3 - Demand

What about demand from China? 

Strangely certain PMI readings have have continued to suggest ongoing expansion. These indices are notoriously difficult to read - folk tend to get excited when they fall below 50, but in an economy such as China which has been growing at 7.5 percent, a reading with a '49 handle' might only suggest 'less fast' growth, which in fact is eventually is inevitable.



In short, it is impossible for the Chinese economy to continue growing at 7.5 percent in perpetuity - if it did then due to the compounding effect the economy of China would relatively quickly dwarf that of every other country in the world.


Something doesn't really seem to stack up here. More likely than not, a significant amount of the Chinese data is materially overstated as has been suggested by mismatches in import/export figures and as I looked at briefly here.

Part 4 - Production

The Reserve Bank acknowledges that its own data out of China related to mining production costs is at best opaque, but also makes the point that iron ore spot prices in the $70-80 range should shake out foreign producers first, with most of the big-hitting Australian miners much further down the cost curve. 

Whether or not this proves to be wishful thinking we will find out in due course, but some Australian producers are looking increasingly marginally profitable. If the RBA's research is accurate supply from China should slow since many of its producers will now be loss-making.


Australia's coal mining producers are now resembling rabbits caught in the headlights with our relatively high production costs making much of our coal production unprofitable, both for thermal coal and coking coal.

I looked at the possible impacts here, but in short, while marginal coal producers may keep the show on the road for a little while, further mine closures and redundancies look to be all but inevitable in the current climate.

The two charts below show just how many Australian coal producers potentially face making losses unless they can somehow slash costs or commodity prices rebound quickly.



A nasty shake-out looks unavoidable for some mining regions and producers.