Economic lessons from WA: nobody booms over this bust
The Western Australian government's budget and Rio Tinto's continuing reliance on the Pilbara reflect economic reality rather than political or corporate rhetoric, write Bernard Keane and Glenn Dyer.
An Australian government with rising debt, budget deficits, slashed spending, broken promises, criticism that with such a strong economy the budget should be in healthy surplus, forecasts of higher unemployment and lower growth — it all sounds familiar, yes?
But oddly, there hasn’t been a peep out of the Coalition about it. No cries of economic mismanagement, no claims about a “budget emergency”, no Tea Party-like references to the “debt ceiling”. Not a sausage.
That’s because it’s a Liberal government responsible for such a budget — the Western Australian government, which handed down its budget yesterday and forecast a deficit next year and surging government debt despite another round of savings and the abandonment of some election promises.
Some economists — the sort who sit in think tanks, investment banks or universities and never face an election for anything beyond president of the social club — decried WA Treasurer Troy Buswell’s budget as evidence of the fiscal torpor of politicians, given the booming state of the WA economy. In fact, the WA government took the right approach, trimming spending but refusing to be obsessed with staying out of deficit even at the cost of curbing growth and pushing unemployment even higher.
WA faces a variant of exactly the problem that the Commonwealth has faced: Australia has been enjoying low-inflation growth (it’s enjoyable for consumers, but less so for governments), which has curbed tax revenue growth, and now the end of the mining investment boom is causing economic growth to taper off until more traditional growth drivers properly kick in — or a more production-oriented Mining Boom Mark 3 arrives. The only sensible course for governments is to cop the resulting further decline in revenues rather than slashing spending, and start seriously looking at their fiscal balance over the medium term — which means more revenues.
Unfortunately for the states, they have rather fewer options for increasing revenue than the Commonwealth, especially if they’re disinclined to increase damaging and economically inefficient taxes like stamp duties. The WA solution, given it had a mining boom underway, was to significantly lift mining royalties — something else that failed to draw comment from the federal Coalition as it railed against the mining tax as “sovereign risk” and a deterrent to investment. Barnett’s increased royalties will pull in over $5 billion from mining companies this year.
Even so, Rio Tinto and BHP continue to invest heavily in their iron ore expansion plans in the Pilbara: Rio is planning to spend around $5 billion on its Pilbara expansion, BHP a similar amount (other companies such as Fortescue also continue to invest, as does Gina Rinehart). Neither Barnett’s increased royalties nor the mining tax, which was upheld by the High Court this week but continues to produce little in the way of the revenue forecast by the government, have deterred them: these companies need the huge revenues, cash flows and profits being produced from selling hundreds of millions of tonnes of iron-rich dirt and rock to China, Japan, South Korea, Taiwan and anyone else — but especially China.
Why, despite shareholder objections, are these companies continuing to invest heavily in iron ore? Despite constant predictions of a China-led collapse in iron ore prices, they remain at historically high levels. A year ago this month, iron ore prices fell to a low of $US87 a tonne but rebounded to more than $US158 a tonne and now sit around $US130 a tonne, which is higher than any one thought one to two months ago. The second quarter national accounts will show early next month, just as they did in the first-quarter figures, that iron ore exports continue to generate growth for the Australian economy. Certainly they have been the major contributors to the trade surplus for the past six months (as federal Treasury and the Reserve bank forecast they would). BHP, Rio and Fortescue all reported higher-than-expected June quarter production and exports.
“A look at yesterday’s interim result from Rio Tinto tells us why these big companies continue to invest in Australia and the iron ore business.”
Their investments will enable Rio and BHP to maintain their position as the world’s lowest-cost producers (the fall in the value of the dollar in fact adds to that attraction now), to put pressure on buyers and competitors alike that will force steel mills to buy from them on the basis of cost, and to put price pressure on smaller rivals (and the giant Vale operation in Brazil).
And a look at yesterday’s interim result from Rio Tinto tells us why these big companies continue to invest in Australia and the iron ore business. Even though prices are down, Rio still has gross sales to profit margins of close to 70% in its WA iron ore business. BHP’s are similar. No other industry in Australia can boast those returns, and they are better than Apple’s and other tech giants.
Rio reported that revenue from its Pilbara iron ore operations was $US10.752 billion, down from the $U11.273 billion for the six months to June 2012. Rio reported earnings before interest, tax, depreciation and amortisation of $US7.295 billion (a gross margin of 67.8%), compared with $US7.995 billion a year ago (71%).
But Rio’s net profit fell 71%: there were yet more write-downs, US$2.5 billion of them, including $US1.9 billion in debt and derivatives that were impacted by the slide in the value of the Australian dollar. It was only a year ago that Rio wrote off more than $US14 billion, all but $US3 billion of it on its aluminium assets. Some $US30 billion has been written down by Rio since 2008. And now after two years of trying, it can’t sell off the worst of its aluminium assets, which are located in Australia and New Zealand.
Rio chief executive Sam Walsh, who headed up the WA iron ore business, has been a long and frequent critic of Australian productivity, red tape, wage costs, industrial relations and competitiveness. Walsh is a media darling among the business media in Australia and the UK for his availability, his colourful and forthright speaking and ability to speak the language that papers such as The Australian Financial Review and The Australian want to hear.
But he never talks about the fat profit margins from the company’s Australian operations, even with conditions weaker than they have been for a couple of years, nor does he talk about the attractiveness of WA iron ore, or how his company needs those assets and their high profits and cash flows, which in turn are giving him time to restructure the company and right the dud decisions like buying Alcan and wasting $US3 billion in a badly planned foray into coking coal in Mozambique that was supported by the same business media and many analysts.
While these foreign ventures went bad for Rio, its Australian assets kept performing — despite the alleged high cost, low productivity, terrible industrial relations laws, bolshie unions, sovereign risk and red tape apparently endemic in Australia.
Whether it’s fiscal policy, or company investment decisions, it’s a good idea to look at what politicians and companies do, not what they say. The reality usually belies the rhetoric.