The unlikely conjunction of massive collapses in the prices of the most disparate group of commodities — oil, iron ore, coal and dairy products — has major budget implications for the government. Commodity prices, according to Bloomberg, will likely be down at the end of this month for the fourth year in a row.
Iron ore and coal prices were forecast to be weak-to-uncertain most of this year, but no one — including the government’s chief commodity adviser, the Bureau of Resources and Energy Economics — predicted iron ore would be around US$71 a tonne, as it was on Friday night (it was over US$130 a tonne a year ago); that thermal coal would be around US$65 a tonne; or that coking coal would be just over US$100 a tonne for the highest-quality product from Queensland. A year ago, BREE released estimates for iron ore around US$128 a tonne, coking coal around US$149 a tonne and thermal coal around US$108 a tonne.
And dairy prices have plunged more than 50% since February, thanks to higher production from the United States and Europe, slowing demand growth in China and sanctions imposed on Western dairy imports by Russia. The impact is greatest in New Zealand, which is facing a terms of trade shock — similar in impact to that in Australia, caused by falling iron ore and coal prices — from a NZ$5.5 billion drop in dairy sector income. Already New Zealand’s October trade figures revealed a 70% fall in dairy export income in October, and October’s trade deficit was at a six-year high. Lower oil prices will help New Zealand, which imports most of its energy, but it won’t be enough to offset the plunge in dairy returns.
That Business Council paper suggesting we become more like New Zealand and try to establish national champions in areas like dairy now looks sillier than ever.
And then there’s oil. No one saw that plunge: BREE forecast oil in 2014 to ease to US$97 a barrel for West Texas-style US light crude and to US$105 a barrel for Brent-style crude — the key global marker. They were at US$68.05 and US$70.15 respectively on Saturday morning in New York. The other key oil price for Australia is the Tapis-style light crude from southeast Asia. The May budget had a price of US$113 a barrel — late last week it was trading around US$78 a barrel.
For Australia, the big dangers are falling oil (and liquefied natural gas prices will start edging lower as 2015 goes on to catch up with the oil price), coal and iron ore prices. All three carry problems for the federal budget and for state budgets, especially in Western Australia, Queensland and New South Wales. Banks are also in the gun — the mining services sector is already a headache for our big banks, with a higher level of impaired or bad debts. In its September Financial Stability Review, the RBA identified mining as one of the problem areas for bank loans.
Gold, copper and other metal prices have fallen as well (we are big exporters of those), aluminium is weak, and even though the weaker dollar is offsetting some of the impact, it’s not falling fast enough. For Australia, the pressure is on budget revenues from both falling company tax payments, lower-than-forecast personal tax collections and the impact of falling oil and other prices in tax revenues and on the CPI (which then means lower income where indexation is involved). On the plus side, indexed linked payments, where they occur, will be lower, and lower oil prices should boost consumer sentiment and free up some household income. But that won’t go anywhere to offsetting the crunch in revenue.
Should the fall in oil prices be sustained into the first half of next year, marginal fields here will be impacted and gas prices will come under pressure. The share prices of Santos, Origin and Woodside are falling because, quite simply, falling oil prices means falling income. But gas prices from export projects in Queensland in the next year, and from WA over the next couple of years, will also be affected. And many Australian companies, led by BHP, have investments in the US oil shale and fracking sector. After investing US$1.5 trillion in the past 10 years, more and more American analysts are worried the oil price slide will trigger a slew of write-downs, company collapses and losses, especially in the tens of billions of junk bonds issued to finance these developments. And for Australian companies, more write downs and impairments will mean higher tax losses and therefore further pressure on company tax revenues.
Then there’s bonds. No one picked the way the bond markets around the world would rally this year — the smart money said the rebounding US economy would mean a rise in global rates (and the Reserve Bank here was looking for rates to rise as the US economy rebounded and the US Federal Reserve ended its huge quantitative spending program, with pressure mounting on a stubbornly high dollar). Both have happened, but US 10-year bond rates fell to 2.17% on Friday in the wake of the great OPEC sell-off in oil, and if anything could go closer to 2% while oil prices continue to weaken.
This morning, Tony Abbott boldly claimed that the budget situation had got under the control the very moment his government was elected. In fact, budget deficits have repeatedly worsened since Treasury and Finance, in their independent pre-election outlook, confirmed Labor’s final budget figures. The forthcoming Mid-Year Economic and Fiscal Outlook was already likely to show yet another blow-out from the government being unable to secure passage of its savings measures through the Senate. But tumbling prices across a range of commodities are likely to make that even worse, and not just in the obvious impact of falling coal and iron ore prices.