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Robert New
In the three months since mid-March 2009, prices for the majority of energy and mineral commodities have risen significantly. The rise of commodity prices has been paralleled by an increase in share market indices around the world. These trends reflect market expectations that economic conditions will begin to recover later in 2009 and 2010, and that demand for energy and mineral commodities is likely to increase.
Much of the optimism, particularly around commodity markets, has been driven by China’s strong growth in imports for commodities such as coal, iron ore and copper in the first half of 2009. Also providing optimism to the market is the stabilisation of credit markets, which was seen as a necessary step prior to a return to global economic growth, especially in North America and Europe.
The extent to which recent price gains are maintained will depend on the economic recovery occurring at a similar rate and trajectory as expected by the market. This is a source of considerable risk to energy and mineral commodity price forecasts. For example, if economic recovery proves to be weaker than assumed, there will be downward pressure on commodity prices. In comparison, if economic recovery proves to be stronger than assumed, demand for commodities will grow more strongly than anticipated, resulting in prices significantly higher than currently forecast.
Despite the recent price increases, commodity prices are still generally below levels observed at the same time in 2008. For example, contract prices for Japanese fiscal year 2009 (April 2009 to March 2010) declined by 44 per cent for thermal coal and 57 per cent for metallurgical coal. With respect to iron ore prices, some Australian producers have settled fines contract prices with Japanese, Korean and Taiwanese steel mills at a 33 per cent discount for JFY 2009.
In the March quarter 2009, China’s imports of some energy and mineral commodities, such as iron ore, metallurgical coal and copper, increased significantly compared with the corresponding period in 2008. The resilience of China’s commodities demand provided some support for prices, which were adversely affected by weak demand from Japan, the Republic of Korea and the European Union. The surge in China’s imports was underpinned by low commodity prices and lower freight rates compared with 2008, which increased the competitiveness of imports against domestically produced commodities. China’s import rebound was also partly driven by the restocking of depleted inventories by consumers, in anticipation of sustained demand from infrastructure investment, and the build-up of strategic reserves.
It is uncertain whether this rate of import demand from China for some commodities, such as coal, iron ore and copper, can be maintained in the second half of 2009 and through 2010. Recent increases in commodity prices and freight rates will increase the cost of imports and may encourage the restart of some domestic production capacity. This will in turn place downward pressure on imports, as consumers have the option to either source inputs from domestic suppliers or use the recent build-up of inventories. Conversely, China’s domestic demand is anticipated to increase over the next 18 months, underpinned by the US$586 billion stimulus package. The stimulus will target construction of infrastructure such as railways, freeways and electricity grids, which will support demand for minerals and energy commodities.
Despite resilient Chinese demand, world trade of many commodities is forecast to decline in 2009. For example, metallurgical coal trade is forecast to decline by 18 per cent, iron ore trade by 3 per cent and thermal coal trade by 2 per cent. The decline in trade reflects weaker global demand for construction materials and consumer durables, which tend to be energy and mineral intensive. In 2010, stronger consumption is forecast for most commodities, including iron ore (3 per cent), metallurgical coal (6 per cent) and thermal coal (3 per cent), supported by increasing economic growth rates.
Global supply of energy and mineral commodities is expected to contract in 2009. A number of mines, particularly those developed in response to high prices over the past few years, have shut down or idled capacity since September 2008. While world production of most commodities is forecast to fall in 2009, nickel and aluminium are expected to be among the worst affected.
In 2010, global supply of most energy and mineral commodities is expected to expand in response to stronger demand and higher prices. The increased production will be sourced either from new projects or the restart of operations which had been idled in response to falling demand. For example, world production of refined nickel is forecast to increase by 10 per cent, aluminium by 3 per cent, and refined copper by 2 per cent.
Australian production of metals and other minerals is estimated to contract by 1.4 per cent in 2008-09, reflecting reduced production of zinc, nickel and lead, which is forecast to more than offset increased production of iron ore. In response to increased demand and higher prices, total production is forecast to increase by 2.7 per cent in 2009-10, supported by increased production of iron ore and metallurgical coal.
Production of energy commodities is forecast to increase by 1.2 per cent in 2008-09, reflecting increased production of thermal coal, oil and natural gas. Energy commodity production is forecast to contract by 0.5 per cent in 2009-10, as lower thermal coal and crude oil production is partially offset by increased gas production. Lower crude oil production reflects the natural decline from mature fields, while thermal coal production is expected to fall in response to weak demand in major importing economies such as Japan.
In 2008-09, Australian export earnings from energy and mineral commodities are estimated to increase by 36 per cent to $160 billion. Underpinning this increase are higher export volumes and record high prices for bulk commodities for JFY 2008, supported by a 17 per cent depreciation of the Australian dollar against the US dollar. In 2009-10, export earnings are forecast to decline by 22 per cent to $124 billion, primarily reflecting declines in bulk commodity contract prices for JFY 2009.