RDP 2011-08: The Mining Industry: From Bust to Boom 2. Global Demand, Supply and Commodity Prices

Global commodity prices soared during the 2000s, driven by strong demand from emerging economies, with the boom exceeding both in duration and magnitude the period of high commodity prices in the 1970s. From 2003 to 2011, global prices for Australia's resource exports (in US dollar terms) increased by more than 300 per cent, after having been fat in nominal terms over the preceding two decades (Figure 1). While the rise has been broad based, there were particularly large increases in the prices of the key steelmaking commodities that Australia exports. Prices of energy commodities, such as oil and thermal coal, also increased strongly. The extraordinary increase in commodity prices highlights that global supply has had diffculty keeping pace with the growth in demand.

The pick-up in commodity prices over recent years followed a period from the late 1980s to the early 2000s when real prices were unusually low by historical standards. Compared with the average price level in the United States, commodity prices fell noticeably from their peak in 1981, to be well below historical averages in the late 1990s; the oil price troughed near US$10 per barrel in late 1998, its lowest inflation-adjusted price since 1974, while real base metals and coal prices were at their lowest levels in at least a century (Figure 2).

The stagnation of commodity prices through the 1980s and 1990s discouraged producers from investing in capacity expansions. The 1990s saw Japan's ‘lost decade’ and the collapse of the former Soviet Union where steel production and energy consumption fell by more than a third. Later in the 1990s, a number of Australia's major trading partners were affected by the Asian fnancial crisis, which was followed by the early 2000s global recession and a sharp slowdown in world trade. With depressed commodity prices and a subdued outlook for demand, mining investment as a share of the economy was relatively low in a range of commodity producers including Australia, while global exploration expenditure was also weak (Coombs 2000; Metals Economics Group 2011; Figure 3). There was a wave of mergers in the global mining industry, as companies sought economies of scale in an attempt to offset sliding proftability. This is also likely to have contributed to the reduction in mining investment, as the merged companies consolidated their capital expenditure and exploration budgets (Hogan et al 2002). As a result of this prolonged period of low investment, the mining industry was not in a strong position to quickly increase supply when global demand for commodities fnally picked up strongly in 2003.

The global steel industry – the source of demand for Australian iron ore and coking coal – suffered a particularly long period of stagnation from the mid 1970s to the early 2000s, with production in the G7 economies and the former Soviet Union falling significantly (Figure 4). This followed a golden period for the steel industry until the onset of the first oil shock in 1973, with strong demand from Japan spurring the development of the Australian seaborne trade in iron ore. After the Asian financial crisis and the 2001 recession in the United States, there was perceived to be considerable overcapacity in the global steel industry. Steelmaking countries – mindful of the US Government's plans to raise trade barriers on steel – agreed in 2002 to significantly reduce steel capacity,^[3] while the Chinese Government placed a prohibition on building new steelmaking facilities and sought to close down obsolete steel mills (OECD 2001). While these announcements highlight how grim the outlook for steelmaking commodities appeared at the beginning of the decade, Chinese steel production nonetheless began accelerating and production in the rest of the world recovered after the 2001 recession.

Emerging economies have been the key drivers of global growth and the surge in commodity prices since 2003. China's steel production picked up strongly in the early 2000s, driving growth in global production as rapid as that seen in the 1960s and early 1970s. While the potential of China's large domestic market was recognised in the early 2000s, the rapid pace at which it would industrialise through the decade and the implications for commodity prices were not widely anticipated. For instance, consensus forecasts consistently under-predicted China's growth from 1999 through to 2007; it was not until the second half of the 2000s that analysts began to forecast that the medium-term rate of growth had increased above the Chinese Government's 7–8 per cent targets in their five-year plans (Figure 5). Similarly, mining companies took some time to be convinced that the pick-up in commodities demand would be sustained, with mining investment as a share of GDP not rising to above-average levels until the second half of the 2000s.

China's demand for steel has been driven by a sustained period of rapid industrialisation and urbanisation, requiring high levels of investment in infrastructure, buildings and machinery.^[4] The ‘steel intensity’ of the Chinese economy has risen over the past 30 years, as occurred during the industrialisation phases in the United States in the late nineteenth century and Japan in the 1950s and 1960s, with resources in the economy shifting away from agriculture towards manufacturing as real incomes rise (Figure 6). Past experience suggests that the process of steel intensifcation eventually slows and reverses once infrastructure is in place and households begin to demand more services, as occurred in the US post-WWII and in Japan since the 1970s. However, the period of high steel intensity in China has the potential to continue for some time given the relatively low level of per-capita income and the continuing process of urbanisation. The United Nations (2009) projects that China's urban population will grow by around 50 per cent in the next 25 years – an increase of over 300 million people – requiring ongoing investment in housing and infrastructure. Furthermore, there is considerable scope for demand from India to rise in the future as it moves into the phase of steel-intensive growth. India's Government is promoting the development of its steel industry to meet the country's substantial infrastructure needs, with the United Nations projecting that India will become the most populous country in the world in the next 20 years (see Cagliarini and Baker (2010) for further discussion).

Strong demand from emerging economies is also affecting energy markets, with the share of global energy consumed by these economies rising from a little over 40 per cent in 2000 to above 50 per cent in 2010, driven by China, India and the Middle East (Figure 7). China is the world's largest consumer of coal – both for steelmaking and electricity generation – while India is the third largest. China's share of global coal consumption rose from around 30 per cent in 2000 to 50 per cent in 2010, with China switching from being a net exporter to an importer of coal later in the decade. While China and India consumed only 5 per cent of global natural gas in 2010, the growth in their consumption has been much more rapid than the world average. Globally, there is also likely to be some substitution towards natural gas as a way to reduce carbon emissions, since it is the cleanest burning fossil fuel. The IEA (2010) projects that China and India will contribute half of the growth in global energy use over the period to 2035, with their energy mix shifting towards gas, supporting the expansion of the LNG industry in Australia.

Footnotes

The agreement was to cut steel capacity equivalent to 14 per cent of global production over three years and included countries that accounted for 80 per cent of global steel production in 2000. The key producer not party to the agreement was China (OECD 2002). [3]

For more detail on developments in the Chinese steel industry, see Holloway, Roberts and Rush (2010). Also see Roberts and Rush (2010) for an analysis of the sources of Chinese demand for steel, which include construction and manufacturing exports. [4]