A furnished two-bedroom apartment in Port Hedland, the world’s biggest bulk export terminal, on Australia’s cyclone-battered north-western coast rents for almost the price of a three-bedroom penthouse in Manhattan.
The $8,155 a month price for the rental on Anderson Street - that’s typically used by mining companies to house personnel - compares with about $8,500 for three bedrooms with pool access and doorman on the Upper West Side. Port Hedland house prices gained 20 percent annually in the past 10 years, according to Real Estate Institute of Western Australia data. It’s a symptom of the high costs dogging Australia’s mining industry that’s at the tipping point of its biggest boom in a century.
The pain is set to worsen for producers, including Rio Tinto Group, which sell commodities in dollars and pay costs in the local currency that hit a 28-year high last month on a trade-weighted index. The so-called Aussie may not drop in tandem with metal prices, robbing miners of a traditional cost remedy in a nation where salaries for oil and gas industry professionals already average the equivalent of $163,600 a year, the world’s highest, according to recruiters Hays Plc.
“If you’re in coal, it’s near a disaster at the moment,” Paul McTaggart, a Sydney-based resources analyst with Credit Suisse Group AG, said by phone. “It’ll be a problem for most sectors of the mining industry” should the Aussie remain close to its near-record levels, he said.
The Australian dollar, the world’s fifth most-traded currency, is forecast to remain above 90 cents to 2015, while the price of iron ore, the nation’s biggest earner, is set for a sustained dip, according to Goldman Sachs Group Inc. It traded at $1.0517 at 5:15 p.m. Sydney time, after gaining 1 percent over the previous two sessions.
The Australian’s currency’s strength has “put enormous pressure not just on the profits of mining companies, not just on the profits of exporters, but across the whole economy,” Treasurer Wayne Swan today told the Bloomberg Australia Economic Summit in Sydney. The Aussie is “defying gravity,” he said.
The waning global commodities boom is prompting BHP Billiton Ltd., which saw unfavorable currency movements slice $574 million from first-half underlying earnings, and rival producers of everything from gold to coal to fire workers and put assets up for sale as they are squeezed by unfavorable foreign exchange rates, lower prices and higher costs.
Net income for Melbourne-based BHP, the world’s biggest mining company, dropped 58 percent to $4.2 billion in the six months to Dec. 31 compared with a year earlier after commodity prices fell, while Rio’s operating income declined 59 percent, according to data compiled by Bloomberg. BHP’s shares in Sydney have slipped 11 percent this year to yesterday. Rio fell 14 percent.
BHP started making a conscious decision to deliver cost cuts 14 to 15 months ago as a response to lower commodity prices, Chief Financial Officer Graham Kerr said in an interview today at the Bloomberg Summit. Bruce Tobin, a Melbourne-based spokesman for Rio, referred to comments by Vivek Tulpule, Rio Tinto’s chief economist, who said Feb. 14 that Australian and Canadian dollars have come to be seen increasingly as reserve currencies due to their low sovereign debt, maintaining most of their value.
The Aussie’s 48 percent gain since the end of 2008, buoyed by the commodities boom and near-zero interest rates in the U.S. and Japan, is the biggest in that period among more than 150 currencies tracked by Bloomberg. The currency has traded above $1 for a record nine months and will probably be at $1.01 by year-end, according to the median forecast of 43 analysts surveyed by Bloomberg.
The Reserve Bank of Australia has said the nation’s record mining boom will peak this year, at a lower level than previously expected, while cautioning that the relatively high exchange rate is likely to persist.
The price of iron ore, which traded April 8 at $137.60 a metric ton, may sink toward $80 a metric ton in 2015, squeezing cash flow at producers such as Rio, the second-largest exporter of the commodity, Goldman Sachs said in a March 19 report.
“The industry in general would be concerned about it because as the price comes down, in U.S.-dollar terms for example, their costs in U.S.-dollar terms are staying up,” Jim Beyer, chief executive officer of Mount Gibson Iron Ore Ltd., said in an interview March 20. “So that puts pressure on everybody’s margin. The ones that would be really sweating it are those that had fine margins in the first place.”
‘Dumb, Fat and Happy’
The mining investment boom in Australia, which the RBA has said is a “once-in-a-century” event, was being driven by China’s insatiable desire to feed the fastest economic growth of any major economy. This boom saw the Standard & Poor’s GSCI Spot Index of 24 raw materials to increase almost fourfold since 2001. Almost one-in-10 Australian jobs is tied to resource extraction and industries that service it, double the level in the mid-2000s, a central bank paper showed Feb. 20.
The mood changed last year and global capital spending by mining companies is set to drop by a third next year to $96 billion, from a record $141 billion last year, according to UBS AG estimates. Producers have slowed expansions and delayed projects on expectations that commodities prices have passed their highs, after economic growth began slowing in China, the biggest buyer of metals.
“When prices are high, people get dumb, fat and happy,” said Mount Gibson’s Beyer. “But as the price comes down and your margins get cut - production for the sake of production is no longer a tenable situation.”
BHP and Rio, which has an approved budget of $22.4 billion on iron ore projects under way, had their earnings forecasts cut from 2014 by Credit Suisse, which this month trimmed its price estimates for thermal coal, copper, nickel and alumina.
While there appears no stopping of escalating costs with truck drivers in the Pilbara mine region in northern Australia getting paid A$200,000 ($207,000) a year and where even unskilled laborers can make more than A$100,000, according to Goldman Sachs.
Iron ore has tumbled 28 percent from a record of $191.90 a ton in February 2011, according to a gauge for China from The Steel Index Ltd., a unit of McGraw-Hill Cos., while benchmark Australian coal prices fell 33 percent from a high in May 2011.
Xstrata Plc, the world’s biggest producer of power station coal, last month said it would consolidate its Australian coal operations, while Rio said it was taking steps to reduce costs and Whitehaven Coal Ltd. cut workers. These companies have all cited the strong Australian dollar as hurting their operations.
The correlation between commodity prices and the Aussie disconnected in the past 12 months because of central bank currency diversification and the nation’s high benchmark borrowing cost, the highest among major developed economies, according to a March 25 Goldman Sachs report.
The relationship of “the Aussie dollar with commodity prices might be less strong for the next year or two than it has been historically,” Adrian Wood, resources analysts with Macquarie Group Ltd., said by phone. “Partly because so many other countries around the world are printing money and Australia isn’t. So, nothing to do with commodity prices.”
Central banks, sovereign wealth funds and asset managers have been buying the currency like never before, attracted by Australia’s AAA credit rating and relatively high interest rates. Foreign holdings of Australia’s debt reached A$207.5 billion as of Sept. 30, the most in RBA figures dating back to 1986.
The inflow of investment into Australia to fund the almost $200 billion of liquefied natural gas projects being built is also bolstering the Aussie, Tim Netscher, chief executive officer of Gindalbie Metals Ltd., said in an interview March 20.
“That’s going to come to an end,” said Netscher, who cites Australia’s trade deficit one issue likely to keep weighing on the currency. “It’s another reason for the Australian dollar to move back to what it traditionally did, which is move up and down with a basket of commodities.”
A 20 percent drop in the Australian dollar would boost Rio’s 2013 earnings before interest, taxation, depreciation and amortization by about $1 billion, Goldman Sachs analysts led by Eugene King said in the March 19 report. “We expect Rio Tinto to generate no free cash flow through 2013-2015 after paying its dividend,” they said.
The Australian dollar’s trade-weighted index rose to 79.5 yesterday, the highest level since 1985, and climbed 3.0 percent since the start of March against Group of 10 currency peers, the strongest gains across the Bloomberg Correlation-Weighted Indexes.
A stable, high price of price of LNG and continued quantitative easing in Japan, the U.S. and Europe will maintain buying of the Aussie, Martin Whetton, interest rate strategist at Nomura Australia Ltd., said by phone. RBA Deputy Governor Philip Lowe, the No. 2 reserve bank official, said March 19 the process of adjusting to an elevated local currency could be “often painful” for companies.
Some companies “will fall by the wayside, and he said as much in his speech,” Whetton said. “It’s a case of harden up or you’re out; it’s a pretty blunt message from the RBA, but it’s reality.”
Top weekly rents in Port Hedland, a town of about 20,000 people some 1,660 kilometers (1,031 miles) by road from the state capital Perth, may hit A$5,000 a week by 2014, according to Jan Ford, the chairwoman of REIWA’s branch in the Pilbara, the mining region that’s home to Port Hedland.
“We already have a few A$3,000 to A$4,000 per week houses in top locations,” Ford said in an interview in REIWA’s March quarter news magazine. “A combination of high commercial rents and high residential rents for staff have forced small to medium businesses to close either because the rents become too high or a bigger business will pay more and force the smaller one out.”