Demand and supply at work – the Western Australian iron ore market

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December 13, 2014 by Paul Goldsmith

Yesterday I wrote about the fall in oil prices and how they have been affected by geopolitical factors that have led to it being rather convenient for the Western conception of international relations. It demonstrated that with some of the commodities we use, there are some quite complicated reasons for their price to rise and fall. Sometimes, though – there are far more simple reasons for the changing price of a commodity, which is why it’s worth looking at the story of the iron ore price in Western Australia.

The Western Australian government estimated in their budget for 2014-2015 that they would gain a certain amount of tax revenue based upon a price for iron ore of $122.70, but today it stands at $80, which is 34% below that. The State Governor, Colin Barnett, has had to answer questions about how they got their forecasts so wrong. This is because the 2014-15 budget contained a forecast surplus of only $75m but for each $1 the iron ore price is less than the estimate – revenues fall by $49m (which means their revenues are going to fall by $1.7bn this year). The resulting deficit has to be explained, and Mr Barnett has done his explaining, and it is rather useful.

Put simply, the iron ore price has fallen because of decreased demand for iron ore and increased supply. China, which used to produce 60% of World steel (which contains iron ore) is longer producing as much as they re-balance their economy from manufacturing to services. The increased supply has come from two massive companies – BHP Billiton, and Rio Tinto, apparently “flooding the market” with iron ore. This is as a result of some massive investment ($120bn) that they have made over the past few years in Western Australia that they have to recoup, and because they are producing at such scale, they are able to produce at low costs – leading to their ability to sell at low prices.

This is not just a bit of a nightmare for Colin Barnett, but it makes life difficult for the high cost smaller producers who make up the majority of producers in Western Australia and who are now unable to get a price that allows them to run their businesses at a profit. Barnett has lamented the effect of the low prices on the smaller producers, who he sees as part of the lifeblood of their communities.

Which is why it is a bit odd to read this quote from April this year, about how the opening of BHP Billiton’s Jimblebar iron ore mine “demonstrates BHP Billiton’s ongoing confidence in the strength of WA’s iron ore industry”. You might have guessed already that the quote came from Western Australia governor Colin Barnett..who actually opened that mine – gloating over the decision to increase mining operations in Western Australia. Did Barnett not wonder whether the increased investment in mining might lead to more, you know, mining?

Capitalism works like this. BHP Billiton and Rio Tinto search for profit and in a competitive marketplace like Western Australia they have found a low cost supply, are producing a lot of it and charging lower prices. It’s hard on the higher cost suppliers, but it’s the way the market works. If you celebrate the upside of that – you have to have a better answer to the downside.

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