Category Archives: Capex

Straya T’day 1/10/2014

National Day brings peace and quiet…

…unless you happen to be occupying Central, in which case you’re embroiled in the thick chaos of rebellion.


For Aussies at least, China’s National Day holiday week offers a welcome respite from the daily torment inflicted on us by the Chinese commodities exchanges.

So no iron ore or steel news today; for once this Straya T’day post will be all-Strayan.

Retail sales miss

Retail sales for August came in lower than expected, printing a 0.1% seasonally-adjusted gain over July, on expectations of +0.4%. Retail turnover was 5.1% higher than August last year. The respective trend figures were +0.2% and +5%.

The yearly gain in sales still looks fairly healthy. (Both charts use trend data.)


However much of this strength reflects the surge in the latter half of last year, which is still ‘passing through the snake’.

Monthly figures have been subdued for most of this year.


The budget didn’t do much for consumer sentiment, and this has no doubt been a key factor in households’ reluctance to loosen the purse strings. It may also be a function of the deteriorating outlook for iron ore, which has been reported more widely and with an increasing acceptance that the situation is not likely to improve materially in the foreseeable future, other than perhaps a tepid restock in Q4.

Manufacturing PMI surprises

In fairness, Australia’s manufacturing PMI surprises me with every release, since its very existence implies that manufacturing has survived another month.

It’s pretty bleak reading, although that’s nothing out of the ordinary. Until Australia’s real exchange rate significantly devalues, there’s little hope of a broad-based revival in business expenditure in the manufacturing sector.

Mining capex unwind is upon us

Along with retail sales, the ABS released quarterly data today on engineering construction work, which is an important measure of mining investment activity. Combined with the flagging terms of trade, the downturn in mining investment is the chief headwind facing the Australian economy over the next couple of years.

Overall, the value of work completed declined 2.2% in the June quarter from March. The value of work completed by the private sector declined 1.9% to $23,130m.


So far the descent has been fairly smooth, however this is set to steepen rapidly over the next 6 to 12 months.


Of course, all this investment is going towards substantial increases in Australia’s export capacity, primarily in LNG. So will the decline in investment give way to a boom in exports, such that the net impact on the economy is benign?

Not quite.

It’s important to remember that Australia’s mining boom over the last decade has been enriching beyond precedent because it was a boom in profits. So despite the vast majority of Australia’s mineral resources being owned by foreign interests, the profits generated by these firms greatly increased company tax receipts and royalties revenue, much of which was then passed on to households in the form of tax cuts and transfers. Booming profits also saw wages in these industries skyrocket, providing another conduit for the windfall to flow into the Australian economy.

The ‘boom’ in LNG exports after the investment phase passes and supply ramps up will be quite different. These mega-projects in Queensland, WA and the NT are going to be about the most expensive sources of LNG on the planet, placing them at the other end of the ‘cost curve’ to Australia’s iron ore majors (see below). This means that current LNG prices aren’t going to deliver the massive profit margins that characterised the mining boom. So although Australia’s export volumes will surge, supporting GDP growth by improving the trade balance, the income effect on Australia will be negligible when compared to the iron ore and coal booms of the last decade.

The gas has mostly been sold on long-term contracts. However, what happens to spot prices once the gas starts flowing remains to be seen. There was already a mini-crash in spot prices this year during the northern summer…

LNG crash

…and yet the ramp-up in Australia’s LNG exports has barely begun.

LNG exports

If spot prices do fall significantly below contract prices, there will be immense pressure on suppliers to renegotiate those agreements.

Here’s where Australia’s LNG projects sit on the cost curve (in orange).


Clearly, if spot prices drop much below the levels they did during the northern summer, and stay there for any length of time, a lot of these projects are going to face serious trouble as buyers attempt to wriggle free of contractual obligations.

Yet another reason why we’re fervently cheering the Australian dollar lower!


Capex firms as iron ore bleeds

This morning the ABS released its survey of private new capital expenditure and expected expenditure, the big brother to yesterday’s construction work done release. Construction work done is based on the value of projects being undertaken by construction companies, whereas today’s release is based on the capitalised value of those projects to the businesses paying for them, as reported in their financial statements.

Encouragingly, the headline figure rose to a seasonally-adjusted $32.6bn, up 1.1% on the previous quarter, while the trend (a moving average of the previous 7 quarters) continued to decline.

Screen Shot 2014-08-28 at 4.27.06 pm

This level of capital expenditure remains very high by historical standards (h/t RBA). And it’s been almost entirely driven by investment in the resources sector.

Chart source: ABS

There have been well-publicised concerns that this bloated level of mining investment could reverse quickly, leaving a hole in the economy which will be difficult to fill (the ‘mining cliff’, as some referred to this scenario). It’s therefore welcome to see capex continue to bounce along at elevated levels.

Nevertheless, with the winding down of investment in LNG export capacity drawing ever-nearer, and the stubborn exchange rate rendering new investment difficult to justify in any industry outside home-building, there remains significant downside risks to this figure going forward. This is somewhat reflected in expectations for new capex in 2014-2015, which continue to show a decline from last year, albeit well above initial forecasts.

Screen Shot 2014-08-28 at 5.08.44 pm

In all, the release surpassed expectations and indicates a gentler descent than had previously been expected.

Raining on capex’s parade today was the advancing rout in iron ore prices, which are exhibiting all the trappings of a classic Q3 capitulation.

Screen Shot 2014-08-28 at 5.33.58 pm

This observed pattern in iron ore prices reflects seasonal conditions in China. As the days grow shorter, construction work slows and demand for input materials cools. Chief among these are steel and iron ore. This tradition was interrupted last year, largely as a result of stimulus measures from the Chinese government and a consequent build-up of iron ore inventories at Chinese ports.


Notably, this surge in port stocks merely held prices in a tight range, and we didn’t see the usual run up in prices into the year’s end. Once the rate of increase in stockpiles slowed this year, prices could not withstand the onslaught of new supply and tumbled accordingly, with spot now down almost 40% for the year in AUD-terms.

With spot falling to $88.20 a tonne overnight, we’ve decisively broken through support at the year’s previous low of $89. This was an important level and so right on cue iron ore futures traded on China’s Dalian exchange copped a hiding today. Iron ore and steel futures both notched up new all-time contract lows, although this has been happening every other day for a fortnight. As always Reuters has the inside word on today’s market action: Iron ore rout extends as Dalian futures sink 2.7 pct amid tight credit

Spot is now a mere $1.50 above its September 2012 low. It is quite possible that we see this go tonight and iron ore fall to its lowest level since 2009. If it does, there’s nothing but air all the way down to… who knows, picking a bottom is crapshoot, but a bottom it will find. Once it does, it should bounce back strongly. But this is very much a market of lower lows and lower highs, the glory days are long behind and there is precious little comprehension in the national psyche of the ramifications of this new reality.

Hold on to your hardhat, Gina!