What the Credit Boom Left Behind

Hot on the heels of our comments yesterday about the high cost of doing just about anything and everything in Australia, today’s Australian tells us $200 billion worth of resource projects are at risk because of…high costs!

The article cites a report, due for release today, which shows resource company executives to be extremely bearish and wary about committing new investment dollars to planned projects.

‘The report comes after BHP Billiton signaled it would shelve its $30bn Olympic Dam project in South Australia; Shell said it might delay Australian projects until an overheated construction market cools; and Chevron warned of cost overruns at the nation’s biggest development the $43bn Gorgon LNG project in Western Australia.’

‘In all, almost $200bn worth of yet-to-be-sanctioned major projects are said by their operators or thought by analysts to be in doubt.’

‘On top of Olympic Dam, these include $24bn worth of Queensland thermal coal projects being planned by Xstrata, Gina Rinehart, Clive Palmer and Adani; $45bn on iron ore expansions by BHP, Rio Tinto and Fortescue; and $70bn of LNG projects under study by Woodside, Shell and PetroChina in Queensland and Western Australia.’

It’s not all bad news though. The article points out that there is still $150 billion of LNG and iron ore projects under construction. This investment should provide plenty of export revenue in the years ahead.

Or maybe it won’t?

Before we get into credit boom economics, a quick word (or two) on the Olympics.

Firstly, the opening ceremony, or what we saw of it, was awesome. The Arctic Monkey’s rendition of The Beatles’ Come Together was superb.

From there, it’s all been pretty much downhill. You haven’t seen Australia’s usual first week success in the pool. Other nations seem hungrier. Maybe it’s the weight of expectation shaving a few seconds off here and there. Maybe it’s the result of years of assumed ascendency that has taken away the mental edge needed to succeed at these levels.

For whatever reason, Australians are at their best when they are the underdogs. Going in with an all-conquering reputation doesn’t seem to bring out the best in us…in any discipline. That’s not to take away from the achievement of just getting there. We couldn’t imagine how much hard work goes into it.

But let’s not pretend they slog away for years and don’t aspire to a gold, silver or bronze medal.

Speaking of which, the medals at the London Olympics are very big and blingy. But the gold medal is mostly silver. It’s only 1.34% gold. Apparently gold medals stopped being gold medals at the 1912 Olympics. Just two years later the world went off the gold standard and slugged it out in the Great War.

Gold is clearly too valuable to be giving it away to athletes who are the best in the world at their chosen discipline. Like everything else, the fiat money standard has devalued sporting excellence.

Getting back to Australia’s economic and sporting performance, is there some weird correlation between sporting and economic complacency and subsequent performance? When you think you’ve done pretty well, the hunger and aggression to achieve more slowly evaporates.

Economically, we’ve done well for decades. Australia has not had a recession for over 20 years. Is this exceptionalism or luck? Whatever it is, it’s leaving a legacy of high wages and low productivity. As we mentioned yesterday, these high wages filter down to impact our cost of living. Compared to other parts of the world, Australia is clearly expensive.

Consider this reader response to yesterday’s topic.

‘Hi Greg, With reference to your latest article, I’m holidaying in San Fran at the moment. Just purchased 8 t-shirts and polos from Old Navy for the same price as ONE polo from Rodd and Gunn! Also, just dined at Osha, the Vue de Monde of thai restaurants here (leaves Sailors Thai for dead) and it cost less than your suburban asian takeaway! Absolutely everything is cheaper here, and BTW the service is so much better and people are sooooo polite. What the hell is going on?’

Indeed, what is going on?

We don’t know. But since you’ve asked, we’ll proffer an explanation.

Australia was about to head into a rather nasty recession in 2008 when the global credit bubble burst. Glenn Stevens slashed interest rates, Rudd and Swan handed out billions and, most importantly, China engineered a credit boom that in relative size dwarfed the US boom of a few years prior.

It was this aspect of the stimulus that most benefitted Australia. Commodity prices took off. Companies responded to the price signals by planning new investments. CEOs committed hundreds of billions of dollars to future developments. High prices indicate strong demand. Strong demand produces a supply response.

But commodity projects take years to develop. You can’t just flick a switch and bring on new supply. Now, with prices falling, the mining companies see that the demand wasn’t real. So they are abandoning expansion projects.

And the ones that are in construction and development phase? The market has a way of bringing them back down to earth as well.

The ‘robust’ economics of these projects (when the development is first announced) slowly evaporates as the monetary inflation that caused the commodity price boom works its way through the system.

In other words, after pushing up the price of commodities, the money moves into the broader economic system. It goes into labour and fuel and pushes up all the costs required to take advantage of the price boom. Except the price boom is now gone. All that it has done is create price distortions and malinvestments.

Where projects still go ahead, return expectations decline. ‘Robust project economics’ manage to only just clear minimum return hurdles.

That’s why you’re seeing so many planned projects put back on the shelf for a later date.

Such is the nature of a credit boom. It giveth, and taketh away.

Just in case you thought there is a lesson to be learned in all this, don’t worry, there’s not. Ben and Super Mario have markets in suspense (both figuratively and literally) as they try to conjure up more credit which will lead to more distortion.

Nick Hubble will have more on that tomorrow.


Greg Canavan
for Markets and Money

From the Archives…

How China is Still Making Steel, But There’s No Real Demand
27-07-2012 – Greg Canavan

Governor Glen Stevens and the Art of Central Bank Speech-making
26-07-2012 – Greg Canavan

Australian Mining Tax Policy to be Abolished, Pigs to Fly
25-07-2012 – Nick Hubble

24-07-2012 – Satyajit Das

Has Australia Blown the China Boom?
23-07-2012 – Greg Canavan

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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