Wednesday, September 17, 2014

China's Proposed Import Bans on Thermal Coal: Not the Real Problem Facing Australia

The Chinese government has announced that it is going to limit certain coal imports from next year. The Sydney Morning Herald reports:
The Chinese government is to limit the use of imported coal with more than 16 per cent ash and 3 per cent sulphur from January 1, 2015 in a bid to improve air quality, especially in cities such as Beijing and around Shanghai.
According to one analyst: ''[Australian coal exports are] typically around 5500 kilocalories and 24-25 per cent ash. So we've got big problems.''

However, others are less concerned by the changes arguing that the impact on other coal exporters will be even greater.
The restrictions applied vary in stringency depending on geography ... The least stringent [restrictions] apply across the entire country and would not affect a single major Australian thermal coal exporter, all of whom would comfortably comply. However it is the most stringent which apply to the major economic zones of Beijing, Hubei, Tianjin, the Yangtze River Delta and the Pearl River Delta which are of the greatest relevance. These areas are on or close to the coast and therefore are the most prospective for Australian seaborne exported coal ... only 10% of Australian coal exports go to China, and the highly restricted region represents 42% of Chinese thermal coal imports further softening the blow. This means the amount of production likely to be affected is low.
What is clear is that we need some context to assess the impact of China's proposed restrictions and any potential damage to the Australian economy.

According to the Department of Foreign Affairs and Trade's Composition of Trade, in 2013, China was Australia’s largest export market, accounting for 31.9 per cent ($101.6 billion) of total exports of goods and services (an increase of 28.2 per cent on 2012); Japan was Australia’s second largest export market ($49.5 billion); the Republic of Korea was third largest market ($21.3 billion).

Major goods and services export markets

Coal is Australia's second biggest export, behind iron ore and in front of education related travel services.

According to another DFAT publication, from 2001 to 2011, "the value of coal exports rose from $12.5 billion in 2001 to $46.8 billion in 2011, a rise of almost 300 per cent."

Traditionally our biggest market for coal has been Japan, with China a much less significant market until recently. Between 2001 and 2011 Coal exports increased their share of exports to China but were still dwarfed by iron ore exports.

Since 2011, Chinese coal exports have more than doubled from $4.5 billion to $9.1 billion in 2013.

Australian Coal Exports 2013 

The point to note here is that China has traditionally mined a lot of coal itself, but in recent years Chinese production has been in decline with significant producers struggling.  An integral component of the restrictions, therefore, will be to encourage more Chinese coal production.

The most important point to note, however, is that there are two major forms of coal exports – thermal and metallurgical. Thermal coal is used mainly for electricity generation, whilst metallurgical coal is used in steel manufacture.

Metallurgical coal exports in 2012-13 were $22.4 billion and thermal coal exports were $16.2 billion. It is thermal coal exports that could be affected by China's bans.

Principal markets for resources and energy exports
in 2012–13 dollars

Source: BREE

The above graphs clearly show the rise in both metallurgical and thermal coal exports to China since the early 2000s, but China remains a significantly less important market than Japan for both.

A problem with the focus on the potential damage to Australian thermal coal exports from the Chinese bans is that it may miss the real problem for Australian exports over coming years. The coal sector in Australia has been in trouble for quite some time, with coal miners slashing their work forces in recent times.

One of the major vulnerabilities for Australia moving forward is the increase in the share of unprocessed raw materials exports, which have substantially increased their share of total exports since 2008 and even more so since the late 1990s.

The real danger for Australian coal exports would be similar restrictions on exports of thermal coal to Japan and South Korea. Let's face it if you want to do something about climate change and levels of pollution then restricting the growth of coal burning will be essential.

Despite the moves by the Chinese authorities, coal remains the second most important source of energy. Renewables have been growing rapidly in recent years, but their share is still depressingly low.

While coal consumption is declining in Europe and North America it is increasing markedly in the Asia-Pacific.

Source: Vox

Thermal coal burning is going to continue for quite some time yet and the Chinese restrictions will have considerably less impact than the growth slowdown in China and the decline in house building and infrastructure development.

China must lessen its investment share of GDP to rebalance its economy. It could do this in an orderly way over the next few years or it could resist the need to rebalance and face an eventual catastrophic rebalancing later in the decade. In other words, rebalancing away from investment towards consumption will occur, it just depends on when and how. Australia will be negatively affected either way.

What this means is that the decline in iron ore prices and export volumes will be way more important than a ban on thermal coal exports. Those concerned about this issue should be more worried by the general decline in commodity prices.

But it's not all gloom and doom for thermal coal. Given the Abbott government's hostility to developing solutions to climate change and to the advancement of the renewable energy sector, it's possible that coal miners may be able to expand their 75 per cent share of electricity production in Australia.  

Wednesday, September 3, 2014

She'll Be Right Mate? Australia's Economic Future

Real GDP per Capita is an important measure of real aggregate progress. While it doesn't tell us anything about the distribution of growth, it does tell us how much an economy is growing per person so that it removes the impact of population growth and immigration. Remember that in a country with a rapidly growing population, growth can be, at least in part, a consequence of that population growth.

The Reserve Bank Governor Glenn Stevens recently gave a speech highlighting Australia's relatively good performance in comparison with other developed countries.

In comparison to the US, UK, Euro area, Canada, Japan and New Zealand. The graph measures performance since 2005 by making all countries equal (100 on the Index) at this point.

As the Governor notes, these figures don't tell us what's coming but he outlines three possible sources of future growth.
Which sectors would be available to lead such an expansion? In the broad, there are three. There are households, governments and firms. Let's think about each briefly.
Households being willing to increase their debt and lower the share of current income being saved was a striking feature of Australia's economic landscape from the early 1990s until just prior to the financial crisis. Consumption spending consistently rose faster than income and the ratio of debt to income went from about 60 per cent in 1993 to 150 per cent by 2006. Households are servicing that higher debt quite well – mortgages make up most of their debt and arrears are running at about one half of 1 per cent, which is low by global standards. But as I have argued before, it seems unlikely that household debt can rise like that again. Nor would it be desirable. So while we can expect that household consumption spending can grow in line with income, or maybe a little faster given the rise in net worth over the past two years, the odds are against households being a driver of strong growth the way they were a decade ago.
What about the government sector? Most governments in Australia are trying to strengthen their own balance sheets by containing the build-up in debt that has been occurring. Public final spending is scheduled, according to the stated intentions of federal and state governments, to be subdued over the next couple of years. In fact, it is forecast to record the most subdued growth for a long time. By and large then, the public sector is not in the phase of using its balance sheet to expand demand faster than normal. 
That leaves the business sector. ...
My conclusion would be that many businesses are in a position to play their part in the growth dynamic over time. The fact that in some areas outside of mining the level of gross fixed capital spending is barely above depreciation rates suggests that, over time, capital spending in those areas will have to increase. The forward estimates of non-mining business capital spending released recently do show a further upgrading of intentions. That won't offset the impending fall in mining investment and it would be good to see further, and more substantial, upgrades over time. But the available data suggest that things are at least heading in the right direction.
Stevens canvasses the external environment in the first part of the speech and it appears that he is fairly sanguine about future possibilities.
Overall then, the global environment remains ‘interesting’, with significant challenges, uncertainties and puzzles. All that said, from Australia's point of view, the world economy continues to grow, inflation remains contained, our terms of trade though falling remain high, and financial conditions are remarkably accommodative.
Our external environment is heavily shaped by China. China is our biggest export partner and it is our other biggest export partners' biggest export partner, which means that any Chinese growth slowdown or rebalance towards consumption will have a negative effect on us and indeed all of Asia.

As Stevens points out:
For Australia's particular group of trading partners, weighted by export shares, growth is running at about 4½ per cent, which is somewhat above the 30-year average. This strength reflects the continued increase in the weight of China as a destination for exports. Even though China is growing more slowly than it used to – at a mere 7½ per cent this year – the fact that its growth is so much stronger than most others combines with its increased weight to push up the weighted-average growth of our trading partner group. 
The determined pessimists among us [that's me!] will see the increased weight of China as a concern: what if something goes wrong and the Chinese economy experiences a sharp slowing in growth? In fact this is a question that could be put for most economies now – nearly 50 economies, including the United States, European Union, Japan, Russia and Canada, now have China as their number 1 or 2 trading partner. The full ramifications of the continuing rise in the weight of China's economy and, in time, its financial system in world affairs will be the topic for numerous lengthy books. But in short, the whole world is now more dependent on China than it was. 
For today, probably the most important point to note is that the near-term task of the Chinese authorities is to manage the desired slowing in credit growth and moderation in asset values. Housing prices are falling in many Chinese cities at present. This is not unprecedented – it is the third time in the past decade this has occurred. (Yes, house prices can fall, even in China.) This area – the asset price and credit nexus – is the one to watch, more than the monthly exports or PMIs and so on. 
Another pricing puzzle is exchange rates. Many in Australia have commented at length about the relatively high value of the Australian dollar against the US dollar. The Bank has made its views on this pretty clear and so I won't reiterate them today. But it's worth noting that many other countries have had a similar puzzle to ours – so the real question is why the US dollar has remained as low as it has.
Yes you read correctly. Nearly 50 countries have China as their number one or two trading partner.

What this means is that Australia is now more affected by Chinese conditions than ever before and what happens to the US dollar will affect the competitiveness of the tradable sector (exporters and import-competing firms).

We need China to keep growing strongly and for the US to increase growth so that the US dollar strengthens. The rest of the world economy also needs the US economy to increase its rate of growth.

Remember that measured by exchange rates the US is still the world's largest economy. The fact that about 70 per cent of the US economy is consumption means that the US remains the vital final destination of a whole lot of goods (and associated services) that have been initially traded between the countries of Asia (think the iPhone etc).

I have long thought that the decoupling of the overall Asian economy from Europe and North America could only be a temporary phenomena. China needs the developed world to keep buying Chinese goods (as does the rest of Asia) but, in turn, the developed world requires China to shift to higher levels of consumption.

In the absence of a shift towards higher consumption in China, it is doubtful whether Europe and North American economic policy-makers will be happy with enhanced export-led growth in China. A revitalised Chinese current account deficit will mean increased exports of Chinese capital and probably higher unemployment in the developed world.

Australians should hope that the world economy can rebalance and avoid the sort of recoupling of the Asian and developed world economies that would lead to an Asian growth slowdown.