Recent Charts

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.  

The Banana Republic Revisited?

(An edited version of this with fewer graphs is available at The Conversation)

We took the view in the 1970s – it’s the old cargo cult mentality of Australia that she’ll be right. This is the lucky country, we can dig up another mound of rock and someone will buy it from us, or we can sell a bit of wheat and bit of wool and we will just sort of muddle through … In the 1970s …we became a third world economy selling raw materials and food and we let the sophisticated industrial side fall apart … We must let Australians know truthfully, honestly, earnestly, just what sort of international hole Australia is in. It’s the price of our commodities – they are as bad in real terms since the Depression … If this government cannot get the adjustment, get manufacturing going again and keep moderate wage outcomes and a sensible economic policy, then Australia is basically done for … If in the final analysis Australia is so undisciplined, so disinterested in its salvation and its economic well being, that it doesn’t deal with these fundamental problems … the only thing to do is to slow the growth down to a canter. Once you slow the growth under 3 per cent, unemployment starts to rise … Then you are gone. You are a banana republic.

(Paul Keating speaking on a wall phone in the kitchen of a function centre to radio personality John Laws on 14 May 1986, cited in Richard H. Snape, Lisa Gropp and Tas Luttrell (1998) Australian Trade Policy: 1965-1997, Sydney, Allen & Unwin, pp. 84-5.)

Revisiting Paul Keating's Banana Republic warning should remind us how economic conditions change and how they keep changing: how new 'realities' quickly become replaced by newer 'realities' masquerading as permanent changes.

Resources have been good for Australia, unlike for some other countries where there really has been a resource curse. However, with the end of the boom it is likely that we will revisit some of the earlier concerns about Australia's over-reliance on resources.

Another quote from the Labor government in the early 1990s also seems particularly relevant at the moment.

This tough, increasingly competitive world of five and a half billion people does not owe, and will not give, seventeen million Australians an easy prosperity. The days of our being able to hitch a free ride in a world clamouring, and prepared to pay high prices, for our rural and mineral products, are behind us. From this fact flows everything else. 

(Bob Hawke, Paul Keating and John Button (1991) Building a Competitive Australia, Canberra, AGPS, 12 March, p. 1.1. Emphasis added.)

This sentiment was true for the 1980s and early 1990s, but less so for the 2000s where rising prices for resources and increases in national income provided an easier prosperity than Hawke might have imagined.

In 2000, Keating was still arguing against the resources as saviour view of long-term Australian prosperity:

The global terms of trade will not suddenly flow back in the direction of commodity producers. So even if we wanted to, we can never again rely on export wealth generated by Australian farmers and miners to pay for the preservation of tariff walls to protect our manufacturing and services sectors from competition. 

(Paul Keating (2000) Engagement: Australia Faces the Asia-Pacific, Sydney, Macmillan, p. 280.)

China changed everything. Its voracious appetite for resources pumped up the prices Australia received for its resource exports – particularly coal and iron ore. All the warnings of the past were quickly forgotten as resource wealth became the new reality masquerading as a permanent change.

Increased prices then led to a huge investment boom, which in recent years has been centred around gas. The scale of this boom has been remarkable as a recent report from the Australia's Bureau of Resources and Energy Economics (BREE) shows.

But this investment boom has now peaked and Australia must now find new sources of growth. According to BREE, the "likely scenario" is that

the value of projects currently at the Committed Stage is scheduled to moderate after 2013 as a result of the completion of mega projects currently under construction. In 2014 the stock of committed investment is expected to decrease by $8 billion, and then by a further $63 billion in 2015. From 2017 onwards, the stock of committed investment in the mining sector is projected to revert back to levels comparable to 2007.

While some commentators, including the Reserve Bank Governor, argue that we are now entering the third – export – stage of the boom, it is likely that just as the boom surprised us on the way up, the crash will surprise us on the way down.
Australia will no doubt export more for at least a few years, as recent data shows, but with increased global supply and lower prices, it is likely that we'll start worrying about our dependence on resources once again.

Recent data clearly shows that commodity prices are on the decline, with iron ore and coal prices substantially lower. According to the RBA:

Over the past year, the index has fallen by 8.6 per cent in SDR terms. Much of this fall has been due to declines in the prices of coking coal, iron ore and thermal coal. The index has fallen by 9.9 per cent in Australian dollar terms over the past year.

For an explanation of the RBA's Index of Commodity Prices and recent changes see here.

Base Metal Prices

Base metals include aluminium, copper, lead, nickel and zinc.

Bulk Commodity Prices

Bulk commodities include iron ore and coal (thermal and metallurgical).

The Economist also notes the general fall in a range of commodities in USD terms in recent times.

Australia is a lucky country, but it is also a vulnerable country. Australia's historical vulnerability to declines in international demand for resources are about to re-emerge, which will make economic management a difficult task for a new government. Things have been tough for the Rudd and Gillard governments, but they will be even tougher for an Abbott government. Labor was helped by the investment-led revitalisation of the Chinese economy, but the Coalition will come into office at a time of Chinese economic consolidation and rebalancing and, possibly, economic stagnation.
In the late 1980s when some commentators were eulogising about the end of the industrial revolution and touting the beginning of the information age, Australia appeared to be doomed unless it weaned itself off a reliance on resources. This new reality was superseded by an even newer one - the remarkable rise of the Chinese economy. Not only did Chinese demand increase the price of Australian exports, but it also decreased the price of Australian imports. Manufactured imports became cheaper. Remember that the terms of trade - the average price level of exports in relation to the average price level of imports - is a ratio (or fraction) and so can be affected by both the numerator and the denominator. 

The terms of trade improved remarkably from the early 2000s, it then declined as commodity prices fell in the immediate aftermath of the global economic crisis. To the surprise of many, including myself, it then ascended again to new heights as China embarked on a renewed investment boom, a boom that required many of the things that Australia exports. There can be no denying that Australia has been lucky to be in a position to take advantage of China’s industrialisation and widespread Asian exceptionalism in the face of a slow American recovery and continuing European crisis. Similarly, however, any downturn in China and other Asian economies will now negatively affect Australia.