Iron Ore in Australia - Case Study Example

Name: Unit: Course: Professor: Submission Date: Iron Ore in Australia Introduction General Overview The Mineral Exploration enterprise is forecast to decline in reference to its lifecycle. The Mineral Extraction industry is quite volatile. This is so as industry services demand depends on anticipated future demands and prices of commodity. For a long period, exploration activity matches minerals demand globally which is directly correlated to the world economic growth. For the last five years, there have been increased exploration activities following strongly commodity prices increase and new mining activities expenditure. Nevertheless, since then prices of many commodities have declined as well as new resources exploration incentives. To understand the overall economy contribution per industry Value Added (IVA) is applied. IVA can to forecast future growth or decline of a commodity. IVA is seen to decline in the next one decade to 2020-2021 at a 7.1% compounded rate. Therefore, mineral extraction industry is seen to perform poorly with anticipated 2.6% real GDP per year in that period. This trend shows a nature of declining industry. In the last five years the frequency of ne industrial created has dramatically gone down following the commodity prices decrease and demand decline (IBISWorld’s, 7). These fluctuations have not in generally affected the mineral at large but, also specifically iron ore exploration in Australia. Steel utilization during developmental stages of a nation is of significant to metallurgical coal and iron ore. In the process of steelmaking, metallurgical coal and iron ore are fundamental ingredients, thus steelmaking is seen to create demand for various primary elements Figure 1. Nevertheless, in the last half decade in Australia compared to metallurgical coal iron ore has had tremendous growth and reduced market subjugation (Lawrence and Nehring, 474). This report will focus on various microeconomic theories in reference to iron ore in Australia. Figure 1: Steel historical demand and supply intermediate input. From the chart for many years demand remained high forcing supply movement aong the vertical curve part. this means prices remained above production marginal cost including that of the highest producer. Supply and Demand curve The supply and demand curve theories are fundamentals of economic. The law believes in movement of goods or services in reference to price. Increase in demand is said to trigger production thus, prompting supply decrease. The suppliers also reconsider the prices and they increase the commodity prices following increase in demand. Supply on the other hand is directly correlated with increase in prices, but with reduced demand the suppliers reduces commodity prices to meet the decreased demand Figure 1. Figure 1: Demand and Supply curve relationship The mining industry on iron ore is forecasts to decrease its annual revenue growth at 4.1% in the five years thought out 2015-2016. In the beginning of the five year forecasts the Chinese strong economic growth triggered escalated levels of iron ore mining development with subsequent decline in intensive steel production. This propelled iron ore demand and skycraped global iron ore prices. In reference to the demand curve, increased production led to increase supply, but with increase in prices. This can be said to have brought a shift of the supply and demand curve to the right as both parameters moved with response to increase prices. However, this was not to last long, and thus demand later reduced due to unbearable high prices with supply still remaining high for a long to maximize the high profits Figure 2. Subsequent, in 2012-2013 Chinese reduced demand resulted to a revenue decline. This implies that the reduced demand catalyzed the prices decline resulting to decrease profits. Figure 2: increase demand and increase supply In 2013-2014 industry revenue bounced back following increased output of Chinese steel, low Chinese inventories, higher output and weaker Australian dollar. Nevertheless, in mid-2014 iron ore prices started falling following oversupply. Prior to this, relatively high global prices on iron ore offered Australian mining firms’ incentives enhancing production increase figure explain price mechanism on incentives. This resulted to large-scales increases and major capacity expansions in regards to iron ore output in Australia. Despite the fact in 2014-2015 weaker prices of iron ore resulted in significant drop in the profit and revenue for the industry, the lower prices are anticipated to force high-cost mining firms of iron ore in china to be shut down, this posses added advantage to the Australian industry following decline in global supplies. Iron ore continued prices decline in 2015-2016 is forecasted to have a 9.9% industry revenue decline annually regardless of increased Australian dollar depreciation and enormous mining volumes increase. In regards to market equilibrium curve at equilibrium amount demanded equals amount supplied. This situation in business is seen as a short-run, while in the long-run the prices are likely to go up. At high prices, some buyers exit the market resulting to surpluses supplied, while at low prices, suppliers are likely to exit the market resulting to shortages like high cost-intensive china firms. Thus, prices interplay on demand and supply is likely to form various equilibrium; with government incentives, supply is extended while rationing brings about demand contraction stable equilibrium is attained Figure 3. Figure 3: Rationing and Incentive price mechanism http://www.economicsonline.co.uk/Competitive_markets/Rationing_and_incentives.html Due to strong volume expansion in the last five years, the iron ore industry if foreseen to steadily expand in the next half decade; throughout 2020-2021. The annual revenue of the industry is projected to increase 5.3% rate over this period realizing a growth total of 67.3 billion. There is anticipation of modest domestic production volumes, with relaxation in prices volatability anticipated in the same period span. Demand on the industry is forecasted to keep growing constantly as moderate growth in China’s economy continues being realized nevertheless, there is anticipation in increase on global supply. This will subsequently lead to depression on iron ore prices within the global markets see figure 4 for signaling effect. Generally, there is anticipation of slow increase on global production volumes following closure on operations for high-cost firms. At the long-run signal better production for present firms and new entrant in the market shifting the supply curve to the right and subsequently price may fall back to earlier established market equilibrium Figure 4. Figure 4: Long-run price mechanism http://www.economicsonline.co.uk/Competitive_markets/Rationing_and_incentives.html In summary form iron ore demand and supply is affected by: iron ore world prices. Australian dollar versus US dollar, iron and steel domestic prices and Global steel prices Five Forces Application In the last five years the industry output on iron ore has surged in Australia increasing employment opportunity. Fortescue Metal Groups (FMG), BHP Billiton and Rio Tinto take the mega share. Although there is prediction of increase in production cost, these companies have the capacity to push on following sustainable production plans on board. These Australian producers will benefit from low cost production as it is seen in the global cost curve at the expense of their competitors with higher cost production. In 2013-2019, the Australia global output iron ore share will increase from 19%-23.7% respectively following the aggressiveness of these three mega three firms. About, 26.0% market share is taken up by smaller firms like Atlas, Mitsui and Hancock Prospecting companies. Hence, the market of iron ore is controlled by many firms forming an oligopolistic form of an industry, with the mega three firms controlling the large market share. Hence, at any point these firms supply decision determine the market price leaving the demand to move in regard to existing market factors (Reserve Bank of Australia, 14). Figure 5: Barriers to entry and World prices for Iron ORE www.rba.gov.au/publications/smp/boxes/2015/feb/a.pdf Barriers to entry The Iron ore industry is naturally faced with high entry barriers with the trend been stable in the last half decade. Mineral exploration is said to be a risky undertaking both for shareholders and lenders. Generally, only small percentage of successful mineral discoveries progresses as mines. This is so for large firms as there is low conversion of prospects to mines. For instance, Rio Tinto points that for every 350 mineral prospects only one becomes a successful operating mine globally. Exploration of minerals is capital intensive contributing to the primary entry barrier for prospective companies. For the large companies they benefit from their production and existing mines to finance their activities of exploration. On the other hand the small firms depend on public and private equity funding. Additionally, the firm within this industry faces skill-related entry barriers in addition to financial risk. Potential industries participants ought to identify part of land with promising mineral extracts and subsequent apply for licenses allowing them to carry out exploration. Substantial skills and resources are required so as to be in line with environmental and safety legislation. New entrants’ threat in this industry is quite low, however new firms can build their mergers & acquisition activities subsequently leading to reduced production cost. Forming partnership is essential as it will help in balancing the factors related to economies of scale. Further, new entrants require long-term contracts with mega buyers of iron ore mostly in China. This will enable new entrant to compete within the local and foreign market more in time of low demand (IBISWORLD, 5). Substitutes and complement As earlier analyzed, demand of iron ore moves with volumes of steel production demanded. Heavy construction activities trigger high steel demand. Iron ore has limited substitute’s competition thus, its demand is minimally impacted. Further, iron ore end products metals can be recycled thus, having a significant advantage against their substitute and alternatives that may require expensive production providing iron ore with economies of scale. Steel competitors are either expensive materials or non-metallic materials providing performance advantage, though buyers may not opt to replace the metals using various alternatives following switching high switching cost. Therefore, iron ore faces weak substitutes which may not significantly affect the profits in short-run. Suppliers bargaining power Iron ore is both capital intensive and human resource power specialized. Firm with ore reserves pride themselves in that they own the land asset. On the other side, companies with specialized equipment, skill and other form of capital requirement may not dish out to ore owners. Thus, the various bodies are likely to form long-term contracts that weaken supplier power. Buyers bargaining power Steel manufactures and iron smelting are the primary companies who purchase iron ore. Being financially stable these companies may negotiate with the miners and form long-term contract increasing power of buyers. Bilateral contracts are feasible in this trade enabling products selling to traders and dealers. The bilateral contracts are significant as they may help in coming up with ceiling prices and floor negotiation thus, protecting the buyers and firms from high and low prices respectively. Further, since iron ore has limited uniqueness leading to value addition, product differentiation limitation strengthens power for buyers. Conclusion In summary, mega companies like FMG, BHP, and Rio Tinto enjoys greater market share of iron ore globally. These firm have improved productivity enabling them to remain low in the cost curve rendering these mega firms have competitive advantage on the global market. The firms also benefits from lower unit cost following services and goods expenditure reduction via minimizing overhead costs, maximizing unit productivity, maximizing suppliers in the emerging markets, increased labor productivity and reduced volumes and prices figure 6. With technology improvement and presence of cost cutting programs majority of Australian miners position them fairly within the market cost curve likely to be flat with time Figure 6. The cost curves were realized through each single mines production average variable cost. The production variable costs are ground support consumables, royalties, transportation cost, processing costs and fuel. Realizing that the industry has a significant high fixed cost which includes infrastructures, equipment and people, the cost curves of iron ore in Australia thus shifts outward and recently years is seen to flatten due to the increase in production capacity in iron ore. The demand elasticity is therefore, negative while the supply price elasticity is positive. The demand of steel and iron ore follows similar supply and demand elasticity due to their correlation. Iron ore movement of prices in the long run is driven by mining technology improvement among other economic activities (IBISWORLD, 10). Hence, following the price elasticity of iron ore is always below 1; the mineral exhibits price inelastic demand and supply curves. Thus, demand and supply elasticity is influenced by available time a commodity remains within a given price, presence of substitutes and income availability to use on the mineral. Figure 6: Iron ore cost curve Recommendation The various players in iron ore market ought to find mechanism and implement policies of controlling what appears to be a monopolistic trend within an oligopolistic enterprise to safeguard the junior miners in iron ore market. Works Cited IBIS World. Mineral Exploration in Australia. IBISWorld Indurty Risk Rating Report, 2016. Print. Lawrence,K. and Nehring, M. “Market structure difference impacting Australian iron ore and metallurgical coal industries”. Minerals, 5(2015):473-487. Reserve Bank of Australia. The Effect of Changes in Iron Ore Prices. 2015. [Web]. www.rba.gov.au/publications/smp/boxes/2015/feb/a.pdf, 5/18/2016. Read More