Australia’s LNG export thrust coincides with weaker outlook
Australia is expected to become the world’s largest LNG exporter by 2020. Price pressure over the next five years is likely due to excess supply, oil‑linked prices and increased contract flexibility. But export volumes are virtually assured thanks to long term contracts to Asian buyers.
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Seven mega-LNG projects that have been under construction since 2009 (worth approximately A$200b — equivalent to around 12% of GDP) are scheduled to begin production over the next two years (Chart 1). When this occurs, Australia will become the world’s largest LNG producer — with a total annual capacity of around 85mt. LNG is expected to become Australia’s second largest commodity export earner, after iron ore.
Australian LNG faces stiff competition — worldwide LNG liquefaction capacity is expected to grow by 65% over 2014–20. Aside from record new Australian capacity, the deluge of supply is owed predominantly to the US shale boom.
Meanwhile, subdued economic momentum in Asia and the EU, fuel switching to coal, and nuclear restarts in Japan have slowed global demand growth. Consultants IHS Inc. estimate that only one in 20 planned LNG export terminals will be necessary by 2025. Similarly, Bloomberg estimates that global export capacity could be up to 40% higher than demand in 2025 if all LNG plants under consideration progress (Chart 2) — meaning gas infrastructure will run under capacity. Yet there are no signs that US LNG capacity expansion is being curtailed — production is expected to exceed domestic consumption by 2017. For Asian importers, US LNG imports could improve flexibility and diversify their energy mix. Offsetting these benefits are higher shipping costs and higher potential future costs of new US capacity.
The bulk of Australia’s new LNG supply has been committed to Asian buyers under long term contracts (typically 15 – 20 years). The export boom is therefore virtually guaranteed. The RBA estimates LNG exports will contribute around ¾% pt to GDP growth in 2016-17.
Though volumes may be reasonably assured, prices aren’t. They are currently near six year lows — US$9/mmbtu in October compared to US$16/mmbtu a year earlier (Chart 3). This is because Asian prices are tied to the oil price, which has been falling. Worse, the worldwide gas glut is giving buyers increased negotiating power and contract flexibility. Long term contract prices are now often subject to periodic renegotiation — either due to bilateral agreement or contractually by large oil price movements.
The weaker profitability and low labour intensity of Australian LNG projects means they will add less to GDP and jobs than their headline export numbers might suggest and what was previously anticipated. This in turn means that the Australian economy can't rely on just LNG to make ends meet in its balance of payments and to generate sufficient employment. A diversified export profile still matters.
Indonesia — grand export opportunities and commensurate challenges
Last month’s Indonesia Australia Business Week (IABW) saw the largest-ever Australian business delegation travel to Southeast Asia’s largest and most populous economy to explore new trade opportunities. However, business must work to realise the export potential.
Already Australia’s 11th largest export market in 2014, Indonesia is an important destination for wheat, beef, live cattle and sugar (Chart 4). Yet only 3% of Indonesia's 2014 imports come from Australia. And the country’s demand for food is expected to swell — imports are projected to rise more than 20-fold from 2009 to US$152b in 2050. For instance, by 2050 imports of beef are projected to reach US$26b, compared with US$500m in 2009. Imports of dairy products are projected to be US$7b in 2050, compared with US$400m in 2009.
Still, a large population, rising middle class, rich natural resource endowment and geographical proximity will make Indonesia increasingly attractive for service exports — in sectors such as finance, communications, tourism, education, healthcare, mining and engineering. Distinct from typical Asian ‘tiger’ economies, Indonesia’s growth has mostly derived from consumption rather than exports. By 2030, McKinsey estimates that Indonesia will add 90 million people to its consuming class — more than any other country bar China and India.
As exciting as this potential might seem, there are some obstacles to fulfilling it. The economy is slowing — the IMF expects GDP growth to fall to 4.7% in 2015 (the slowest pace since 2002) before recovering to 5.1% in 2016. External factors such as weak commodity prices, China’s slowdown, and heightened risk aversion prompting capital outflows are to blame. But so are persistent internal structural shortcomings, including excessive decentralisation and bureaucracy, corruption and infrastructure bottlenecks. Despite President Joko Widodo’s reformist intent, nationalistic economic policies have created a more hostile investment environment — via unrealistic ownership restrictions and domestic content requirements.
Fortunately, the slowdown seems to be increasing the government’s commitment to reform. Mr Widodo shuffled his cabinet in August to bolster its technocratic expertise and give the economy a higher priority. Six reform packages have been introduced since September which aim to boost the economy and win new investment. They include plans to:
- harmonise national and sub-national laws
- simplify business licences and land acquisition procedures
- reduce port cargo turnover time
- introduce tax breaks for new investors, and
- increase the predictability of annual minimum wage increases.
The government has also sought to relieve bureaucratic impediments that have frustrated new infrastructure spending, with Indonesia’s plans to join the Trans Pacific Partnership may be an important spur here. Minister for Trade and Investment Andrew Robb announced during IABW the intention to resume Indonesia-Australia Comprehensive Economic Partnership Agreement (IA-CEPA) negotiations following discussion at Leaders and Ministerial level.
Meanwhile, the central bank has announced measures to stabilise the rupiah and increase market confidence. Indeed, moderating inflation and recent rupiah gains (Chart 5) may offer some limited room for monetary easing. But the need for caution stems from Indonesia’s heavy reliance on fickle portfolio inflows and potential financial market volatility stemming from Fed lift-off.
Despite a confluence of negative factors confronting the Indonesian economy, fundamentals are improving. New inroads into Indonesian markets promise long term dividends for exporters.
Australia’s major export markets tread water in 2016 ‘Doing Business’
The business climate in Australia’s largest export markets remained pretty much unchanged in 2015, according to the World Bank’s latest 2016 ‘Doing Business’ survey — although Indonesia and India made progress.
The survey report provides quantitative measures of regulatory complexity and legal protections across 189 economies. The method has attracted controversy. Rankings focus on basic metrics applied to local SMEs — such as the time and cost of opening a business, the availability and reliability of electricity and the speed of commercial dispute resolution. Important indicators of business conditions on the ground — including security, corruption, labour skills, broad institutional quality, financial system effectiveness, protectionism and macroeconomic health are not directly considered. For instance, despite Iceland’s 2008 economic meltdown it slid only three places to 14th in the following year’s Doing Business gauge.
For all its imperfections, however, Doing Business remains an influential benchmark that catalyses reform worldwide. Overall, when weighted by the scale of exports in 2014, Australia’s 15 largest export markets treaded water in the most recent update (Chart 6). China, Thailand, Japan, Malaysia fell a collective nine places; while India, Indonesia, Vietnam and the UAE improved a collective 19 places. Australia’s other largest export markets retained their 2015 ranking. The majority of Australia’s 15 largest export markets are within the top 20 countries.
Indonesia posted the most significant gains — leapfrogging 11 positions to 109th. In line with President Widodo’s focus on economic reform and reducing red tape, particular progress was made on paying taxes and dealing with construction permits. India was the second best performer among our major export markets. Prime Minister Modi came four spots closer to his goal of ranking among the top 50 countries by 2017 — but at 130th, there is still a considerable way to go. Businesses can now get electricity 14 days faster and starting a business has been made easier by eliminating minimum capital requirements. But India remains in the bottom 10% of countries for enforcing contracts and dealing with construction permits.
AUD depreciation boosts Australia’s exports
Despite the rise of global value chains, recent IMF research concludes that exchange rate movements still have sizeable effects on export volumes. Indeed, AUD depreciation has coincided with a substantial increase in non-resources exports.
Recent currency movements have been unusually large — for instance, the AUD has fallen by a third against the USD since January 2013 (the real trade weighted index (TWI) is down 18% over the same period). While the real TWI remains 40% higher than the pre-commodity boom average (2000-02), conventional economic models suggest the depreciation should have a strong impact on trade. With a lower AUD, Australian exporters are more competitive because they can maintain profitability at a lower USD price. Yet the increasing fragmentation of production across different countries has led some to conclude that the relationship between exchange rates and trade may have weakened. This is in addition to financial system weaknesses, soft global demand, and growth compositional changes that could also reduce the immediacy of trade channels.
IMF research refutes this claim. The experience of both advanced and emerging market economies over three decades suggests that, on average, a 10% real effective exchange rate depreciation causes real net exports to rise by 1½ % of GDP. Yet there is substantial cross-country variation around the average. For distinct economies, the impact of currency depreciation on exports is determined by the amount of slack in the domestic economy, the functioning of financial systems, and the degree of integration into global value chains.
The relationship between exchange rates and trade in intermediate products (inputs into other economies’ exports) has indeed weakened. But the bulk of global trade remains conventional (non-intermediate) trade, and Australia is less reliant on global value chains than most given our natural resource endowment and geographic isolation. Further, the rising size of exports and imports in GDP means that the exchange rate matters more for GDP even if the relationship between the exchange rate and trade has weakened.
Because currency movements continue to matter, a direct redistribution of net exports among economies has resulted. Since January 2013, currency fluctuations have seen a shift of real net exports from currencies tied to the USD to currencies that move with the euro and yen (Chart 7). The AUD has fallen 30% against the US and 20% against a basket of major trading partner currencies since January 2013. Over the same period non-resources exports have increased 27% (Chart 8). Export Finance Australia’s own recent analysis estimates that agricultural exporters would be the largest benExport Finance Australiaiaries of a weaker exchange rate. Indeed, since January 2013 rural exports have increased 35%, while services and manufacturing exports have increased a more moderate 19% and 27% respectively.
‘Mega opportunities’ for Australian agriculture exporters
Research by the Rural Industries Research and Development Corporation (RIRDC) and CSIRO predicts ‘mega opportunities’ for rural exporters as the world grows hungrier, wealthier and fussier by 2035.
By 2050, the United Nations Food and Agriculture Organization (FAO) estimates more than 2 billion extra people will need 60-70% more food than is currently available. Aside from a larger population, demand for more and diverse foods will be driven by rising per capita incomes and the transition from subsistence production in developing economies. In Asia, over 1 billion people will move out of poverty by 2060. Diets will shift from staples towards high-protein and boutique foods (Chart 9) — RIRDC estimates that beef consumption will rise 120%, while dairy consumption will double. The growing consumer class will demand higher standards for ‘clean and green’, nutritious and ethically produced food.
Australia is well positioned—both in terms of geography and comparative advantage — to supply expanding overseas markets. Premium agricultural exports will also benefit from broadening consumer tastes and rising standards. New opportunities to increase market share will arise from communicating the high standards of the provenance, environmental performance and healthiness of Australian products. Agricultural expertise will also be increasingly exported as emerging economies seek to develop their agricultural sectors. For instance, Export Finance Australia has provided financial support to Wellard Rural Exports for the export of 4,500 quality Australian dairy cattle to Sri Lanka — as part of a government-backed dairy development program.
Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) expects the gross value of Australia’s farm production to increase by 8% to a record A$57b next financial year — given a more competitive AUD and strong international demand. Export earnings from farm commodities are forecast to hover around A$43b (Chart 10) — 14% higher than the five-year average. In particular, fisheries export earnings are set to increase by 11% to around $1.6b, after increasing an estimated 10% to $1.4b last year. Gains for coarse grains (up by 9%), wheat (4%), wool (1%), canola (2%) and chickpeas (70%), will be offset by forecast falls in export earnings for beef and veal (down 3%), dairy (4%), live feeder/slaughter cattle (8%), cotton (33%) and mutton (13%).
Cassandra Winzenried, Senior Economist
The views expressed in Export Monitor are Export Finance Australia’s. They do not represent the views of the Australian Government. The information in this report is published for general information only and does not comprise advice or a recommendation of any kind. While Export Finance Australia endeavours to ensure this information is accurate and current at the time of publication, Export Finance Australia makes no representation or warranty as to its reliability, accuracy or completeness. To the maximum extent permitted by law, Export Finance Australia will not be liable to you or any other person for any loss or damage suffered or incurred by any person arising from any act, or failure to act, on the basis of any information or opinions contained in this report.