Cash explosion

Reuters reports today that:

Mining giant BHP Billiton Ltd has begun auctions for spot iron ore shipments to Chinese steel mills, local media reported on Friday, marking the latest shift in its pricing strategy to cash in on rocketing prices.

BHP, the world's third largest iron ore producer, has started to auction a 170,000-tonne spot iron ore shipment every fortnight to Chinese customers, the China Securities Journal reported, citing a procurement manager at an unidentified steel mill in southern China.

A tight supply market, combined with fast-rising spot prices, meant that BHP was unwilling to extend even quarterly prices to new customers, the paper reported, forcing many steel producers to buy iron ore either priced on a monthly basis or to take extra spot market shipments.

Spot iron ore prices were on course to hit an eight-month high on Thursday, after all major price indexes rose to trade as high as $US184 per tonne, powered by sustained Chinese buying and supply concerns as a tropical cyclone threatens to interrupt production and shipments in Australia.

Last March, all three major iron ore producers, including Vale SA and Rio Tinto Ltd, agreed with Asian customers to shift pricing for the majority of its iron ore to shorter term contracts based on market-cleared prices and on a landed basis.

According to this blogger's calculations, the Dec10 contract price was around $142. The average for the quarter was in the mid $150s. A 8-9% rise was looking a fair bet for Q1 2011.

However, the current spot price is headed inexorably through $180 per tonnes. if BHP can force through these monthly contracts, presumably based on the trailing average of prices for the previous month, then the price is going to rise into uncharted territory very quickly.

In the 09/10 year, we exported 266 million tonnes plus of iron ore to China and another 124 million or so elsewhere. Rising prices go straight to the bottom line so we're talking roughly an extra $390 million income for every $1 rise.

According to a 2005 RBA study that money is distributed thus:

A substantial part of the increase in profits accrues to state and federal governments. Royalties, which are a pre-tax item, are payable to state governments on mineral and onshore petroleum production.

A substantial part of the increase in profits accrues to state and federal governments. Royalties, which are a pre-tax item, are payable to state governments on mineral and onshore petroleum production. These are mostly at ad-valorem rates, and although there is substantial variation in rates and dei nitions, they probably imply that around 5 per cent of additional revenues from higher commodity prices typically accrue to state governments. More signii cantly, based on the statutory corporate tax rate, up to 30 per cent of the increase in proi ts would be payable in corporate income tax to the Australian government. The higher level of proi ts would also result in some additional tax revenue from personal income taxes paid by shareholders on dividends or – in the longer run – on capital gains. Although the payment of these royalties and taxes may initially reduce the stimulus from higher commodity prices, there will still be an expansionary impact to the extent that higher government revenues allow higher government spending or a reduction in tax rates. Over a period of time, assuming government net fiscal positions are held roughly constant, the increase in revenues owing from higher export revenues to domestic governments would thus represent a corresponding stimulus to the economy

... The remainder of the initial boost to revenues (roughly two-thirds of the total) accrues to shareholders of the companies. This occurs either in the form of higher dividends, or if earnings are retained, in the form of capital gains. Domestic shareholders include both households and institutional investors such as superannuation funds. However, to the extent that there is foreign ownership of the Australian resources sector, part of the addition to incomes will accrue to foreigners.

Although there are no precise figures on aggregate foreign ownership, some ABS data for 2000/01 suggest that foreign ownership in the resources sector is around 50 per cent. This is probably somewhat higher than at the time of earlier resource booms.

The expansionary effect of these income flows on the Australian economy can be expected to operate through a number of channels. Higher dividends and capital gains accruing to domestic shareholders will feed into household income and wealth and, over time, into household spending. More importantly, higher commodity prices are likely to have substantial effects on the behaviour of resource producers, assuming that the price increases are not viewed as completely temporary.

Australia may be taking a hit from the dropping coal volumes and flood damage, but as reconstruction stimulus begins, and coal shipments resume, these incredible terms of trade developments are going to pour cash over everything.

The RBA may want to look through short term inflation spikes but it will do so at its peril. La Nina is setting the stage for a giant Australian blowoff.