How iron ore plays a big part in our economy

Iron ore has been the backbone of the Australian economy and many investment portfolios for much of the 21st century.

In 1921, iron ore accounted for 68% of Australia’s export revenue. This was the year that iron ore prices peaked at almost $US230 a tonne.

However, its growth as an export icon really took off with the first shipment of iron ore from the Pilbara in Western Australia in 1966.

Today there are three major companies that mine iron ore in Australia - BHP, Rio Tinto and Fortescue Minerals. Considered blue chip stocks, they are often favourites with investors and their share price performance is linked to iron ore prices.

Iron ore’s importance worldwide stems from its use in steel, a key material used in infrastructure, housing and manufacturing equipment globally.

China’s role

The main recipient of Australia’s iron ore is China. In 2022 China bought 1.1 million tonnes of iron ore, 65% of which came from Australia.

While demand is still high in China, Covid put a dampener on its economic growth. Its strict measures did not start to roll back until December 2022 and investors began to worry.

While economic activity is slowly resuming, it has reduced significantly from its heady days. As a result, demand for iron ore has also fallen.

This has seen the price of iron ore drop to around the $US100 a tonne mark from its $US230 million peak in 2021.

Although China’s economy is not performing as energetically as it did a decade ago, recent moves to boost domestic demand are causing some optimism among market watchers, although there are still bears around who are more circumspect.

Global demand

The rest of the world is wrestling with recession and that too has put a dampener on the market.

Added to this slowdown in demand are moves to increase supply by Australia’s major producers and Brazil’s Vale Mining.

Luckily, iron ore is relatively cheap to produce in Australia at around $US30 a tonne, which shelters the miners somewhat from price fluctuations. While Rio Tinto and BHP can remain profitable with prices dropping as low as $US60, lower prices will have a flow on effect, impacting superannuation balances, investor returns and the broader economy.

Impact on the economy

Unfortunately, lower profits mean significantly lower tax revenue and that in turn will affect the Australian economy.

While profits are still boosting the government’s coffers, the outlook is less bright.

Tax revenue from iron ore has made a significant contribution to our economy and has been a key reason for the recent federal budget surplus after 15 years of deficits.

Nevertheless, the domestic economy is still expected to slow as high inflation and global challenges make their mark.

Budget papers estimate that a $US10 per tonne increase in the Commonwealth’s assumed price for iron ore exports is expected to result in an increase in tax receipts of around $500 million in both 2023-24 and 2024-25.

The federal government is still cautious about the economic outlook for Australia and are forecasting a return to a budget deficit and the possibility of a recession as the move to higher interest rates puts brakes on the economy.

Aside from economic performance, any reduction in revenue for the mining companies will also translate into lower dividends and lower price growth for investors.

But despite some bearish sentiment in the market including the growing number of institutional and individual investors steering clear of mining stocks over ethical and environmental concerns, there is no denying that iron ore is still a big money spinner.

If you would like to discuss options for investment in the current economic climate, please contact a Nexia adviser today.