Catastrophic forecast for the Australian economy

Rising energy costs are so ‘ruin’ that Australia could slip into recession before Christmas. There is an easy solution.

Mining and extractive industries such as: oil and gas often say they are “saving Australia”. So their argument is that when commodity prices are high, Australia can prosper whatever happens elsewhere.

However, this was always only half the argument, as commodity prices often fall and when they do, the extractive industries lead Australia down.

But what happens when raw material prices are so high that it harms Australia? And what is the right response when those high prices are driven by human suffering such as war?

These are the critical questions with which the Albanian government in the early days of office. Australian gas and coal mines impose economically disastrous international prices on the local economy because of the Ukraine war and if nothing is done soon, every Australian in eastern Western Australia will soon become a lot poorer.

WA is OK because it has a domestic gas reservation policy, so the local price is less than $6 gigajoules (Gj).

The energy shock

Australian gas prices are traditionally in the $3Gj range. Yesterday they hit $382Gj for a short period as the wholesale market failed. we are now see the gas regulator set prices in other states for $40Gj.

These prices are well above the price we charge our export customers for the same gas because the gas export cartel of Shell, Origin, Santos, Woodside and Exxon has sent so much gas overseas that Australia is starving and eroding.

Gas plays a major role in determining the price of electricity in parts of Australia, particularly Victoria and South Australia. So these prices definitely go to bananas as well.

Coal plays a bigger role in NSW and Queensland, but coal and gas are interchangeable in the stationary fuel market, so follow each other’s prices. Coal traditionally costs $100 per ton. It’s now $500 a ton.

In short, the energy markets on the east coast of Australia are failing and it could be: crash the economy

Demand destruction for businesses

As things stand, gas bills could rise between 500 and 1000 percent. This would wipe out what’s left of Australian production. Anything above about $7Gj will shrink Australia’s industrial base.

The Albanian government has a mandate to restore production due to the vulnerability exposed by China and the pandemic of recent years. We will see the opposite as the trend closure of industrial gas users accelerates dramatically after 2014:

Add to that the coal price hikes and that effect on electricity prices, and we get a scenario where every business on the East Coast will see energy bills rise from 100 percent to 200 percent over the next two years. If that happens, large parts will be closed, workers will be laid off and investments will be reversed.

Demand destruction for households

Utility bills make up just 3 percent of the CPI, but if they double or triple, that’s a corresponding income shock for every household east of WA. In fact, this is a real wage cut of 4-6 percent over the next two years.

This will stem directly from discretionary spending budgets and affect the entire consumer sector, which accounts for 55 percent of GDP. Roughly speaking, it’s hit $20 billion to $33 billion a year in spending and double that in year two.

It will destroy growth.

CPI crisis, rate hikes and house price crashes

It’s true, 3 percent of CPI doesn’t sound like much. But if that price doubles or triples, then it’s huge. The RBA will have…wait for it…another 4-6 percent of inflation to deal with for the next two years.

But that’s not even the worst. Any business east of WA will have to pass on the new costs. So the 60 percent of the economy that is non-tradable will add another 1.5-1.8 percent to the CPI each year. Tradeable can also add it. A total of 7.5-9.8 percent extra inflation over two years.

This will deliver the runaway interest rates that the futures markets have predicted, as the RBA is forced to tighten enough to “make room” for an economically empty war-profit price shock.

A house price crash would ensue, which in turn will collapse the banking system. That would drive the Aussie dollar to the moon in the midst of a recession that would cause even more hollowing out.

Budget breakdown and unequal distribution

The federal budget would be hammered on several fronts.

First, a recession would weaken revenues and radically increase spending.

Second, interest payments on the huge national debt would explode.

Third, the poorer you are, the greater the share of utility bills in your spending. So much more compensation would be paid to low-income households.

Fourth, there would be some benefit from coal profits, but the gas cartel pays no tax. So, unbelievably, there is no benefit from the increased export revenue.

What should the Albanian government do?

The war in Ukraine does not appear to be ending any time soon and the Russian sanctions regime that is curbing the flow of gas and coal to Europe is anything but permanent. The European ban on Russian coal will not come into effect until August.

Gas and coal prices will eventually fall as global supply adjusts and renewable energy investments skyrocket, but not fast enough to avert the aforementioned economic disaster for Australia. For the time being, the European war is the marginal price driver for both gas and coal prices worldwide.

The answer is simple for Australian gas prices. Withholding larger volumes of gas from export markets for the Australian economy on the east coast does not even require policy innovation, nor is it a political risk. It’s already twofold.

The coalition established the Australian Domestic Gas Security Mechanism (ADGSM) in 2017. At the time of writing, gas prices plunged from $20Gj to $10Gj. And that was only achieved when Prime Minister Malcolm Turnbull threatened to activate the Heads of Agreement.

All Anthony Albanese has to do is activate the ADGSM and engage the gas cartel executives for a polite chat in which he makes it clear that the local gas price will either fall below $10Gj in the near future or that he will activate the ADGSM, as and tighten with explicit pricing targets if necessary.

WA already has this policy and has a gas price of $5.50Gj.

For coal, the answer is similar, albeit slightly more complex because the market is more fragmented.

A domestic coal security mechanism could apply a 100 percent levy on all domestic sales over $100 per tonne. To encourage compliance, $20 per tonne of this levy is returned to those mines that meet the sale price criteria.

The point is, there are plenty of ways to bring energy prices up to par. It is only a matter of political will to tackle the belligerent gains.

If that sentiment fails from the Albanian government, the entire Australian economy in the east could be plunged into recession before the end of the year.

David Llewellyn-Smith is chief strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding editor and editor of The Global Economy of The Diplomat, the leading portal to geopolitics and economics in Asia. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review. MB Fund is underweight Australian iron ore mines.

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