Mining Industry in Australia: A Case Study of BHP Billiton and Iron Ore Market

This report evaluates the mining industry in Australia with a case study of BHP Billiton and iron ore market. It covers the market structure, demand and supply determinants, elasticity of demand, recent events affecting the industry, and more.

ECONOMICS AND INTERNATIONAL TRADE
Economics and International Trade
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Table of Contents
Introduction................................................................................................................................2
Overview of mining industry in Australia.................................................................................2
Market structure of iron ore industry in Australia.....................................................................4
Demand and supply determinants..............................................................................................6
Price elasticity of demand..........................................................................................................7
Recent event affecting iron ore industry....................................................................................8
Conclusion..................................................................................................................................9
References................................................................................................................................11

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Introduction
In Australia, mining is one of the primary industries making significant contribution
to the economy. The mining activities are spread across all the state and territories. Estimates
show that 0.02 percent of land areas in Australia are directly affected by mining. Australia is
rich in different mineral resources. Minerals such as Iron ore, Nickel, Aluminum, Copper,
Gold, Silver, Uranium, Diamond, Zinc, coal, petroleum, natural gas and others are available
in large quantities (Eklund 2015). Apart from growth in domestic industries, the mineral
resources in Australia contributes to global growth. The report aims to evaluate mining
industry in Australia.
The chosen company for the analysis is BHP Billiton. It is one of the largest
diversified resource companies engage in discovery, conversion and development of various
natural resources such as iron ore, copper, coal, petroleum, nickel, natural gas and uranium
(bhp.com 2018). The paper considers iron ore market for demand and supply analysis. The
market structure, demand and supply determinants, elasticity of demand and impact of
sudden shock have been evaluated to completely understand the industry.
Overview of mining industry in Australia
Mining industry in Australia is considered as one of the vital pillars for the economy.
As recorded by Australian Bureau of Statistics, the gross value added of mining industry has
increased at an average annual rate of 6.5 percent in the last decade (Static.treasury.gov.au
2017) The industry alone account approximately 9 percent of the economy. Despite a
declining trend in global commodity prices mining industry remains largest exports earner for
Australian economy. In merchandise trade, mining accounts 64 percent. In total export, the
share of mining is 50 percent. Australia is world’s leading exporter iron ore. The iron ore
export accounts nearly 53 percent of world trade (Minister.industry.gov.au 2018).

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Figure 1: Contribution of mining industry to employment and export
(Source: Static.treasury.gov.au 2018)
In addition to its contribution to national income and export earnings, the sector is
also important because of its contribution to national employment. Mining is one of largest
employers of labor force with employing more than 230,000 workers. Many of these workers
are employed in different regional areas of Australia. The substantial investment made in the
resource sector largely benefits the workers (Pwc.com.au 2018). The expansion of capital
stock has contributed to an increase in average weekly earnings of labor force by 66 percent.

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Figure 2: Monthly growth percentage of mining and ASX 200
(Source: Pwc.com.au 2018)
After the recent slowdown in 2015, mining industry has showed a quick recovery.
Since the second quarter of 2015, ASX 200 has experienced a modest growth. As against this,
investors of mid-tier mining sectors enjoyed a handsome return driven by a market growth
rate of more than 60 percent. The majority of this growth has been accounted by companies
having exposure to iron ore, coal or gold. The industry recorded a net profit of $1.6 billion in
the year 2017. This is the first time in the last five years that the mod-tier mining companies
accounting a collective profit.
Market structure of iron ore industry in Australia
Most resource market today are dominated by only a few producers in the market.
This creates an oligopoly market structure in supply and allows producers to choose a level of
output that does not follow the demand curve. Similar to structure of resource sector, the iron
ore supply itself presents an oligopoly market (Rba.gov.au 2018). One main reason behind
oligopolistic nature of iron ore market is huge capital requirement. Main constraint in the iron
ore market is the operating cost rather capital cost. Establishing large mines having ability to

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move out millions of iron ore and wastes constitutes a cost of at least $1 billion. Small firms
are not able to carry out such expenditures. Any sudden price crash in the market disrupts
stability and stops capita flow to the small market players (Lawrence and Nehring 2015). The
capital constraint works as an entry barrier in the industry and allows large players to
dominate the market.
The large three companies in Australian iron ore mining are BHP Billiton, Rio Tinto
and Fortescue Metals Group. Like oligopoly market the three large firm dominate the
majority of market share (Ingram 2018). These cashed up and innovative companies make
huge investment in technology to sustain to stimulate productivity by driving down cost.
Figure 2: BHP Billion’s income shares from different mining business
(Source: bhp.com 2018)
The share iron ore is the highest in BHP Billiton’s income. Following this, the
company keeps a strong focus to sustain investment in the segment. The other two players
Rio Tinto and FMG also focus on increasing their volume of production to sustain their
market share.

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Figure 4: Iron ore production of big three companies in Australia
(Source: transtainer.com.au 2018)
Demand and supply determinants
The market forces of demand and supply determine price of iron ore. Two primary
determinants of iron ore demand are demand generate from domestic steel industry and
export demand.
Domestic steel industry demand: Steel is one key ingredient used in construction and
infrastructural development. The steel industry in Australia ensure a secure and flexible
supply of steel for construction of bridges, roads and skyscrapers (Golev and Corder 2016).
The development and expansion of steel industry generate huge demand of iron ores for
leading iron ore companies.
Export demand: In case of Australian mining, export demand from various nation especially
from China constitute a larger part of demand for the mining businesses. China is the largest
exporter of iron ore from Australia. The expansion of steel and construction sector of China
large pulls up the demand for Iron ore in Australia. The shipment of Iron ore constitutes 60
percent of total export in Australia (Hurst 2015). The increase in global demand of steel and

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that from the emerging economies have boosted up iron ore demand in Australia. BHP
Billiton being a leading player in the Iron ore market enjoys upward demand pressure from
rising export demand.
On the supply side, two factors affecting supply of iron ore are own price and cost of
production.
Price: One factor affecting supply of a good is its own price. The law of supply suggests a
positive relation between price and supplied quantity. The higher demand of iron ore driven
by growth of demand in domestic and export market has increased price of iron. Higher price
increases profitability of a company. Higher iron ore prices encourage the company to invest
more in iron ore segment and raise supply.
Production cost: Cost of production is the primary determinant of supply of a product. In
order to remain competitive in the world market companies need to focus on lowering the
production cost. With the objective of lowering cost and increase supply BHP Billion has
invested to build a world class infrastructure and decrease cost. The company has recently
announced to undertake Inner Harbour Debottlenecking Project (bhp.com 2018). Such
rational decision helps to maintain a steady supply of iron ore in the domestic and world
market.
Price elasticity of demand
Price elasticity of demand is a measure capturing percentage change in quantity
demanded following a certain percentage change in own price of the product. Demand of iron
ore is mainly derived from steel, the demand for which depends on construction demand. As
there is no immediate substitute of iron ore, demand elasticity is likely to be low. One
estimate of iron ore elasticity in the world market suggests the estimated elasticity to be -
0.24. That means with 1 percent increase in price of iron ore, demand for iron ore likely to be

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declined by 0.24 percent (theconversation.com 2018). The relatively inelastic demand implies
that the market will initially adjust through change in supply. The low cost producers replace
the high cost ones. With inelastic demand, revenue falls with a decline in price. This is well
evident for mining companies in China. The export of iron ore to Chins though has increased
by 18 percent in a year, there is a decline in export earnings by 31 percent because of a fall in
price.
Recent event affecting iron ore industry
China’s demand of iron ore plays an important role in driving growth of mining
industry in Australia. Iron production is one fundamental resource for developing countries.
China now has become the largest consumers of iron ore in the world market. The economic
boom in China driven by the growth of manufacturing and rapid urbanization fueled demand
for raw materials like iron ore. As recorded by BHP Billiton, expansion of China’s economy
contributed to 100 percent expansion of iron ore production in 14 years (Hong et al. 2017).
China’s economy has now started to cooling off. This has occurred for first time in last 20
years. Steel production in China declined in early 2015 lowering demand for major iron
producers in Australia.
The slump in China’s economy thus adversely affect iron ore industry and the major
players. With a slowing demand and existing pace of supply, there is a surplus of iron ore in
the market (Jin, Li and Wu 2016). The resulting surplus lower equilibrium price by flooding
the market with excessive supply. This has been explained in the following figure.

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Figure 5: Effect of China’s slowdown on iron ore market of China
(as created by Author)
Demand and supply in the iron ore industry is given by DD and SS. The industry is in
equilibrium at point E. Corresponding price and quantity are given by P* and Q*
respectively. Following economic slow-down in China and a decline in iron ore demand, the
industry faces a contraction of demand. This shifts the demand curve inward to D1D1. The
resulted decline in demand moves the equilibrium downward to E1. Both equilibrium price
and quantity contracts at E1.
Conclusion
The report briefly evaluates mining industry of Australia. Mining industry is one of
the important industries in Australia making a significant contribution to GDP and
employment. The growth of mid-tier mining companies exceeds that of other companies in
ASX 200. BHP Billiton is one of the leading mining companies of Australia. Among various

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mining product sold by the company, one important product is Iron ore. The industry operates
in an environment of oligopoly market. Three large firms dominate the industry. Entry is
restricted by the capital constraint. On the demand side, two vital determinants of demand are
domestic steel production and export demand. Factors influencing supply of iron ore include
price and production cost. Iron ore being a crucial input in steel and construction industry
faces a relatively inelastic demand. In recent years, the industry however faces a contraction
resulted from economic slump in China.

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References
bhp.com 2018. BHP | Iron ore fundamentals. [online] BHP. Available at:
https://www.bhp.com/media-and-insights/reports-and-presentations/2015/06/iron-ore-
fundamentals [Accessed 19 Jan. 2019].
bhp.com 2018. BHP | Our business. [online] BHP. Available at: https://www.bhp.com/our-
businesses [Accessed 19 Jan. 2019].
Eklund, E., 2015. Mining in Australia: An historical survey of industry–community
relationships. The Extractive Industries and Society, 2(1), pp.177-188.
Golev, A. and Corder, G., 2016. Modelling metal flows in the Australian economy. Journal
of Cleaner Production, 112, pp.4296-4303.
Hong, J., Yu, W., Marinova, D., Guo, X. and Gollagher, M., 2017. Implication for China’s
Resource Demand on Sustainability in Australia. In Technology, Society and
Sustainability (pp. 323-334). Springer, Cham.
Hurst, L., 2015. Assessing the competitiveness of the supply side response to China's iron ore
demand shock. Resources Policy, 45, pp.247-254.
Ingram, T. 2018. Ignorance pushed iron ore market into 'dance of death'. [online] The
Sydney Morning Herald. Available at:
https://www.smh.com.au/business/companies/ignorance-pushed-iron-ore-market-into-dance-
of-death-20150609-ghjmt4.html [Accessed 19 Jan. 2019].
Jin, X., Li, D.D. and Wu, S., 2016. How will China shape the world economy?. China
Economic Review, 40, pp.272-280.
Lawrence, K. and Nehring, M., 2015. Market structure differences impacting Australian iron
ore and metallurgical coal industries. Minerals, 5(3), pp.473-487.

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Minister.industry.gov.au 2018. Mining and the Australian economy: the Australian
Government's priorities for the mining sector | Ministers for the Department of Industry,
Innovation and Science. [online] Minister.industry.gov.au. Available at:
https://www.minister.industry.gov.au/ministers/frydenberg/speeches/mining-and-australian-
economy-australian-governments-priorities-mining [Accessed 19 Jan. 2019].
Pwc.com.au 2018. Aussie Mine 2017. [online] Pwc.com.au. Available at:
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Jan. 2019].
Rba.gov.au 2018. Discussion. [online] Rba.gov.au. Available at:
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Static.treasury.gov.au 2017. Minerals Council Of Australia. [online] Static.treasury.gov.au.
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theconversation.com 2018. Competition the wrong test for iron ore inquiry. [online] The
Conversation. Available at: https://theconversation.com/competition-the-wrong-test-for-iron-
ore-inquiry-41814 [Accessed 19 Jan. 2019].
transtainer.com.au 2018. Cost cutting, iron ore buoyancy reaps profits for Rio, BHP and
FMG - Transtainer. [online] Transtainer. Available at:
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fmg/ [Accessed 19 Jan. 2019].