As Australians mull over the concept of good vs bad debt and the various policy announcements in the lead up to next week’s Commonwealth Budget, it is important to remember the revenue line.

With the volatility of Iron Ore prices over the last three years a swing factor for Commonwealth Revenue, a US$10/mt move is worth about $2bn to the bottom line, the Federal Treasury could be forgiven for not factoring higher prices into its forecasts. At its last update (December’s MYEFO) the Treasury expected the iron ore prices to decline over 2017 from around $US80/mt to an average price of US$68/mt in H1 17 and US$55/mt by September. However a mixture of Chinese Government’s efforts to boost the flagging economy through infrastructure spending and speculation from traders has driven demand for iron ore and prices have responded accordingly. Recent price moves has seen Iron Ore average between US$82/mt and US$95/mt over the past 12 months. 

But what about the outlook going forward and how will this impact the Commonwealth Budget?  

Source: Bloomberg. Trade balance data to 28 February 2017. Iron ore price to 30 April 2017.

According to our Global Resources Team, “it’s all about China”, Chinese Government spending fuelled Iron Ore demand and price increases in 2016 and  this is expected to continue through to the end of 2017 (albeit at a reduced level). Much of this has been to keep China's economy on an even keel ahead of key political changes in late 2017. While this recovery in demand isn't expected to decline in the near term, it will eventually, indeed demand likely peaked back in 2014. Despite this, the major iron ore producers are still increasing supply to the market and prices will need to adjust eventually.

The positive news for Australia and our expected Budget position in coming years is high quality, low cost iron ore that Australia produces in mountains will continue to be demanded and our low cost producers will continue to make good margins in coming years as a result. This will continue to help support nominal GDP growth, our trade balance and revenue growth helping the Budget return towards balance “over the forecasts horizon”.