The challenge
In 2024, countries such as South Africa, Chile, Argentina, and Australia will each need to address a challenge. The world around them is rapidly and dramatically changing as we undergo decarbonization and restructuring of industries. Each country wants to participate in and benefit from this change, but they must recognize that they are not the leaders and must participate accordingly. The need for change is the threat of the next ballot.
Projects RH operates in North and South America, Australia, Hong Kong, and recently South Korea. Our team meetings focus on linking clients with diverse views and priorities, which is the reason we plan to announce our presence in South Korea soon. The world is becoming more interconnected, and we must acknowledge weaknesses in supply chains highlighted by Covid-19 and reviews of international political tensions and actions. Projects RH aims to stay apolitical but acknowledges that investment opportunities and credit ratings are impacted by external factors. We do not see this as politics but applied economics.
Europeans have driven a green agenda, with the first tariffs taking effect on products sourced from countries with dissimilar energy cost structures. They believe their industries should not be disadvantaged by complying with policies that they perceive as global.
While there are wars on Europe's doorstep and in Northern Africa, the impact of Covid-19 on supply chains remains significant. Significant implications exist for countries at the end of the supply chain.
The question is, does government intervention de-risk the changes needed to make a country relevant or is the government picking winners and largely not in the national interest?”
Australia is a case study
Countries, such as Argentina, South Africa, Australia, and to some extent Canada, are located at the end of the supply chain. However, they possess valuable resources that other nations desire. As the Australian Treasurer, Dr. Jim Charmers, eloquently stated, these countries require a compelling strategy that targets their geographical, geopolitical, geological, and metalogical positions. Realistically, countries with strategic minerals will play a significant role in shifting the industrial base from fossil fuels to renewable energy. These crucial minerals include rare earths, uranium, battery metals, coking coal, iron ore, and gold - as evidenced by Project RH's recent experience. Many would ask why gold? The answer lies that in times of uncertainty central banks hoard this precious commodity and at USD 2400 an ounce it is particularly precious. Although gold is readily available in various countries, its value depends on whether it can be extracted at a reasonable price. As one of our clients said on Saturday at $2400 an ounce a cost price at $1400 makes such a project a great opportunity. It was not so great at $1900.
Australia has most of the minerals mentioned above, and Projects RH's team is particularly well-versed in the country's resources.
What Is Happening
The Australian government is monitoring with great interest the cash flowing into the United States as a result of the Inflation Reduction Act. This is seeing a massive rejuvenation of American industry based on its transition to renewable energy and the production of a new generation of equipment, machines, and consumables. The Australian government's announced strategy is the "Future Made in Australia" policy. As commentator Graham Lloyd reminds us, "Economists know that it is not possible for a nation to subsidize its way into prosperity."[1]
Countries such as China, the United States, and Europe have huge domestic markets and can easily export to much of the world. However, if they export at their marginal cost of production, they could stifle the development of similar industries in smaller countries. Given that many of these smaller economies are located at the end of the trade routes, it is necessary to decide how much of these raw materials they need to process or use for themselves and what they are willing to export. This is already a huge matter of debate in Australia.
For decades, Australians have debated how much of their raw materials should be exported and how much should be value-added before it is exported. The same debates have happened in Canada, Indonesia, Malaysia, Chile, and South Africa, to name a few. The second side of this whole debate lies in what a country requires for itself. During Covid-19, we saw what it was like to be at the end of the supply chain. In the case of Australia, it had everything it needed, except for certain vaccines, but not everything it wanted. If the impact of Covid-19 had been protracted or there had been a war, did Australia really have what it needed?
As a country of 26 million people, Australia cannot hope to manufacture cost-effectively everything the country wants and needs. As the USA demonstrated before WWII, if a large country like India, China, Europe, or the United States can decide to manufacture for itself most things, they have economies of scale. In the case of Australia, it is already decided that the manufacture of ammunition is strategic, and it has even managed to secure export contracts to the USA. This is both good and bad as it links it into military supply chains.
It is well known that China is the leading producer of solar cell technologies and exports them at a cheaper price than most countries can produce. This week the Australian government announced a $100 million program to keep solar cell manufacturing in Australia by providing them with the money they would have gotten if they had gone to the United States. A country like Australia can do this on a one-off basis, but is it wise, and we know it's not sustainable. On a pro-rata basis, Australia is a major consumer of solar cells, but this level of demand does not guarantee that it will be a low-cost provider. The decision to make solar cells in Australia, and inevitably subsidize them, is a political decision. In effect, the government is picking winners. The government did identify a political winner.
A decade ago, Projects RH was involved in an investment structure known as "Project Iron Boomerang". Project Iron Boomerang would have seen infrastructure built across northern Australia to allow coal to be transported from Queensland to the northern regions of Western Australia, and iron ore to come east on the return journey. At each end of the rail system, the coal and iron ore would have been converted into steel and exported. The object was to value add in Australia and reduce the amount of freight involved in sending all the components for making steel from Australia to India, Korea, Japan, and China, and for it to be made in those countries. However, this multi-billion-dollar opportunity was simply too large to win champions and faced too many vested interests in the production of steel from the countries listed above.
The Global Experience – Do We all Want the Same Thing
Most countries aim to be at the forefront of the post-fossil fuel-driven industrial revolution. Indonesia, for instance, has invested heavily in the development of a ferro-nickel industry, despite the fact that the price for ferro-nickel has fallen below its cost. This recent example highlights how governments often believe they can "pick winners." However, it is important to recognize that the market is also flawed as private sector entities can invest too much, resulting in boom-bust cycles in commodities. I guess the difference from a projects RH perspective is that it's private money making a commercial decision on the best available information and not government doing it on a policy basis.
It there a right answer?
Sadly, with all the wisdom of the team at Projects RH, we do not think there is a single right answer, as each nation needs to understand what its strategic needs are and decide where it stands philosophically with its commitment to the World Trade Organization to allow for free trade. It is really this facet of being at the end of the supply train which makes countries do things that may not be prima facie economic. For example, it is very hard to deny that a country like Australia should not make bullets or in their modern name, missiles that are consumed by their military. But there are many things that do not make sense. The government wants to make this, including in Projects RH's opinion, solar cells. Given that they are made in China and exported for less than $0.16 each, they cost $0.26 in Europe and somewhere between 28 and 30 cents in the United States. With their volumes, why does Australia believe they will ever have the volume to justify the industry? Importantly, India has decided that it is a strategic investment into solar cell manufacturers, knowing it will be a major user of the production for decades to come. Would it make more sense for Australia to do a bilateral strategic purchase agreement with India and the United States instead of investing in the industry for itself? At the same time, Australia may say they need purchase agreements for our beef and iron ore.
Playing at the edges
In the case of Australia, the government has announced two strategies: 1) to block acquisitions that reduce competition and, more importantly, 2) to increase delays as the bureaucracy, without any commercial reason, decides whether to allow foreign mergers and acquisitions and decides who the right foreign investor is. In the first case, the bureaucracy will determine, on the basis of reducing competition, which companies can merge or be acquired by another local entity. The basis of this will be whether they reduce competition in a meaningful way. In effect, they will measure jobs and not look at the true national interest, including efficiency. The problem is that the bureaucrats will only be able to look at historic numbers, as they will not have the forecasts of those intending to make a private sector investment decision. At Projects RH, we have worked on such policies where the deciding impact has been whether the amount of tax paid will be reduced, and where the focus is on the tax being paid by employees rather than the companies. No one cared about national competitiveness.
In the second case of having more regulation on foreign investment the concept of being introduced of the “right investors”. One suspects that this has more to do with the home government of the company than the company itself. In Australia, we have seen a commercial business stopped from making a mining acquisition because the controlling shareholder was a Ministry of the government of France. The fact that this business was run at arm’s length on commercial terms and the minority of the shares were listed did not interfere with a policy decision based on no foreign government should own interests in mining in Australia. Using the same logic Optus is 100% owned by Singtel and in turn the majority shareholder of Singtel is Tamasek – the sovereign wealth fund of Singapore. The argument is that Tamasek is at arm’s length.
Generally, the "right investors" will be people who share your ideology and, frankly, whom you like. Governments, like all of us, know those who share their values and beliefs in what matters. For a country like Australia, people who share their beliefs would include Japan, South Korea, the US, UK, and Canada, but not China, Russia, or North Korea. From a Projects RH perspective, it would be interesting to know if the "right investors" also include companies from Mongolia, the UAE, Hong Kong, Colombia, Panama, the Caymans, or the Bahamas.
The Second Reason
Sadly most politicians consider their first duty to be re-elected. In order to do this, they need to have a happy electorate. In the case of Australia happy electorate is one who are employed, paying low taxes, low mortgages, with a good education system guaranteeing good jobs for their children. Picking winners allows governments to develop manufacturing industries, create schools and jobs where they need politically. One of the critical things about having your own defense industry is you do need to have lots of skilled people. In the case of Australia, the maintenance alone of nuclear submarines will create thousands of jobs in South and Western Australia.
Is the price right?
As the end of trade routes approaches, it will continue to be important for countries to have something to contribute in order to earn a seat at the table determining global governance. As countries become more concerned with protecting sovereignty and supporting themselves, some fundamental economic principles may be neglected. However, it is always a matter of degree. For instance, while it is understandable for Australia to manufacture bullets and missiles, the country's decision to produce solar cells may be questionable. Ultimately, the decision may not hinge on economics or national defense, but rather on politics and job creation. Although some argue that the use of technology would lower costs, it is important to recognize that Australia's mineral industry is highly efficient and well-paid, yet employs relatively few workers on a global scale.
No doubt, all countries want to make themselves feel special, strategically safe, and improve the standard of living for their communities. The global industry is undergoing a massive period of change, coupled with the need for new investment as it decarbonizes. The market is the best way to determine what should be where, while we do need to respect each nation's need to have what it considers strategic industries.
The question that we will need to answer is how much we are prepared to pay for these critical industries, indirect government grants, concessions, accelerated depreciation, and other tax incentives, leading to high prices domestically because of tariffs and the impact this will have on inflation and therefore interest rates. Across the world, one could expect to see ongoing debates between the various political groups within governments as they battle for these priorities, remembering that they need to be re-elected.
At Projects Rh we are happy that we don't need to be re-elected and our opinions are fierce and independent. We base our work on numbers in facts.
If you believe we do not have the correct approach to the world, we welcome your comments. We are not afraid of being incorrect, but we rely on logic and facts.
By Paul Raftery, CEO of Projects RH. We are happy to receive questions of comments at paulraftery@projectsrh.com
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Source: Address to the Bannerman Competition Lecture, Sydney
Charlmers, J.; “Merger reform for a more competitive economy”, Address to the Bannerman Competition Lecture, Sydney , 10 April, 2024
Ison, S & Commins, P.; “Labor figures split over productivity chief’s alarm” The Weekend Australian, 13-14 Apr 2024, pp 1 & 2.
Lloyd, G.; “Domestic Dream All Air Without Gas”, The Weekend Australian, 13-14 April 2024. P. 2
Spears, D, “Video: Treasurer Jim Charmers”, Insiders, ABC News 24 14 April 9:00 am AEST.
[1] Lloyd, G.; “Domestic Dream All Air Without Gas”, The Weekend Australian, 13-14 April 2024. P. 2
