Steel makers in China have told
Australia’s iron ore giants they expect the Chinese government will attempt to
put the brakes on booming steel production in the second half of calendar 2021,
mainly to cut the steel sector’s carbon emissions.
But rather than fearing such an
intervention at a time of heightened trade tensions between Australia and
China, local miners may be able to use it to their advantage. Demand from steel
makers outside China is so strong that any slowdown in the Chinese market will
give Australian miners a rare opportunity to broaden their customer base.
The price of iron ore fell 5.3
per cent to $US200.72 a tonne on Friday, ending a week in which Chinese
officials signalled their frustration with high ore prices, which have more
than doubled in the past 12 months.
While China has a long-term, if
somewhat vague, plan to reduce its reliance on Australian ore over the next 15
years, sources inside Australia’s iron ore giants say none of the government’s
current frustration is being directed at Australian producers.
Instead, there is recognition the
Australian miners are working as hard as possible to get as much ore as possible
into the white-hot market, which is being boosted by a demand surge that
started in China about 12 months ago and has expanded to the rest of the world
amid a post-pandemic economic recovery.
Such has been the level of demand
in recent weeks, Chinese steel mills that were only breaking even in January
have seen profit margins explode. As a result, these steel producers are
running as hard as they can; the utilisation rate of blast furnaces inside
China’s steel sector is running above 90 per cent, while electric arc furnaces
considered uneconomic just 12 months ago are now running full tilt.
Not only have mills been trying
to get as much ore as they can lay their hands on, they have been prepared to
pay for Australia’s better quality product; better ore allows mills to run more
efficiently and increase their output further.
While a level of speculation has
crept into iron ore spot markets in recent weeks, sources inside the big iron
ore miners insist it has been limited. Demand is real and very strong – particularly
from the Chinese housing sector – and miners say there are no signs that
traders are hoarding ore to get leverage to push prices around.
The best proof of the underlying
demand is the strength in the port-side iron ore market in China, which exists
to help steel mills get their hands on ore quickly. Sources say prices in the
port-side market were $US25 higher than in the seaborne market a few weeks ago,
indicating the desperation of mills to get their hands on ore quickly; even
now, the port-side market is $US10 a tonne ahead of the seaborne market.
China’s steel mills have had two
good reasons to go hell for leather.
The first is the recognition that
theirs is a cyclical game and the good times won’t last forever. Indeed, there
are signs that margins have retreated in the last week, with Commonwealth Bank
analysts reporting on Friday that margins for some steel products have fallen
60 per cent from abnormally high levels in the middle of May.
But sources inside the Australian
miners also suggest Chinese steel mills are saying they expect their government
will try to slow the level of steel production in the second half of the year.
Partly this is about cooling
prices; China’s National Development and Reform Commission said last week it
wanted prices to fall and said it would encourage more production from China’s
domestic iron ore mines, although this ore is notoriously expensive to produce.
But it is also important to
remember that the Chinese government started the year with a plan to drive
steel production lower in 2021 to reduce pollution from the sector, which is
estimated to account for about 15 per cent of the nation’s total emissions.
As recently as March, the city of
Tangshan cut the blast furnace capacity across its steel-making sector by 30
per cent to reduce emissions, and there was broad speculation that Chinese
officials would look to roll out similar cuts across other cities.
But the Chinese government’s plan
hasn’t worked. Such has been the level of the demand inside China and across the
globe that international and Chinese steel margins have risen, encouraging
China’s steel mills to go harder than ever.
Research house Capital Economics
estimates that Chinese steel production rose by 7.5 per cent in April compared
with March and while Capital Economics believes April’s production level may
prove to be the peak, Australia’s miners have seen strong activity continue
into May.
But the iron ore miners are very
much alive to the warnings from their Chinese customers that the government
will step in, in a way that cools steel prices and gets its broader plan to cut
steel-sector emissions back on track.
This won’t be easy to do –
ironically the production cuts in Tangshan cut supply and pushed up Chinese
domestic steel margins through March, April and May – but UBS analysts last
week speculated steel export bans might be part of the plan.
These would increase the supply
of steel to China’s domestic market, pushing down steel margins and eventually
demand for ore and prices – although the announcement of previous curbs on
steel exports have resulted in Chinese steel mills ramping up production before
the restrictions come into force.
No
panic stations yet
Usually, the suggestion of
Chinese intervention in the steel market would have Australia’s miners worried.
But the level of demand across the rest of the world is so strong that they see
no need to panic.
“If China cuts steel production
someone else will do it,” a source inside one of Australia’s big miners says.
Surging steel prices are pushing
up prices around the world and producers outside of China are scrambling to
keep pace.
Earlier this month, European
steel giant ArcelorMittal lifted its steel prices for the 12th time since
November, taking a tonne of hot rolled coil in Europe to €1050 – up by more
than 80 per cent over the past seven months.
Nucor, the biggest steel maker in
the United States, is the best-performing stock in the S&P 500
year-to-date, as US producers struggle to find workers after shrinking their
operations for the past four decades.
Even steel producers in
COVID-19-ravaged India are going flat out to increase exports, which rose about
26 per cent in the March quarter, according to S&P Global Platts.
Part of the problem is that there
is little buffer in the system; the sudden surge in demand in reopening
economies is so strong that steel stockpiles have been rapidly depleted. Even
as this demand surge fades, restocking is likely to keep steel markets tight,
providing support for iron ore prices.
And beyond that, as BHP chief Mike
Henry pointed out at Bank of America’s annual global mining conference last
week, investment in the infrastructure required to drive decarbonisation will
help underpin steel demand over the coming decade.
But some inside our big miners
believe that meeting the strong levels of demand seen beyond China right now
gives Australia a rare chance to diversify its customer base in a way that
seemed unlikely 12 months ago.
This diversification has already
been forced on to Australian producers of the other key ingredient in steel,
metallurgical coal, who were hit by China’s unofficial ban on Australian coal
imports last October.
Indeed, should China pump the
brakes on its steel sector, the fact Australian metallurgical coal is already
going into markets outside China could help smooth the path for the iron ore
miners to increase sales into these markets. Over time, higher iron ore exports
to India, Europe and parts of Asia beyond China might then provide a boost for
Aussie coal.
China takes about 75 per cent of
Australia’s iron ore and it will remain the main game for BHP, Rio Tinto,
Fortescue Metals Group and Gina Rinehart’s Roy Hill for decades.
But given China’s long-term
desire to reduce its reliance on Australian ore, it makes sense for local
miners to have as diverse a customer base as possible. The next 12 months might
just provide an opportunity to do that.
Source: Australian Financial Review