Iron ore has plummeted to the lowest in
two-and-a-half months after China ramped up its commitment to reduce emissions
by cutting steel output amid a slowdown in global manufacturing.
Booming demand and limited supply drove
iron ore to record highs in the last few weeks but an acceleration in China’s
efforts to control steel production and weakening demand is beginning to weigh
heavily.
The commodity tumbled 7.4 per cent to
$US181.57 a tonne on Friday and is now in bear market territory, having fallen
23.5 per cent from the record $US237.57 reached in May.
The decline weighed on the Australian
dollar which dropped 0.7 per cent to US73.44¢.
“We’re seeing iron ore prices coming back
down to earth quite quickly which is often the case when fundamentals reassert
themselves,” HSBC chief economist Paul Bloxham said.
“The slowdown in global manufacturing and
reopening of the services sector is occurring against the backdrop of the
vaccine rollout and Chinese authorities wanting to take steam out of the
commodities market.”
Environmental concerns
China’s leaders signalled on Friday that
hitting Xi Jinping’s target for peak carbon emissions by 2030 remained a key
priority and it would soon release an action plan on how to achieve this.
However, comments reported by Xinhua news
agency also hinted that the Chinese government was concerned that actions taken
by some companies to cut carbon emissions had been too aggressive and could
compromise the country’s economic recovery at a time when it is experiencing
power shortages.
Comments by the China Iron Steel
Association (CISA) on Sunday also worried investors. CISA said it expected more
crude-steel output cuts to meet the government’s emissions’ reduction targets.
Chinese magazine Caixin said in an online
report that China’s leaders wanted to correct a so-called “campaign-style”
approach to reducing carbon emissions to help cushion the blow to the economy.
While they wanted to stop the development
of projects with high emissions and energy consumption, they also wanted to
avoid more drastic measures which companies were taking to hit government
targets regardless of the economic of social fallout.
China, which has restricted imports of
Australian coal, has been struggling with power shortages this year due to hot
weather. China’s National Energy Administration said last week the country’s
electricity consumption rose 16.2 per cent in the first six months of the year
compared to a year earlier.
‘Significant contraction’
China has had limited success so far in
curbing output. Production climbed 12 per cent in the first half of the year,
meaning a substantial drop this half for China to meet its objectives.
“Plans to cap steel output growth in 2021
at 2020 levels implies a significant contraction in the second half of 2021,”
said CBA mining and energy commodities analyst Vivek Dhar.
“China’s crude steel output expanded
around 12 per cent in the first half of this year. A similar rate of
contraction would be required this half for China’s crude steel output to
remain unchanged from 2020 to 2021.”
However, there are early signs that China
is getting on the right track. Bloomberg reported that daily crude-steel output
at major mills fell 5.6 per cent in the first 10 days of July from June. It
followed a drop of 5.6 per cent in June.
China’s most recent push, which has
triggered the selloff in iron ore, comes as the government urges steel mills to
limit output.
The world’s fourth-largest steel
producer, Shagang Group, said last week that it would curtail production and
overseas sales to comply with government efforts to cut emissions.
Additionally, Chinese steel mills have reportedly resold contracted iron ore
volume back to the market, according to S&P Global Platts.
The growing traction of the restrictions is set to
have important implications on iron ore markets, particularly as China
experiments with the optimal grade of ore to use.
The nationwide focus on reducing steel output will allow iron
ore prices to decline without steel mill margins needing to fall according to
Mr Dhar. It also means productivity at steel mills will be a lower priority.
Historically, these conditions have triggered a shift in
preference away from higher grades of iron ore – a trend seen last week with
high-grade premiums declining. However, this does not necessarily guarantee
that a sudden shift to lower grade products is imminent.
“Using lower iron ore grades means higher impurities and higher
coke requirements (derived from coking coal),” Mr Dhar said.
“With coke and coking coal prices elevated in China, a shift to
low iron ore grades may not be the most economic decision for steel mills. The
optimal mix of steel raw materials will likely only be known once the recent
price volatility subsides. And that could be weeks.”
The decline in lower grade iron ore spot prices led the sell-off
last Friday. Ore with 58 per cent iron content plummeted 10.8 per cent to
$US131.50 a tonne according to NAB.
Financial Review