China plays hardball with ore miners
By Steve Mackrell
LONDON - In an era when the "Great Game", "Pipelineistan" and "peak oil" have
become the stuff of dinner-table conversations the world over, it has become
commonplace to analyze the power games and high-stakes geopolitical maneuvering
that surround the acquisition of oil supplies.
But take a closer look. Oil is not the only industrial commodity vital to
nations' wealth and power, nor is it the only one that has
seen a
dizzying price spike lately. The market for iron
ore - needed to make steel, the most important
industrial metal - has over the past few years
been through one of the most spectacular
run-ups in its
history.
The spike has dramatically shaken up a long-established ferrous-metals industry
that is not used to this degree of price movement. The profits of iron-ore
producers are at record highs. Even though there is a great deal more iron ore
in the world than oil, ore prices may not have peaked yet: they are set to rise
again this year.
The spreading consequences can be seen beyond the industry itself. Steelmakers
are signaling resistance to record ore prices. There is talk of government
price caps on ore imports, and accusations of interference with market forces.
What is one to make of it all?
It all used to be so easy. The ore-mining companies, based in the major
producing countries of Brazil and Australia, would sit down once a year with
their main customers, the big steelmakers of Japan and Europe, to negotiate
annual contract prices. The price of iron ore remained relatively stable
throughout the 1990s.
What upset this comfortable status quo was the spectacular growth of Chinese
steelmaking, with its ravenous demand for imported iron ore. In turn, the
pressure placed on Chinese steelmakers - which already suffer from low profits
- by rising iron-ore prices has changed the structure of the price
negotiations: in the current round of talks to determine annual contract
prices, which will run from next month, China demanded and received a place at
the negotiating table. And China is making sure its voice is heard loud and
clear.
So
what's the background to all of this? Simply that
over the past few years, China's increasing hunger
for steel has led to an unparalleled growth in
domestic steelmaking - 15 years ago China made 10%
of the world's steel (80 million tonnes), while
this year it will make an unprecedented 33% (about
400 million tonnes). And to make that steel
requires more and more iron ore, some of it mined
domestically, but with a growing proportion having
to be imported, principally from Australia, Brazil
and, increasingly,
India.
Demand by Chinese steelmakers for imported iron ore has quadrupled from 70 million
tonnes in 2000 to 275 million tonnes last year.
It should perhaps be mentioned that not all steelmakers are beholden to the
producers of iron ore. For example, electric-arc furnaces (EAFs, or
mini-mills), which produce about one-third of the world's steel, use a feed of
ferrous scrap and hence, for the most part, are not overly dependent on iron
ore (although such scrap substitutes as directly reduced iron and pig iron are
in fact ore-based). It is the integrated steelworks, using basic oxygen
furnaces (BOFs), which produce about two-thirds of the world's steel, that
depend on iron ore to feed the blast furnaces, which make the molten iron,
which in turn feeds the BOF steelmaking plant.
Why the Chinese rush for iron ore? The Chinese steel industry, because of
indigenous coal and iron-ore deposits, is predominantly based on the
iron-ore-hungry BOF steelmaking route, which produces some 85% of China's
output. A further complicating factor is that China's steelmakers also use
domestically produced ore. The numbers for 2006 break down as follows: China's
blast furnaces will probably produce 360 million tonnes in 2006, an increase of
30 million over 2005, which will require an additional 48 million tonnes of
iron ore.
China's use of domestic ore is expected to be 528 million tonnes, which, it so
happens, also represents a 48-million-tonne increase over last year, but - a
big but - because local ore has a low ferrous (iron) content, this translates
to only 23 million tonnes of concentrate. That leaves an ore shortfall of 25
million tonnes or so, all of which will have to be imported. So last year's
record imports of 275 million tonnes of iron ore could well hit the
300-million-tonne mark in 2006.
Another wild card is that transporting iron ore is no trivial task: the
material's bulk means that amounts tied up in transit at any moment are
significant, and there could be a further 30 million tonnes of iron ore tied up
in Chinese seaports at the moment.
That gets the numbers out of the way. What about the politics? First, we need
to identify the key players whose actions will determine how the iron-ore
crisis - if one can call it that - plays out. There are three: the ore miners,
the steelmakers (writ large), and the Chinese.
There are just three major ore suppliers: Companhia Vale do Rio Doce (CVRD) of
Brazil, and the two Anglo-Australian giants Rio Tinto and BHP Billiton.
Together, the three control about 70% of seaborne iron ore. So how do the mines
see things?
First and foremost, they would argue that prices must be determined by the
rules of supply and demand - market forces - and at the moment, demand is
strong, with spot prices currently higher than contract prices. Second, to meet
the meteoric rise in ore demand, huge investment programs have been launched,
and the miners argue that the levels of investment needed to meet existing and
future demand can only be supported by realistic price structures. CVRD alone
is investing about US$4.6 billion this year in mining and transport projects.
Simply stated, if more ore is needed, then more investment is needed, and that
inevitably affects the end-user prices.
Unsurprisingly, the steel industry takes a different view. There is a feeling
that the unprecedented 71.5% increase in the contract price last April was more
than adequate and should be held for at least another year. Steel prices had to
rise in 2004 on the back of higher raw-material costs, but fell back again in
2005 as steel demand weakened. For steelmakers to pass on higher steel prices,
caused by the ore-price increases, to customers this year could be trickier -
especially since EAF-produced steel, which competes directly with BOF steel for
many product types, has not seen any significant increase in costs for its
input material, ferrous scrap.
Among steelmakers, who themselves are beginning to consolidate into bigger and
stronger groups, there is also a growing desire not to be held to ransom, so to
speak, by three giant ore producers. So 2006 is seeing a new new stubbornness
in the air - which brings us back to Chinese steelmakers.
This year, there is a new voice in the negotiations, with Chinese steelmakers,
represented by Baosteel, entering the discussions for the first time. China's
greater role is directly attributable to the country's overtaking Japan as the
world's largest importer of iron ore.
This year, China is expected to import a massive 43% of the world's sea-borne
iron ore, probably 300 million tonnes out of a world total of 700 million
tonnes. And China, having ousted Japan as the key negotiator, is feeling its
way in using its huge buying power to force a settlement they deem fair. (For
Japan's part, it is probably letting the Chinese take the lead in order to
insist on the suppliers equaling for Japanese customers any price relief that
China is able to negotiate.)
The appointment of Baosteel to negotiate for China was highly significant,
especially since it was accompanied by a government ban on negotiations by all
other Chinese steel companies. In effect, the action undercuts market forces by
forming the Chinese industry into a single cartel for the purpose of ore
negotiations.
From China's point of view, the clear rationale is to put greater pressure on
the miners by combining the buying power of China's steelmakers. There is no
question that the stakes are high for the Chinese steel sector: Morgan Stanley
chief Asia economist Andy Xie noted on March 16 that "for many steel mills in
China, the ore price amount could mean the difference between life and death in
2006 ... China may have to play hardball to stop the ore producers [from]
bankrupting China's steel industry."
But are the hardball tactics working? Based on reports of the negotiations so
far, it appears that both sides have had to compromise. In late February, it
was reported that initial negotiations between Baosteel and the miners had
broken down, for exactly the reason one would expect: price. China argued that
the ore producers should act with restraint, in view of the fact that some 40%
of China's 80-odd large and medium-sized steelmakers reported financial losses
in 2005. Chinese industry officials have also fretted publicly over the
possibility of oversupply in the global iron-ore market, as the big investments
of the past two years come on line.
But such arguments cut little ice with the miners, who understand well that
production declines in the Chinese steel industry, in the event negotiations
failed and supply deliveries were halted, would be catastrophic for the Chinese
economy. However, this is very unlikely in any case, since the custom in the
industry is for the previous year's prices to be maintained if negotiations
drag on beyond the usual time frame. So the ore miners have little to lose by
standing fast: at worst, they will continue to be paid the same record prices
they were paid last year.
As of late this month, China was continuing to hold out for price relief, with
the National Development and Reform Commission (NDRC), China's top economic
planning body, saying on March 15 that Chinese steelmakers would not accept
higher prices, calling the miners' profits "huge and unreasonable", and
pledging to fight "unacceptable" demands in order to protect the country's
steel industry. "China cannot afford a further rise in prices," the NDRC report
stated flatly.
The action might be having some effect: a March 27 Bloomberg report cited
Australian analysts as saying that the miners might have to accept a 10%
increase this year as opposed to the 20% they had originally wanted, and noted
that the "big three" miners have all seen declines in their share prices
because of the dispute.
The question now is whether the issue of 2006 iron-ore contract prices has gone
beyond the level of companies and has become a diplomatic issue, after the
revelation that the Chinese government warned the country's steelmakers that
ore imports may be blocked if prices are too high.
This raises the possibility that Chinese caps on imported iron ore could be
ahead; would Australia or Brazil retaliate if that step was taken? (The
Australian government has already said it would be "alarmed" to see Chinese
government intervention.) And what would the implications of a trade war over
iron ore be for China's World Trade Organization commitments - to say nothing
of the implications for its steel industry, which has become increasingly
dependent on exports?
Steve Mackrell is the operations director at the Iron and Steel
Statistics Bureau (www.issb.co.uk),
the leading producer of steel industry statistics in the United Kingdom.
run-ups in its
history.
India.
Demand by Chinese steelmakers for imported iron ore has quadrupled from 70 million
tonnes in 2000 to 275 million tonnes last year.
