Tag Archive for: iron ore

Iron ore futures: possible paths for Australia’s biggest trade with China

The iron ore market is wrong-footing forecasters again, as it has throughout the past 20 years. No one expected the iron ore price to surpass US$200 a tonne as it did in May, and no one predicted it would then plunge below US$100 as it has this week.

There have been numerous unpredictable events shaping the balance of supply and demand, including the collapse of tailings dams in Brazil, a 2014 credit squeeze in China and now the slow-motion collapse of one of China’s largest property groups, Evergrande.

The biggest problem since the early 2000s has been forecasting China’s demand. China’s 2016 five-year plan said there would be no further growth in China’s steel production, but output last year was up by a massive 33%.

China’s latest five-year plan, released early this year, again orders that steel production show no further growth from this year onwards, but in the first half of the year, output rose 12%.

Iron ore prices started falling in July and August as it emerged that the Chinese government was determined to cap production to meet its emissions-reduction goals. The managed decline turned into a rout in September as fears for the health of the Chinese property market, which consumes a third of the country’s steel production, were fanned by Evergrande’s debt crisis.

The iron ore market has seen such volatility before, albeit spread over years rather than months, diving from a 2011 peak of US$190 to less than US$40 in 2014.

As a new ASPI report explains, there are several possible futures for the iron ore market beyond the current turbulence for the medium term. The path that is taken will have implications for Australia’s troubled relationship with China.

A central view, which is similar to the outlooks published by the Department of Industry in March and BHP in August, accepts that China’s steel production has peaked but says iron ore will remain in short supply for the next year or two as demand grows in India and elsewhere.

Beyond that, Brazil’s production should recover and late in the decade there should be new production out of Africa. The price will drop to around US$50–70, which would still be more than double the production costs of Australia’s biggest miners.

Unlikely as it seems when the market is plunging, it’s also possible that the shortages that propelled the iron ore price to records in the first half of this year may re-emerge next year.

The default response of the Chinese government to economic downturns has been to stimulate steel-hungry infrastructure and building construction to ensure that growth targets are met.

The central government has less control over what happens in China’s provinces than is generally supposed, and there’s a momentum behind the growth of the steel industry that has proved difficult to stop. According to a Finnish non-government organisation, in the first half of this year Chinese authorities approved the construction of 18 new blast furnaces with a combined capacity greater than that of Germany’s steel industry.

The directive in the 2016 five-year plan that steel industry consolidation should result in the top 10 steelmakers generating 60% of China’s output was disobeyed, with the share only rising from 34% to 36%.  The demand that the use of scrap steel as feedstock rise from 10% to 30% also achieved only marginal gains. BHP estimates that it will take China until 2050 to reach a 20% share for scrap.

China’s hopes that Guinea on Africa’s west coast could become a rival to Australia and Brazil may come to naught. Although the Simandou mountain in Guinea contains vast reserves of high-quality ore, getting it onto ships involves a 650-kilometre rail link through rugged country to a jetty that must traverse 15 kilometres of mudflats before the seabed can be dredged to allow for supertankers.

Chinese engineers have performed similar marvels at home, but a twist in Guinea is that the rail route must go through heavily populated areas providing commuter and general freight transport as well as transporting up to 2 million tonnes of iron ore a week. And then there’s the political instability, with a military coup ousting the government there a few weeks ago.

Any attempt to replace Australia as its primary source of iron ore will come at a high cost to China. Australia will remain the closest and cheapest source of the mineral.

Continued shortages may see the iron ore price again surpass US$200, potentially ascending to US$300. China’s extensive trade barriers to Australian commodity exports are a disincentive to investment by the major mining companies in lifting Australian supply, making a shortage more likely.

However, if an iron ore glut emerges—whether because China is able to engineer new sources of production or because its economy suffers a lasting downturn—Australia’s largest and most valuable export may become subject to the coercive barriers that China’s government has raised against other Australian exports.

Although the major miners are comfortable that they have the lowest production costs and good relationships with their Chinese steel-mill customers, that may not protect them from Chinese trade barriers. Rather than importing 700 million tonnes a year of Australian ore, a global glut may enable China to cut Australian supplies by several hundred million tonnes.

The distortions China has created in the coal market, with its ban on Australian coal resulting in prices to Chinese steel mills and power stations far above prices in the rest of the world, shows that the authorities are prepared to bear a cost for their politically inspired trade barriers.

When Chinese barriers to Australian coal became obvious late last year, Prime Minister Scott Morrison warned that a ban ‘would obviously be in breach of World Trade Organisation rules’.

Australia has taken action at the WTO against Chinese tariffs on barley and wine, and China has taken action against Australian anti-dumping duties. However, there has been no action on the broader bans on Australian produce.

The ASPI report argues that the Australian government should follow up on last year’s warning and launch a WTO action against the informal barriers on coal. Success in such an action would create a precedent to stop similar discrimination against Australian iron ore.

Iron or? Getting energised about reducing Australia’s trade dependence on China

So, all Australian coal exports to China seem to have stopped. As usual, the Chinese government is keeping its actual decisions to itself and letting them leach out through state media and other sources. In this case, it’s a directive to stop all imports of Australian coal, probably both metallurgical and thermal.

China’s government ending $14 billion in annual trade seems to be the wake-up call Australia needed. It’s time to stop hoping that Beijing’s economic coercion will end soon or be managed through trade agreement dispute-resolution processes we know Beijing has no intention of honouring. It’s time for new partnerships that don’t just reduce China’s economic leverage, but can also shift climate policy and drive economic rebuilding and prosperity. And iron ore, perhaps counterintuitively, may be the place to start.

The Chinese government may be deliberately opaque, but it’s crystal clear that Xi Jinping is determined to continue inflicting costs on his own economy and citizens by wielding access to China’s market as a weapon against Australia, as he has against others.

This behaviour, across a range of traded goods and commodities now, is a deliberate and direct breach of commitments China has under World Trade Organization rules and of the increasingly badly named China–Australia Free Trade Agreement. As Prime Minister Scott Morrison has noted, that matters to any company and any government that operates under the WTO or any other trade agreement with China.

So, it’s good news that Trade Minister Simon Birmingham has told us the government is taking China to the WTO over its imposition of alleged anti-dumping duties on Australian barley. A WTO dispute will take a very long time, be comprehensively gamed and frustrated by Beijing, and probably not change its behaviour. Yet, while not being a solution for Australian trade, it will be useful in demonstrating to others the Chinese government’s disregard for rules and commitments it’s signed up to.

On ‘the relationship’ between Australia and China, even if the unexpected happened and the magical solution that Beijing’s advocates propose occurred—a Xi–Morrison meeting—and out of that meeting Xi lifted all the coercive trade measures he has put in place against Australia over the past six months, not much would change.

There would be a bounce as trade picked up, but Xi has reset the playing field for engaging with the Chinese market in ways that will outlast 2020 and any peace-pipe smoking in the near future. The Chinese government’s behaviour over much of this year has graphically changed the nature and scale of the business risk to any companies—Australian or otherwise—operating in China. Beijing’s stopping its use of trade as a weapon would be no guarantee that it wouldn’t start again, at less than a moment’s notice.

Xi has demonstrated the sheer scale of the sovereign risk that his government poses to businesses—and the speed with which that risk affects trade and business relationships. This is starting to drive a recalibration of supply chains and market plans.

There’s no near-term simple solution to selling commodities and goods that were headed to China to others. Some globally traded commodities like barley can find other markets fast. And, as in the case of barley, Australian exporters can find themselves receiving prices similar to or even higher than what happy Chinese buyers paid in less coercive times. Treasury Wine Estates has set out a two- to three-year business plan for diversifying its export market, and that timeframe is credible for other businesses.

But it’s worth remembering that a lot of Australia’s China trade has had a supernormal boom over the past six years, so in some ways, our response is about rediscovering and reconnecting with other markets. Did it ever make sense to sell 90% of our export lobsters to China and think that was risk free?

In other cases, like iron ore, it’s time for government and industry to chart a new course and invest in partnerships and technologies that work around the risky China market. Xi’s actions are creating common risk perceptions between Australia and countries like Japan, Germany, Canada and the US, something that can drive government and business plans in positive ways.

That’s good news as we rebuild our economies in the wake of the pandemic. Now is a great time to rebuild, because technological change and investor and consumer demand are combining to make new industrial processes like clean steel manufacturing using renewable energy economically viable and attractive.

Even the driest economists interested only in comparative advantage can understand how AustraIia’s low-cost, high-quality, reliable supplies of iron ore can be combined with our low-cost, abundant supplies of renewable energy. It’s not much of a leap to connect these two advantages to the production of clean steel using hydrogen instead of metallurgical coal, as German steelmaker ThyssenKrupp has started to demonstrate.

High-tech manufacturing nations like Germany and Japan know they need new sources of economic advantage given the technological and economic challenge from China. Their manufacturing firms know they need to do more than just double down on joint ventures with Chinese companies, because those partners are more likely to be existential competitors in the near future. Australian clean steel, along with hydrogen production, can help provide this new source of advantage, particularly if it’s produced in partnership with German and Japanese firms. This has some similarities to an idea floated recently by National Party Senator Matt Canavan, who wrote about working with other steel-producing nations.

As Chinese authorities start to pressure Rio Tinto and BHP on iron ore pricing and supply and look for ways to get leverage over these mega-suppliers China is grudgingly dependent on, it’s time for Rio and BHP to do more than talk fondly about their Chinese partners and hope for the best.

It’s not hard now to imagine BHP and Rio partnering with ThyssenKrupp, BDI, and Daimler or Volkswagen to give the German auto industry new global competitive advantages from the combination of German technology and Australian scale of production for iron ore, clean energy and clean steel. Japan’s impressive car and steel industries create the foundations for a similar new partnership there, made easier by the existing energy partnership between our economies and businesses.

For those who say it could never happen, consider Germany’s leadership on renewable energy and its strategic understanding of China shown in its recent Indo-Pacific policy, combined with the steps Rio and BHP are already taking on renewable energy to power their mining operations. Add in the pressure to get moving on the economics of climate change as the Biden administration takes office.

And consider how China responded to a similar need to reduce it dependency on foreign technology firms by building outfits like Huawei from a standing start just a few decades ago. China worked alone, while Australia can work with some of the most trusted and capable partners on the planet.

Nation-building isn’t the negative, loaded thing it was before the pandemic and before Beijing showed the world how it plans to operate now that its peaceful rise is over. It’s time to stop simply soaking up Chinese economic coercion and get ahead of Beijing’s next moves.

That means making new plans, with new partners that will drive our security and our prosperity, while also reducing China’s ability to use trade as a weapon. Iron ore and clean energy could well be at the heart of this for Australia.