August 07, 2009Chinese Steel Production Is Underpinning Global...

August 07, 2009

Chinese Steel Production Is Underpinning Global Iron Ore And Coking Coal Production, But How Long Can It Last?

By Alastair Ford /www.minesite.com

It can be a dirty business, iron ore. Sure, finding an attractive mineral deposit and keeping hold of it once it starts to look rich enough to tempt avaricious bureaucrats or rival local operators is never easy. But it’s surprising how many of the current tussles at the beginning of the metals supply chain involve iron ore. The great West African iron ore deposits have lately been witness to allegation and counter allegation as two small London-traded mining companies battle for control of the old Tonkilili projects, and judging by the accusations that have been thrown around, the libel laws in Sierra Leone are clearly open to very liberal interpretation.

Across the border in Guinea Rio Tinto has just been dumped off the Simandou iron ore project, which has now been passed over to one of the most influential individuals on the continent in the metals arena, the Israeli Beny Steinmetz. Elsewhere, the battle for the Berezovskoye iron ore deposit in the Chita region of Russia between the Chinese conglomerate Xiyang continues. And further up the line, in Australia Rio Tinto executives are still smarting following the arrest of several of their price negotiators in China on allegations of industrial espionage.

Iron ore is clearly still a much sought after commodity, even after the global financial crisis, and some of the world’s less salubrious characters are clearly not too worried about how they get their exposure. The driver, as ever, is China. To underline this point, one only has to look at the recent financial results from the mining major Anglo American. These results were widely viewed as terrible, as diamonds, platinum and gold all underperformed. The one saving grace was Kumba, the company’s iron ore division, which delivered US$738 million of earnings to the parent, the largest single contribution, on the basis of a new focus on selling directly to China.

Chinese steel production is still on the rise, and hit record levels in the first half of 2009. That the rest of the world’s production is flat or in decline means that the Chinese, along with the Japanese, the Koreans, and other key buyers of iron ore once again have the upper hand in the annual price negotiations with the major producers BHP Billiton, Rio Tinto, and Vale, and that they are also enjoying a buyers’ market for the other key ingredient to steelmaking, metallurgical coal. But with spot iron ore at a 10 month high at around US$110 to US$112 per tonne, the Chinese may now have to settle for a less severe price cut than they'd been hoping for.

BHP Billiton recently referred to the overall prevailing economic conditions as “a modest demand environment”, but on the other hand also reported coal and iron ore as among the strongest propositions it has right now. The difference is that while operations involving metals or alloys such as aluminium and manganese are in decline or operating below capacity, the Chinese demand for steel is at least allowing for iron ore and metallurgical coal output to stay steady or increase, even if pricing for those products is weaker. This means that margins are being squeezed on the coal side, and some mines are shutting down, but overall the mood in the industry remains optimistic. Meanwhile with spot iron ore prices trending upwards, many smaller Australian producers have been able recently to sell even at a premium to spot.

The trend now probably will be away from annual price negotiations for iron ore, and away from spot settlement for coal shipment, as the Chinese increasingly lock down supply in project specific deals, or off-take agreements. In spite of the recent spat between Chinese officialdom and Rio Tinto, lots of these deals are being done with Australia. Chinese companies are moving in a big way to lock in supply from projects in the Australian iron ore producing areas of the Yilgarn and Pilbara, as a defensive move against any possible combination of BHP Billiton’s and Rio’s operations down there.

Meanwhile Chinese imports of coking coal have also jumped significantly, for the slightly paradoxical reason that lower coal prices have rendered many of China’s own mines uneconomic. US coal giant Peabody, and Switzerland’s Xstrata have both ratcheted up coal shipments to China recently, although Xstrata’s boss Mick Davis has warned that prices may soon return to levels at which China’s own mines can be reopened. However, a further complication is that China has been on a long campaign to close down unsafe coal mines, which has further restricted the local supply.

What happens next largely depends on the success of president Obama’s stimulus package. US spending is expected to drive up the cost of steel and associated raw materials, and indeed Nucor, the second largest US steelmaker raised prices recently for the first time in many a long month. If the stimulus can drive a global recovery then coal and iron ore prices will be on the march again. But there’s only so long the Chinese can prop up these markets on their own. Anecdotally, the Chinese expect some domestic weakness of their own by 2011. By that time, with any luck, recovery elsewhere will be taking up the slack.