Steeling themselves

A rod for its own back: while China needs steel, it needs iron ore too

Bloodied but unbowed. That’s how the China Iron and Steel Association (CISA) will be reviewing recent events, as the annual negotiations on the contract iron ore price gear up again this month.

In truth, last year’s talks ended with the Chinese team in disarray. Having refused to accept the miners’ contract offer of about $61 per tonne, CISA then had to watch spot prices climb to as much as 80% above the benchmark price. Its members were far from pleased, even if they did agree with the principle that Chinese buyers should be entitled to a volume discount.

CISA’s difficulty was in holding out for cheaper ore even as Chinese steelmakers were queuing up to import it by the shipload (see WiC25). Steel has been in demand for all the new bridges, roads and railways being built in the government’s infrastructure stimulus. HSBC estimates that 60,000 new projects were launched in the first eight months of the year.

As the new negotiations begin, CISA is trying to talk down demand in coming months. It says steel production will fall as the stimulus efforts lose some of their steam, and that a decent supply of ore has already been stockpiled too.

But the miners think the Chinese are bluffing and they have indicated that the contract price will have to increase by as much as 35% on last year’s level. For Shan Shanghua, head at CISA, this is unreasonable: “If the demand side is always losing money and the supply side is always making money, can that continue?”

So who is right? A glut in supply has seen steel prices drop 25% from a 10 month high in early August. HSBC says current inventories remain at record levels too. But it also expects the stimulus package to continue to generate demand, as much of the spending is still to arrive in the next two years.

CISA’s other tactic is to trumpet that domestic consolidation is underway, and that smaller, less efficient mills are now closing. It reckons that this will go some way towards chopping off an estimated 150 million tonnes of annual overcapacity. Steelmaking economics mean that many mills are reluctant to mothball production, so demand for ore is resilient even when market conditions come off the boil.

But talk of consolidation is not new, even if policymakers on the fringes of last week’s World Steel Association meeting are saying that there is a newfound determination to get on with the job. Even this year, analysts estimate another 58 million tonnes of capacity is under construction.

An industry shakeout might also help to cull the unrulier elements in the Chinese negotiating team. CISA had particular problems last year in getting the smaller mills to toe the official line, especially when the spot price was climbing so quickly. Many broke ranks to do side deals with the miners.

But Rio Tinto, BHP, Vale and the other miners will be betting that CISA cannot maintain a united Chinese front and that the talk on consolidation is more words than action. They know that previous efforts have often floundered in the face of opposition from local governments, who oppose the impact on employment and tax revenues.

In the bigger picture, Chinese demand has been key to the miners’ prospects this year and is likely to remain so for the foreseeable future. So CISA argues that it must have a lot more say as a price-maker in the negotiations. But the Financial Times thinks the miners will be reluctant to engage in detailed talks, and are far more likely to present the Chinese with a ”take it or leave it” offer.

The steel industry in China is undergoing other changes. More domestic firms are moving into higher-end products, like the type of steel sheet used in cars and home appliances. That would seem to make sense, as so many future cars and fridges are likely to be made for Chinese consumers. Japanese newspaper Nikkei worries that this will hit its own steelmakers’ share of the Chinese market.

But higher quality steel requires higher quality ore, industry specialist Michael Komersaroff tells the Dragonbeat blog. And imported ore normally fits the bill much better than China’s own lower grade domestic supply.

The miners win whichever way the Chinese turn, it seems.

© ChinTell Ltd. All rights reserved.

Sponsored by HSBC.

The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.