Talking Point

Iron laden

China suddenly finds it cheaper to buy materials. For the world: bad news…

Symphony of steel: demand for the metal is plunging as China slows

“If you want clean air, you should move to Africa.” Such was the somewhat cavalier remark alleged to have been made by a government official in Jingzhou last week, to a group of university professors from Yangtze University.

The academics were protesting against a steel mill operating next door to their university. They claim it has become a chronic source of pollution, reports Bloomberg, with an associated increase in coughs, sore throats and even leukemia on campus.

Faculty and students are now demanding that the mill be shut down. For those in the international mining and shipping sectors, potential closure of the mill might inspire mixed feelings. China’s steel industry is pivotal to profits and growth in both their industries. And the latest signs are that neither are as healthy as they would like them to be at the moment…

Ports in a veritable storm…

It wasn’t long ago that WiC was writing about the soaring price of iron ore and the flailing tactics of Chinese negotiators to get prices down (see WiC56). The reason? A property boom and massive spending on infrastructure meant there was a seemingly insatiable demand for steel – as well as the chief raw material that makes it, iron ore.

This kept shareholders of BHP Billiton and Rio Tinto happy. Likewise it saw shippers enjoy booming freight rates and shipyards expand their order books for new vessels.

But as the Economic Observer reports, that trend has been reversing. Demand in China for steel has slowed, leading to 100 million tonnes of iron ore now piling up at the country’s ports. “Port stockpiles indicate that steel mills are reducing and limiting their production,” an official with Tangshan Iron and Steel told the newspaper

It’s not hard to see why steel producers are cutting back output. As reported in last week’s Talking Point, a slowdown is underway in the property market. That means less demand for steel. Then there are the problems in the rail industry (see WiC127), which has seen a halt in the construction of new lines. Close to 60% of China’s steel demand is accounted for by construction and infrastructure, HSBC estimates, with the remainder driven by manufacturing (the outlook is not so good there too, given weakness in China’s major export market, the EU).

Mysteel.com, an industry website, notes that China’s fixed asset investment growth has slipped to its lowest point for the year, with real estate investment growth down to its lowest level in 18 months, and railway investment growth at its lowest since April 2004.

“China’s steel industry is experiencing a winter,” is the verdict.

Since mid-October steel prices have also continued to decline, with China’s top producer Baosteel cutting prices of some products by between Rmb200 to Rmb600 per tonne. The monthly decline in price for threaded steel was 6.68%, for example, a decrease hastened by the dumping of inventories.

Where steel goes iron ore follows…

To be precise, where Chinese steel demand goes, the price of iron ore follows. As HSBC points out in a recent research note: “Almost all growth in global steel production since 2003 has come from China, where monthly production tripled to almost 60 million tonnes in this period. This has resulted in a doubling of China’s share of global steel production to 46% since 2003.”

So Chinese demand has a decisive impact on the price of iron ore and the financial fortunes of the big three mining firms; BHP Billiton, Rio Tinto and Vale.

The price of ore reached a high in early September of $188 per tonne, but has since fallen by around 35% on the spot market. Zhang Changfu, the vice chairman of Chinese steelmaking association CISA, told the Economic Observer: “China’s demand is decreasing and Chinese steel mills have stopped firing furnaces. The drop in iron ore price is very reasonable. I think it will fall again.”

The plunge in the spot price has been so dramatic that a number of Chinese mills have opened discussions with miners to renegotiate the higher quarterly prices they’d earlier agreed. Perhaps it is a measure of the precarious state of demand that newspaper 21CN Business Herald says Brazil’s Vale has been showing willingness to do just that, opening talks with individual Chinese firms about lowering prices.

How far could prices fall?

During the global recession of early 2009 iron ore prices reached $58 per tonne. But it would require a very hard landing in China (or perhaps a wider implosion of the eurozone) to get back to those levels. The consensus view at a panel discussion held by the Hong Kong Shipowners Association last week (with representatives from both the dry bulk shipping industry and Chinese steelmakers) was that ore prices would fall to around $110 in the coming year.

One of the key factors in predicting prices is forecasting performance in China’s domestic iron ore industry, where the quality and quantity of output can vary widely. The problem here, as HSBC puts it, is that the domestic sector is “woefully under-researched”. But it estimates that at least a third of output is poor quality (i.e. lower grade, with ore content of 10% versus as much as 60% for the stuff imported from Brazil and Australia). Chinese producers are estimated to provide steelmakers with about 200 million tonnes of ore per year but, because of the declining quality, there is a major substitution effect when imported ore prices fall dramatically, as is happening now.

For example, if prices fall below $100 per tonne, HSBC estimates about a third of the Chinese ore industry “turns off”.

So if you assume China experiences a ‘softish’ landing, the substitution effect would seem to suggest a floor on recent price declines at around the $100 level.

HSBC sees that outcome as a likely one, also believing that Chinese steel demand will continue to grow at a compound annual growth rate of 5-6%.

Still not enough for the shippers?

As WIC has reported before (see WiC71) the shipping industry faces a double whammy. Not only is it heavily exposed to Chinese demand for iron ore (which accounts for 30% of dry bulk shipping volumes). But it also has to reckon with a glut of new vessel supply.

Ship utilisation rates have already fallen to below 80%, with the number of dry bulk ships in the water (think large panamax and capesize vessels) up by half in just three years. And the supply situation doesn’t look like getting any better: HSBC says that as many new vessels will be launched in the next two years as in the last 10 combined.

The Baltic Dry Index is the chief measure of the freight rates paid to charter these ships. And by early November a combination of weaker economic news from China and too many ships leaving the dry dock had seen it fall 18% from its 2011 peak.

Not surprisingly, falling rates also put financial pressure on the shipping firms. In WiC120 we described how Cosco was trying to force shipowners to accept lower fees for their charter contracts (signed at the top of the market). Cosco didn’t get its way (backing down after three of its own ships were seized by bailiffs) but the effort was a symptom of a broader trend. And this week, another Chinese shipping company has been in the news for failing to keep up with its payments to shipowners. Grand China (part of the Hainan-based HNA Group) has also halted payments on vessels used to transport dry commodities. Three European shipowning companies are now reported as either withdrawing their vessels from Grand China contracts or pursuing legal remedies to recover outstanding payment.

Given currently low freight rates, about 17% of the world fleet’s is facing cashflow strains, reckons HSBC.

The knock-on effect is that the financial pain is also being felt in the shipyards too. Not so long ago it was a sellers market for the yards, as shipping firms looked to expand their fleets with major orders. Again, not so now: the panel at the Hong Kong Shipowners lunch agreed that prices for new-build ships would continue to fall next year in response to the supply glut. For the Chinese yards they forecast prices dropping to $45 million for a standard capesize vessel, which would mean losses on each ship sold.

And Vale’s strategy now looks shipwrecked too?

For Vale – the Brazilian ore producer – the news has been doubly bad. Falling ore prices – as you might expect – will dent Vale’s profits. But the miner has been hit with another financial headache: the unwinding of its shipping strategy.

As reported in WiC125, Vale is now facing trouble over its $2.3 billion investment in 35 very large ships (known as Valemax) to transport ore. Its plan was to compete with the Australian ore producers (shipping less distance to China, they have lower transport costs) by owning more of its own shipping capacity. So it bet big: the combined size of its behemoth ships – some of which are made in China, with the final vessel to be delivered by 2013 – is 14 million deadweight tonnes. That is 5.6% of the existing capsize fleet worldwide.

That also means that each ship is 400,000 deadweight tonnes, far exceeding standard vessel sizes and requiring special port facilities. And here is the rub: China’s shipping industry – worried about competition from the new fleet – has been lobbying the government to deny Vale access to local ports on safety grounds.

In a much-reported move in June, the first Valemax was redirected to Italy while on its maiden voyage to Dalian and Vale still hasn’t been able to dock any of its ships in Chinese ports.

If the ships cannot be employed on voyages into China the business case for building and operating them evaporates.

So last week, according to 21CN, Vale approached China’s Cosco about buying the fleet of new mega-vessels. The newspaper reported that Cosco quickly rebuffed the offer on the grounds that the industry is already sluggish and it doesn’t need to enlarge its fleet. Of course, that may well be a negotiating tactic and, in current conditions, Vale doesn’t look to have much of a poker hand to play. If the China steel price continues to fall – and the price of ore with it – the cost of Vale’s maritime miscalculation looks like compounding. Back in Rio de Janeiro its executives will be hoping for a way out, something a little more likely if Chinese steel output picks up – that means it’s in Vale’s interest for the controversial mill in Jingzhou to stay open.

Keeping track: in WiC129 we discussed Vale’s problems in docking its giant 400,000 tonne ships in China. Resistance from local shippers first saw a Valemax ship turned away from Chinese ports in June. Since then the decision to launch the behemoth fleet (set to grow to 35 vessels, with the raison d’etre of carrying Vale’s iron ore from Brazil) has been proving a costly problem. Valemax had remained unwelcome at all Chinese ports.

But last Friday the Financial Times reported a glimmer of good news: a Valemax had been allowed to unload its ore in Dalian. The ship was owned by Singapore’s Berge Bulk but chartered by Vale. Noted the FT: “It remains unclear whether the permission to dock reflects a general change of heart towards the Valemax carriers on the part of Chinese authorities or will be limited to the four vessels operated by Berge Bulk.” (Jan 6, 2012)

In WiC129 we discussed Vale’s problems in docking its giant 400,000 tonne ships in China. Resistance from local shippers first saw a Valemax ship turned away from Chinese ports in June. Since then the decision to launch the behemoth fleet (set to grow to 35 vessels, with the raison d’etre of carrying Vale’s iron ore from Brazil) has been proving a costly problem. Valemax had remained unwelcome at all Chinese ports.
But last Friday the Financial Times reported a glimmer of good news: a Valemax had been allowed to unload its ore in Dalian. The ship was owned by Singapore’s Berge Bulk but chartered by Vale. Noted the FT: “It remains unclear whether the permission to dock reflects a general change of heart towards the Valemax carriers on the part of Chinese authorities or will be limited to the four vessels operated by Berge Bulk.”


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