Collective bargaining

Iron ore ranks just behind just semiconductor chips and oil as China’s third biggest import annually. No surprise then that Chinese mills have been digging in their heels over a commodity that is essential for steelmaking. Many of the boldest moves in the past have been backed by Beijing but often they ended up digging a deeper hole for Chinese steelmakers instead.

In 2006 just ahead of then Chinese Premier Wen Jiabao’s visit to Australia, Citic Pacific splashed around $2.5 billion on a magnetite mine in Pilbara. The project saw some of the worst cost overruns and delays in mining history. A hefty foreign exchange loss in 2008 resulted in the Hong Kong-listed conglomerate’s controlling stake being nationalised by its state-owned parent Citic Group.

That dismal experience did not prevent Chinalco from offering to invest $20 billion in 2009 in the heavily leveraged Rio Tinto. The deal would have seen the SOE’s stake in the Australian miner double to 18%, plus offer it separate joint venture ownership of some of the world’s best mines. To the ire of the Chinese, Rio first wooed Chinalco only to jilt the Chinese aluminium and steel producer and turn instead to BHP.

China has learned lessons aplenty about trying to gain greater control over Aussie ore prices and in its latest strategic effort it has taken a new tack. This month Beijing quietly announced that a newly minted SOE will now lead China’s quest to secure greater pricing power in global iron ore trading.

What’s the new company?

China Mineral Resources Group (CMRG) held its inaugural meeting this week with vice premier Han Zheng unveiling the new SOE’s nameplate, Xinhua news agency reported.

“The establishment of the company is a major move by the country to guarantee the supply of important mineral resources by making good use of the domestic and international markets and resources, which is crucial for the security of industrial and supply chains and high-quality development,” Xinhua explained.

The state news agency offered little else in the way of details about CMRG apart from stating that it would adopt market-oriented operations in order to build itself into a mineral resources firm with “global competitiveness and influence”. According to information held on the country’s business registry, to which CMRG was added on July 19, the SOE has a registered capital of Rmb20 billion ($3 billion) and its business scope covers the import and export of minerals, ore mining, exploration of resources, supply chain management and investment.

CMRG will be based in Xiongan, a ‘new area’ set up in 2017 adjacent to Beijing that’s designed to absorb some functions of the Chinese capital. One of these functions is housing the headquarters of SOEs. Those that depart Beijing for Xiongan are cognizant that the new urban area has the heavy backing of President Xi Jinping (see WiC361).

As things stand the shareholding structure of the new SOE is not clear. CMRG’s legal representative and chairman is Yao Lin, a veteran of China’s second biggest steelmaker Angang Steel for more than 30 years before becoming Chinalco’s chairman in 2019. Chinese media outlets reported earlier this month that the 57 year-old would be stepping down from Chinalco on government rumours he was to be transferred to “another important position”.

Guo Bin, another industry stalwart from Baosteel, will become CMRG’s general manager, while several senior officials from other steelmaking SOEs have also joined the new company’s management team.

Why create a new SOE?

In 2010 there were 130 ‘centrally administrated SOEs’ under the oversight of the State-owned Assets Supervision and Administration Commission (Sasac). That number was drastically reduced to 97 by the end of last year.

This trimming was a result of the central government’s push to cut red tape and encourage consolidation among SOEs with an overlapping business focus (such as the merger between Sinochem and ChemChina). A number of new mammoths have also been created in recent years by combining the business units of competing SOEs.

For instance, China Rare Earth Group (CREG) was created in December last year by merging the rare earth units of three SOEs that dominate the industry. Similar policy thinking has also seen the creation of China Tower, which combined the completed (and often overlapping) 4G infrastructure networks of the three big telecoms carriers – a move designed to lower costs and rationalise future expenditures on the buildout of more advanced next generation 5G and 6G towers.

China Oil & Gas Pipeline Group meanwhile meshed together the pipeline assets of energy giants Sinopec, PetroChina and CNOOC.

This makes CMRG a rare newly-created SOE in what is otherwise “an era of grand mergers”, Securities Times observed. The state-run newspaper (which is an affiliate of the People’s Daily) has offered its own insights into the new SOE’s role, reporting that preparation for its establishment started in mid-2020.

A key role for CMRG, Securities Times reported, will be “consolidating the state’s iron ore import businesses, negotiating with foreign miners on iron ore prices and raising the Chinese side’s pricing power in iron ore trades”. It will also become a platform to consolidate existing SOEs’ overseas ore mines, as well as the exploration of new ones including those in China.

“The realisation of these goals will be able to suppress ore prices in the long run,” Xu Yingchun, a consultant at industry data provider CUSteel, told the newspaper.

The idea is to bring down ore prices?

CMRG’s newly enshrined role was previously scattered across different state entities, including steelmaking SOEs.

China is the world’s biggest iron ore importer. According to CUSteel, steel mills worldwide consumed 1.65 billion tonnes of ores in 2019, with China alone buying up nearly 65% of the commodity.

China’s steel industry, however, has been notoriously fragmented despite efforts by Beijing to consolidate the sector and drive out surplus production and polluting capacity. There were still 500 actively producing steelmakers at the end of 2021, of which the top 10 contributed 40% of the national steel output (a low concentration compared with the US where the same number of firms accounted for more than 80% of production).

On the sales side, the supply of ore has been dominated by an oligopoly comprising Anglo-Australian miners Rio Tinto, BHP and FMG; as well as Brazil’s Vale (the quartet provided more than half of global ore supplies in 2021).

That means Chinese steelmakers have suffered from limited bargaining power in global ore trades, a situation that’s out of step with the country’s dominant overall demand. This trend goes back years: longtime readers of WiC will recall many of our early issues in 2009 and 2010 spilled as much ink on Beijing’s battles with the iron ore miners as we do today on semiconductors and electric vehicles. But this same power imbalance has made the Chinese government more uncomfortable in the face of an increasingly unfriendly international environment.

During the country’s annual parliamentary session in Beijing last year, He Wenbo, executive chairman of the China Iron & Steel Association (CISA), openly proposed that a national champion should be created to gain more clout with suppliers over pricing – a role that the CISA has largely failed to perform since the turbulent year of 2009 when iron ore prices surged into the stratosphere.

What happened in 2009?

That was the year when Citic Pacific’s newly acquired mines in Australia were supposed to be operating and shipping ores back to China. Production was delayed. The Hong Kong-listed firm instead reported a $1.6 billion net loss (its first ever) for 2008, blaming a bad hedging position in the Australian dollar for burning a hole in its bottom line.

China then lost out on its biggest foreign investment as Chinalco said Rio Tinto had rejected a $19.5 billion investment from the Chinese side because of “something other than economic concern”.

Putting further strain on China’s relationship with Australia, several Rio Tinto executives including the China head of the firm’s iron ore business, were arrested in Shanghai in mid-2009, with the latter given a 10-year jail sentence on corruption charges (see WiC55).

By then the annual negotiation between major miners such as Rio and Chinese steelmakers was on the verge of breaking down. Prior to 2009, iron ore prices were fixed for an entire year in secretive talks between the world’s biggest miners such as Rio and their key clients. This largely non-confrontational relationship – which had gone unnoticed by media for decades as too boring to grab headlines – changed with the global financial crisis in 2008. A knock-on effect was that, initially, there was a meltdown in global commodity prices. Chinese steelmakers saw an opportunity to drive down the contract price for ores by at least 40%.

The negotiation at the time was led by CISA. Nevertheless, as many Chinese newspapers would report later, the state-run trade body effectively wielded little influence over steelmaking SOEs around the country which were competing with each other. Many went on to negotiate their own supply contracts with Australian miners. Some went as far as leaking CISA’s tactics at the bargaining table.

Beijing’s $485 billion stimulus package then changed the calculus of the miners. Rampant demand from China for steel for the infrastructure splurge on bridges and high-speed trains set ore prices on a tear, rising above $100 per tonne.

Eventually “no formal agreement” could be reached for the year, Xinhua reported at the time, with desperate Chinese steelmakers signing short-term contracts with the likes of Rio and BHP. The miners soon abandoned the cosy decades-old benchmark system in favour of a shorter-term, index-based pricing mechanism resulting in the Chinese mills – even as the biggest single buyer – losing any pricing power over ore.

As ore prices surged to a record high last year, so too did China’s forex spending on ore imports – at $185 billion – despite Beijing’s increasingly frosty relations with Canberra (an outcome that saw a number of Aussie imports banned from China, but not Australia’s high quality iron ore on which Chinese industry depended and for which there were few other sources fit to substitute).

According to data from Huaqi Information, an energy market consultancy, major Chinese steel mills reported a combined profit of about Rmb1.2 trillion between 2012 to 2021, which was less than half of the EBITDA of the ore-exporting quartet during the same period. “In other words, all Chinese steelmakers have been working for the three iron ore miners from Australia for a decade!” observed Huaqi Information.

Will CMRG do better than CISA?

Before the ‘open door’ policy reforms of the 1980s, many raw materials could only be imported to China via a single designated state-run agency.

Unless the iron ore trade reverts back to this socialist mode of operation, there is no certainty that CMRG will do a better job than CISA in bringing older, bigger and more powerful state-owned mills – such as Baosteel – into line.

In a select few key commodity markets such as copper, SOEs such as Jiangxi Copper have a group-buying arrangement and collectively negotiate with miners including BHP. Even if the central government puts out directives for top steelmakers to go down the same route, charging CMRG with importing ores for them, that’s still no guarantee of success.

Mining.com, an online and print magazine, has questioned whether it would have much bearing on spot prices beyond some short term ‘wins’ for the Chinese side. “Channelling all of China’s iron ore imports through one entity would be a gargantuan task. And history has shown difficulties with centralised trade, including corruption and other inefficiencies,” it wrote. “Sceptics will argue supply and demand is more important.”

CMRG will have to be heavily monitored – for instance, against any corrupt allocations of ore when supply is tight – and is likely to be buffeted by intense local government lobbying.

CMRG’s boss Yao Lin should understand the problem more than anyone else. The infamous case of Rio’s jailed China head aside, shockwaves were also sent across China this week after Yao’s predecessor at Chinalco, Xiao Yaqing, was put under investigation by the feared anti-graft watchdog the CCDI. Xiao, now 62, was the head of Chinalco in the turbulent year of 2009 when the firm was dealing with the controversial investment in Rio Tinto. Xiao was later promoted to become the head of Sasac.

Issues with policing graft aside, the logistical challenges of buying ore in vast quantities cannot be discounted either. Beyond these difficulties policymakers may see other opportunities for CMRG, for instance promoting the yuan’s use outside China. Symbolically enough China Daily reported that BHP saw its first shipment of yuan-denominated spot-trade iron ore dock at a port in Shandong this month.

State media has celebrated this event, also playing up the ‘recalcitrant Australia’ angle and the seeming leverage the recent yuan-denominated sale suggests. “Australian firms understand they cannot always play by their own rules in business partnerships with Chinese clients, their largest global buyer, and the use of the Chinese yuan for trade is a positive change,” a professor of Australia studies declared to the Global Times.

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