China doesn’t like the volatility in iron ore prices and is suspicious of the spot markets and indices that provide the moving benchmarks for contract prices.
Periodically it tries to crack down on perceived speculation in futures markets and by iron ore traders – the latest effort was launched only weeks ago – and periodically it calls in senior executives from the iron ore miners (as it has done recently) to chastise them for the elevated prices and jaw-boned them into doing something about them.
The reality of the iron ore market is that it works. The four big seaborne iron ore producers have greatly increased the volumes of ore they produce in response to China’s demand. The prices are set at arm’s-length from the producers and reflect both the balance of supply and demand and the costs of the marginal producer.
That marginal producer isn’t Rio,BHP,Fortescue or Vale but China’s domestic iron ore miners. The big four seaborne iron ore producers are at the low end of the cost curve and at the high end of the quality curve. China’s domestic producers are at the wrong end of both curves.
China’s authorities might be suspicious of markets but the prices the big producers get and the massive profit margins they generate reflect the big Chinese steel mills’ need and preference for their ore,which enables high-quality steel to be produced efficiently and with lower carbon emissions than would be the case with lower quality ore.
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There is little doubt that China,having imposed bans on a range of Australian exports –including wine,barley,coal and lobsters – would be frustrated that the coercive impact of those sanctions has been almost completely offset and undermined by its reliance on Australian iron ore. About 60 per cent of its iron ore imports are from Australia.
With cash costs in the mid-teens the Australian miners are fabulously profitable at prices way below the current level of more than $US140 a tonne and are generating many billions of dollars of revenue for the federal and state governments – more than enough revenue to blunt the impact of China’s trade sanctions on the economy.
China is making an effort on multiple fronts to reduce its reliance on Australian iron ore. It has been encouraging Vale,plagued by production and development mishaps,to increase its output.
A priority in its latest draft five-year plan,developed last year,is to develop one or more big mines itself and diversify its supply based by sourcing more from Mongolia,Russia,India and Africa. More use and increased imports of scrap are being encouraged. The highly-fragmented steel sector is being directed to consolidate.
China doesn’t like the volatility in iron ore prices and is suspicious of the spot markets and indices that provide the moving benchmarks for contract prices.
The Simandou mine in Guinea in which Chinese companies are heavily involved -- the biggest and highest-quality underdeveloped resource in the pipeline -- could come on stream towards the end of the decade and,after close to $US20 billion ($27.7 billion) of investment to build the mine and the port and rail infrastructure from scratch,might add about 100 million tonnes a year to industry capacity.
Even if all those efforts come to fruition,however,BHP,Rio and Fortescue will remain at the low end of the cost curve and the upper end of the quality curve and they will still have the advantage of their geography – their proximity to China and therefore their lower shipping costs – their existing infrastructure and their stable and -world jurisdiction.
Unless China produces less steel and lowers its decarbonisation goals – or is prepared to reduce the competitiveness and profitability of its steel sector by displacing Australian ore with higher-priced and inferior quality material – it will remain dependent on that Australian ore.
China could create a single platform to negotiate with the Australian companies but they could simply refuse to deal with it or sell on anything other than traded prices. There’s no commercial sense in gifting Chinese mills a slice of the margin they’ve created through their own efficiency and the quality of their orebodies.
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The seaborne miners have actually got more leverage than China in the current circumstances,along with the corporate memories within Rio and Vale of what occurred a decade ago when they thought they were negotiating in good faith.
Their own self-interest dictates that,if China does try to push ahead with a single buying desk,they reject the attempt to displace and distort a market that,regardless of whether prices are high or low,broadly reflects the fundamentals of supply and demand and their own competitive positions.
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