If China demands less steel, Australian exporters will suffer

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Hello from Hong Kong, where the beaches have reopened but mah-jong parlours and karaoke bars remain shut.

Our main post today is about one of the defining commodities of China’s response to the coronavirus — iron ore — and how a likely decline in demand will affect its trading relationship with Australia.

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How Chinese steel demand affects Australia

In China, coronavirus brought with it an unprecedented appetite for iron ore. Over the course of 2020, it imported 1.17bn tonnes of the commodity — more than any year on record.

This fed into record steel production, which uses iron ore as one of its raw materials. Steel production also surpassed 1bn tonnes last year as China unleashed a construction boom that helped swiftly counter the economic impact of the pandemic. That meant China was the only major economy that expanded in 2020, yet the industrial nature of its recovery also raised fresh questions about the sustainability of its growth strategy.

Still, Canberra was not complaining. While rising geopolitical tension between China and Australia led to tariffs and restrictions on a host of the latter’s goods, such as wine and barley, it is no surprise that the iron ore trade was largely undisturbed. Of the total amount of iron ore China shipped in, about 713m tons or 61 per cent of it came from Australia. In turn, Australia is extremely reliant on China, which buys the vast majority of its exports of iron ore.

But China, having ramped up its industrial sectors to boost growth, is now trying to rein in steel production as part of a move to limit carbon emissions. President Xi Jinping last year pledged to make China, by far the world’s biggest carbon polluter, net zero by 2060. Economists also expect its wider recovery to rely less heavily on industry and transition towards household consumption as, by the end of last year, its output rate had already reached pre-pandemic levels.

Recent government visits to Tangshan, the city at the heart of the steel industry, to warn about pollution have come alongside a parallel attempt to curtail activity in China’s booming property sector, which consumes a third of the steel the country produces.

What does all this mean for the flows of iron ore between Australia and China as the latter’s coronavirus strategy begins to shift?

In the shorter term, that depends on whether trade is measured in volume or price.

In a sign of falling appetite in terms of volume alone, shipments of iron ore from Australia to China have dropped every month since September. In February, imports stood at 51.5m tonnes, compared with 70.6m in July, according to Census and Economic Information Center data. As the chart below shows, broader Chinese demand for iron ore has eased off its recent highs, though the fall has been less dramatic than that experienced by Australia.

Line chart showing Chinese iron ore imports have soared as construction has boomed

But the value of iron ore shipments from Australia in February hit $7.8bn, its highest level for any month on record, CEIC data shows, due to a surge in the price of commodities.

Steel prices have climbed in part on expectations of production curbs in China, with benchmark prices rising to more than Rmb5,500 ($840) per tonne by last week. That has also helped support the price of iron ore, analysts say.

“The idea that you suddenly force steel mills to become more efficient partially through restricting production, what that tends to do is just force the price of steel higher, and given that higher steel prices improve steel mill profitability, what tends to happen is the price of iron ore goes up with it,” said Robert Rennie, head of financial market strategy at Westpac.

Australia also faces competition, particularly from Brazil, where shipments are up 19 per cent in 2021 so far, according to UBS, in contrast to struggles last year. The commodities industry is also focusing heavily on Simandou, a mine in Guinea that is the world’s largest untapped deposit of iron ore. In late 2019, a joint venture backed by China secured the rights to develop it. Public statements from China about the mine could be bad news for Australian exporters.

Rennie also points to longer-term dynamics at play in the iron ore trade. Mature economies such as Europe and the US make heavy use of scrap steel in manufacturing new steel. More than half of the steel manufactured in Europe in 2019 was made this way. China, by contrast, used scrap for just 22 per cent of its steel in the same year.

If China begins to rely more heavily on scrap, this would reduce imports, though it would need far more electric arc furnaces to utilise it and would only have a material impact in the long term.

For iron ore exporters such as Australia, these effects could combine with a less pressing need to build in the first place, even if the pandemic unexpectedly ushered in a wave of new construction. That would counter a very long-term trend for China to use ever more steel.

S&P Global Platts expects steel demand from the construction sector to remain high in 2021, even in the face of government pressure. But in a recent note, it said that urbanisation, which had been the “core driver of China’s property development and steel consumption over the past 20 years”, typically became less steel-intensive after the urbanisation rate breached 60 per cent. It noted that urbanisation in China exceeded 60 per cent in 2019 and was expected to reach 70 per cent by 2030.

As Platts wrote, “demand for construction steel may be close to — or may even have already reached — its peak”.

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