China's plan to control Aussie ore market

Company News

by Glenn Dyer

Let’s take a moment to think about China’s latest whizzbang idea to try and control the Australian iron ore industry with a centralised buying agency.

News of the plan emerged this week, after several leaks to Bloomberg and other western agencies in recent months.

The China Mineral Resources Group, with registered capital of 20 billion yuan ($US3 billion), has been established to invest in mining of minerals, as well as trading and purchasing, said Tianyancha, a Chinese online database of company information (a move widely reported by Bloomberg, Reuters and Chinese state media such as the Global Times).

Sounds an interesting idea, but we have to remember that China’s domestic resources industry is state-controlled and regulated already and doesn’t have a very good track record.

While it is a mix of state- and privately-owned companies, all respond to central government intervention and rules – that includes the key domestic iron ore industry (which is inefficient and the domestic coal industry which is also inefficient).

China’s domestic iron ore industry doesn’t have enough high-grade ore of the type (62% Fe that Australia and Brazil typically produce and export).

China has considerable coal reserves (but even so it has been cheaper to import thermal and coking coal from Australia and Indonesia for coastal power stations and steel mills than to try and supply the same products from the country’s coal mining sector in the centre of the country or from Mongolia).

Last year the coal industry could not supply enough thermal coal, in a timely enough fashion, to prevent shortages at a number of power stations triggering an embarrassing series of blackouts and rationing in August through early November.

Rules imposed by the central government as it attempts to make the country carbon neutral by 2060 had seen coal production slow, even as the country still relies on coal for more than half of its power. Some mines met their yearly quotas by August because of strong electricity demand in the June half of 2021, then went on care and maintenance because it is seen as possible corruption to provide more than the state set quotas allow, especially if that extra coal is sold.

That saw shortages of coal appear in the north, south and in parts of the eastern and southern coastal provinces (especially with the Chinese blocking Australian exports which meant those coastal power stations and steel mills had to find an estimated 80 million tonnes of extra coal very quickly).

That in turn saw coal prices rise as desperate state- and privately-owned coal users chased supplies of thermal and coking (metallurgical) coal).

But with the government strictly controlling electricity prices, coal-fired power plants were unwilling to operate at a loss, with many drastically reducing their output instead through August and into September when the first major rolling blackouts started.

Energy-intensive industries such as steel-making, aluminium smelting, cement manufacturing and fertiliser production were among the businesses hardest hit by the outages – many has to curtail production or close facilities – that contributed to a slowdown in production and business activity in the final months of 2021.

As a result of this embarrassment, China introduced stricter controls on thermal coal prices late last year to control speculation and while that has cut the cost of the key raw material for power stations, it has seen claims coal mining companies (state and private) have been supplying low quality coal to power stations instead of the more expensive to mine higher quality coal.

To avoid a repeat of the outages and rationing in the winter of 2021-22 and this summer, China has spent tens of billions of dollars on new coal mines, expanding existing moves, lifting quotas and accelerating investment in new coal fired power stations) to avoid a repeat of the blackouts in winter and this summer.

China’s regulation of the oil refining industry is equally haphazard – state-owned giants co-exist with smaller operators called ’teapot refiners’ who depend on import quotas.

Sometimes the state stops issuing quotas to help the state-owned refiners or to punish the teapots who trade their quotas with each other or with outsiders to make money when profit margins are low.

They are not supposed to do that but since President Xi launched his hypocritical crackdown on corruption, the trading import quotas has been frowned upon – severely.

The teapots are useful now because they have been encouraged to buy cheap Russian oil (and allow the state-owned refiners to avoid the dangers of being sanctioned by western governments).

Teapots account for around 20% of China’s annual oil imports but imports slumped 31% in the January – June period because of the impact of Covid containment measures across a third of the country and especially in Shanghai, Beijing, parts of Guangdong and Jilin as well as Tangshan and Tianjin.

Chinese regulation and industry oversight is administered in a capricious fashion – the two years crackdown on private tech companies is a case in point because many of those companies dared to head to the west and especially the US or new capital and opportunities – and some did not realise how serious that the Xi government was about Chinese control (rather the State) of data of all kinds, especially from ride share, social media platforms, EVs, rental, food delivery, education and other industries.

So now China reckons it can bring all this ‘expertise’ to bear on iron ore imports, sourcing and production.

Because of poor reserves, dud mining practices and low-quality ore, China must import nearly 80% of its annual consumption of about 1.2 billion tonnes.

It thinks it can do better than the state- and privately-owned mills have done – the record prices of early 2021 when 62% Fe fines topped $US240 a tonne) rankled. China is ignoring the $US140 a tonne plus fall in prices to less than $US100 a tonne at the moment.

The big three Australian miners – BHP, Rio Tinto and Fortescue Metals have been reluctant to comment on China’s plans, but said there was no change in their relations with Chinese customers.

Fortescue supplies iron ore to customers under long-term contracts, Chief Executive Elizabeth Gaines told Reuters this week, playing a straight bat.

“We will continue to work closely with our customers and other key stakeholders in China to … optimise our distribution channels to meet the needs of our long-standing customers and the Chinese steel industry,” Gaines said.

She could have been talking about rivals Rio and BHP as well.

But while its peers have been reluctant to talk, BHP has pretty direct this week in Melbourne.

The world’s biggest miner pointed out that history showed plans for centralised iron ore purchases did not work.

“At the end of the day, we believe that markets will sort out where the price needs to be based on supply and demand,” Chief Financial Officer David Lamont told a business forum in Melbourne.

BHP led efforts more than a decade ago to end annual iron ore price-setting talks in a shift to market-based pricing via an index system which now dominates global pricing.

Chinese steel mills know that and also know if they try and set a maximum price as they are doing with domestic thermal and coking coal, they will risk losing high quality ore supplies.

Fortescue Metals is the most exposed of the big three Australian companies because it has two new mines coming on stream. BHP and Rio are bringing one new mine each into production which will replace ore from reserves that is being exhausted. Fortescue’s new mines – Eliwana and Iron Bridge are designed to expand the companies’ sales.

Eliwana is a fines operation designed to lift the average grade (it’s a haematite ore) of Fortescue’s key blend, Iron Bridge is a lower grade magnetite mine and processing business. Its more marginal an operation than the new Eliwana mine.

The new company is expected to coordinate procurement of imported iron ore, develop domestic iron ore resources, and oversee development of mines overseas.

The Simandou iron ore deposits in Guinea would be a prime target but a Chinese backed consortium with one of the licences is involved in an argument about the pace of the development and handing over a 15% free carried interest in the project (Rio Tinto is in the same boat with its part of the projected mining area) to the Guinean junta.

But the crisis in Sri Lanka where huge Chinese infrastructure loans have added to the country’s debt burden and financial problems, is forcing governments in emerging economies become more sceptical about the blandishments of Xi and his envoys.

Will the state-owned buyer (not a novel idea in China at all) be adept at trying to match demand to supply when the state-owned companies now dominating Chinese steel making, keep getting it wrong and are responsible for the wild swings in prices and stocks?

The problems in iron ore pricing are driven by the vagaries of Chinese planning, building and construction, government policies towards the stricken building industry, demand from key sectors such as cars and the dead hand of existing state-owned regulation and the panicky demand and supply equations of steel mill executives.

Bad weather in Australia and Brazil plays a small part on the supply side but that’s all.

China will not be able to play off the Australian producers with Vale and other suppliers -there are no other countries capable of matching the quality and volumes that Rio, BHP and Fortescue now mine and ship every day. Some smaller Australian players might be driven from the market (Mineral Resources and Mount Gibson are candidates).

But you can bet that the state-owned CITIC will continue to ship its loss-making magnetite from Clive Palmer’s deposits in the midwest of WA. That is a loss-making high-cost magnetite mining project that just can’t compete with the more profitable, higher quality haematite-based mines run by the big three companies in the Pilbara.

Those mines produce high quality fines which is the basic iron ore product used in Chinese mills. CITIC doesn’t. India, Iran and South Africa can’t produce the same quality or quantity and the Simandou deposits in Guinea are higher quality (65% Fe or more compared to the 58% to 62% average in the Pilbara) but are a decade or more away from being developed.

Only Brazil can and in Brazil, the dominant miner is Vale. Brazil can’t really compete, even with Vale’s 65% Fe fines product – because it is so far away from China when compared to Australia.

The Australian miners can mine and ship ore to China at twice the rate that Vale does. That’s despite bigger ships, a port joint venture with a Chinese company and other attempted fixes such as stockyards and transhipment facilities in Asia (which add to Vale’s costs).

Covid, bad weather, two tailing dam collapses since 2015 and an uncertain government (and Covid) have made Brazil (and especially Vale) far less reliable a supplier than Australia.

To try and bring iron ore under state control (externally) China will have to be willing to forgo quality, quantity and regular and reliable shipments of iron ore from the closest major suppliers in Australia.

BHP, Rio and Fortescue know that if they are patient, they can wait out the Chinese buyer/buyers, easily supply iron ore at $US100 a tonne – their costs have risen to just over $US20 a tonne, but they will be cut or controlled with more automation and energy prices will eventually fall.

Vale’s profit margins are much thinner than the big three Australian companies at $US100 a tonne.

For Australia generally, federal budgets are based on iron ore prices averaging $US55 a tonne so while a fall in export revenues from iron ore will be noticeable and cut nominal GDP and tax income, it would not be as catastrophic as some of the nervous nellies in US, Chinese and local business media are claiming.

BHP and Rio Tinto easily dealt with the Japanese steel mills when they were the biggest buyers in the seaborne iron ore market and that in house memory is still there.

And there’s a silver lining for the big three – they are already heading off down the renewables route and they can take their iron ore cash flows and build or buy businesses to help accelerate that journey and there is nothing the Chinese can do.

Glenn Dyer

Glenn Dyer has been a finance journalist and TV producer for more than 40 years. He has worked at Maxwell Newton Publications, Queensland Newspapers, AAP, The Australian Financial Review, The Nine Network and Crikey.

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