Bound to Iron: China's next five years

Published by MAC on 2011-01-31
Source: Nostromo Research, Interfax China

Digging behind the global steel statistics

Iron ore pricing - the strait jacket of China's domestic market

China accounts for more than half of all global iron ore exports. As the country's need for the mineral increases, domestic demand is pushing up global spot prices for fellow top importers Japan, South Korea and Germany. The key difference: China's capacity to deal with the cost impact. In the next issue of China Mining & Metals Weekly, we will take a closer look at China's ability to manage its iron ore demands.

Domestic iron ore production declined in 2009 as cost considerations pushed China's steel mills to import cheaper iron ore from abroad. With the shift from an annual pricing contract to a quarterly system in March 2010, prices became more responsive to market forces. Second quarter (Q2) pricing in 2010 gave key global producer Vale Ltd. a 90 percent price increase for iron ore sold to Japanese steel mills, and another 50 percent rise in Q3. South Korea and China soon followed suit. The domino effect, that started with Japanese concessions, marked a stark reversal of national influence during price negotiations with the Big Three global iron ore giants (Vale, BHP Billiton and Rio Tinto) Together, these companies control roughly two-thirds of the $88 billion seaborne iron ore trade. Given that one-third of these exports are bought by China, one of the nation's major steel companies, Baoshan Iron & Steel Group (Baosteel Group), traditionally served as the principal negotiator for iron ore pricing contracts in Asia during the past five years. Japan's recent break in formation likely derives from the competitive ability and structure of its steel industries. Both Japan and South Korea are able to compete successfully in the global steel market at a time when officials in Beijing are struggling to reorganize the nation's highly fragmented steel industry by 2015.

Until China's steel industry is effectively consolidated, overcapacity will continue to depress domestic steel prices. Intense competition among numerous steel producers precludes consumer price increases. This makes high import prices for raw materials like iron ore difficult for struggling steel mills to absorb. (On the other hand, given that larger mills have already made moves to procure domestic iron ore mines, the most affected producers are medium-sized mills. In this light, high iron prices may be indirectly driving mid-sized competitors out of the market or into mergers, hastening Beijing's goal of sector consolidation).

It is precisely the depressed prices for steel products like wire rods that are driving China's export sales. Domestic overproduction and full stockpiles are pushing steel exports to neighboring markets such as Southeast Asia. Yet China's competitive advantage in these markets relies on low-pricing. Chinese steelmakers reduced wire rod prices by as much as 25 percent last summer to make their goods more attractive to countries like Vietnam, where South Korea is currently a main rival for steel good orders. South Korea and Japan, however, are less eager to lower export prices to gain market share.

Both Japan and Korea have concentrated steel sectors that do not enable market leaders to manipulate domestic pricing in response to external cost factors. The five largest steel makers in Japan dominate three-quarters of the domestic market. In Korea, POSCO (Pohang Iron & Steel Co. Ltd.) controls nearly 65 percent of the market. In contrast, the top 15 steel producers in China account for just under half of the country's total production. With established market shares, these steelmakers can more easily transfer rising cost pressures to downstream consumers (automobile assembly, ship building, and construction companies). South Korean steel prices are boosted by unmet demand from its auto industry. Japan saw its 2010 Q3 prices for iron ore rise to $150 per ton, but were able to pass the burden on to end-product manufacturing companies. Many such steel customers in Japan are high-end producers with large profit margins capable of absorbing price changes or passing it on to customers.

As China struggles to balance input and output costs, the China Iron and Steel Association (CISA), an industry organization that represents China's major steel mills, is calling for an iron ore pricing system based on the cost of steel production. As the producer of more than half the world's steel products, such a system would return pricing leverage to China once again. The likelihood that rival steel companies or iron ore producers would hand this influence back to China is clearly minimal.

Overall, the combination of inelastic steel prices at home and rising input costs clearly defines the profitability challenge for China's steel industry. [Below, Interfax examine[s] asset acquisition trends in China, Japan and South Korea as they seek to undermine the oligopoly of the Big Three iron ore producers and hedge against future iron ore price hikes.

- Chantal Grinderslev, Analyst

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Iron Ore sourcing: China's Resource Race

China already accounts for more than half of all global iron ore imports. As China's need for the mineral increases, it is facing competition from both South Korea and Japan in the race to acquire resources overseas. China's neighbors have a head start but China remains a formidable, well-financed powerhouse in completing mergers and acquisitions abroad. In this issue of Interfax's Metals and Mining Report, we look at the policies and strategies each country is pursuing to secure iron ore.

Chinese interests abroad are driven by urgency to fill domestic supply gaps, but are boosted by government support and cash. In 2003, China replaced Japan as the world's largest iron ore importer. China now produces nearly 70 percent of the world's iron supply, and as the largest importer is now driving the global iron ore trade. As much as 80 percent of China's imports are sourced from the Big Three iron ore giants (Rio Tinto, BHP Billiton, Vale), which makes China more vulnerable than its Asian neighbors to price hikes and cost volatility. China's industry is fragmented, which makes a unified bargaining position difficult.

China's metal producers have also stepped up mergers and acquisitions (M&A) both domestically and abroad - in Australia, Mexico and Brazil - through a combination of government-backed incentives and loans for target countries, enormous financial reserves and improved negotiating skills. Yet, China's steel mills appear to be struggling to keep up with iron price increases. China's sudden emergence as a big buyer of iron ore pushed prices up fourfold between 2002 and 2008. In addition to the structural differences between Japan, South Korea and China steel industries mentioned in last week's Interfax report, Japan and South Korea's pursuit of overseas assets since the 1970s has allowed them to better weather the upswing in iron ore prices. As recently as ten years ago, the two countries signed a cooperation agreement to develop iron ore resources in Australia.

Source: Government of Australia, Department of Agriculture, Fisheries and Forestry and the Data Management team of ABARE

Just last year, both South Korea and Japan's governments initiated policies to directly promote overseas acquisitions in the mining sector to keep pace with China's recent M&A drive. Japan's Ministry of Economy, Trade and Industry prepared a bill last year to allow state-owned Japan Oil, Gas and Metals National Corp (JOGMEC) to collaborate with private companies when investing in foreign mines. Previously, such cooperation was only allowed in the oil and natural gas sectors. This new bill, passed by Parliament in March, emphasizes industry integration and offers government guarantees to fund rare metals, base meals, and iron ore projects.

Meanwhile, South Korean companies made record investments of more than $12 billion on overseas energy and mineral resource projects in 2010, according to government estimates.

Last fall, officials announced plans to extend financial assistance and tax benefits to companies exploring overseas resource development projects. The country plans to increase its self-sufficiency ratio for six strategic minerals including iron ore, uranium, nickel and lithium, from 25 percent of total imports in 2010 to 42 percent in 2019. In order to accomplish this, South Korea has focused on small- and mid-sized investments abroad, typically avoiding direct competition from China.

China's huge cash reserves, and the value placed on asset ownership, typically allow it to outbid competitors. Since 2007, energy and mineral resource deals by Chinese firms were valued at nearly seven times those of South Korean companies. Seoul-based M&A consultancy Samjong KPMG Advisory Inc. reports increased interest in acquisitions abroad, but advises most clients to avoid competing directly with Chinese companies for public deals, knowing they will likely be outbid. The ten largest resource deals completed by South Korea in 2009 did not have a Chinese challenger.

Yet, a source close to China's Ministry of Commerce (MOFCOM) told Interfax that Chinese companies have been outbid for roughly a quarter of overseas metals and mining deals worth more than $300 million since 2005. Nonetheless, numbers indicate that Chinese companies' cash-filled coffers remain their greatest advantage in securing deals overseas. Central bank data shows that Chinese corporate bank deposits, a gauge of the amount of cash companies have on hand, totaled over $3.5 trillion in September.

As a result, Chinese companies tend to look to acquire assets in less ideal environments where they stand a better chance to close deals on a liquidity basis, without attracting unwanted public and government attention. (South Korean companies, on the other hand, are targeting assets in developed market like the U.S., Canada, and Australia.)

Clinching a deal is becoming more expensive amid heightened iron ore demand, lower production (a 6.2 percent decrease in 2009), and increasing valuation of overseas resource companies. For example, a 21.52 percent stake in Brazilian iron ore miner Mineracao & Metalicos SA (MMX) cost Wuhan Iron and Steel Co. (WISCO) just $400 million back in 2009. A recent 14 percent stake purchase by South Korean SK Networks Co., Ltd. in September cost nearly 2.7 times that per share - totaling $700 million. The deal may be worth it. The 14 percent share gets SK Networks nearly 9 million metric tons of iron ore annually, or 17 percent of the import-dependent country's yearly consumption.

Cost constraints and competition for iron ore are only going to intensify over the next two decades. A portion of increased iron ore demand is coming from new entrants into the steel production industry. Last year saw increased steel output from the Middle East while steel output in Asia's traditional producers (India, Japan, South Korea, Taiwan) remained roughly level. Meanwhile, China's steel demand, already more than half of the global total, is not likely to peak for another 15 years (assuming a conservative seven percent compound annual growth).

- Chantal Grinderslev, Analyst

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China's iron ore and steel industry - roundup of 2010, outlook for 2011

The year 2010 continued to witness the global economic recovery. It was the final year of China's Eleventh Five-Year Plan, and saw preparation beginning for the Twelfth Five-Year Plan, to be released in March 2011. For China's iron ore and steel industries, it was a year of great changes and challenges, but also of opportunities.

In April of last year, the annual iron ore pricing mechanism, which had been in place for decades, was replaced with a quarterly pricing system. The new system calculates an average price every three months in accordance with real-time changes on the spot market and based on the previous quarter's average prices.

After the introduction of the quarterly pricing mechanism in the second quarter (Q2) of the year, iron ore prices almost doubled when compared to Q1 and remained high throughout the second half (H2) of 2010. As a country that depends highly on iron ore imports, China saw steel industry production costs increase dramatically. Despite the fact that industry experts expect China's steel industry profits to be up RMB 3.8 billion from the RMB 81.2 billion recorded in 2009, a large portion of this was generated from upstream and overseas business.

Due to rising contract prices, China increased efforts in 2010 to develop domestic iron ore resources. Since May, the total output from domestic mines has been more than 90 million tons. It will be difficult to maintain this rate of development in the short term, however.

Overseas investment also increased last year in reaction to the quarterly pricing system, with a number of Chinese mines seeking to acquire iron ore resources in other countries. WISCO, for example, began to receive iron ore from its Canadian investment in July and from a Brazilian project in August. As a result of such moves, China's iron ore imports dropped for the first time since 1998, down 1.4 percent year-on-year to 618.6 million tons.

In order to meet the targets outlined in the central government's Eleventh Five-Year Plan, policies to reduce emissions and energy consumption were intensified in its final year. In September, each province with a strong steel industry presence issued measures to eliminate outdated capacity and limit production and energy supply. The government said the plan's goals were met, and China's total stockpiles dropped to 13 million tons, easing the pressure from oversupply.

Last year also saw a number of mergers take place between leading steelmakers, efforts encouraged by the central government. Most notable were those between Shoudu Iron & Steel Group (Shougang) and Tonghua Iron & Steel Group (Tonggang), Anshan Iron & Steel Group (Angang) and Panzhihua Iron & Steel Group (Pangang), and the consolidation of 12 local mills in Hebei Province. These mergers are expected to increase the competitive power of China's steel mills when seeking overseas investments, ultimately expanding the Chinese market.

And despite the central government's moves to control the real estate industry in 2010, demand for steel products was bolstered by the vigorous promotion of low-income housing projects.

Looking to 2011, energy consumption and emissions will be reduced even further in line with the goals for the Twelfth Five-Year Plan. The central government also aims to build a further 10 million low-income apartment blocks, pushing up the country's demand for steel.

According to Shanghai-based Mysteel Information, China's crude steel output is expected to rise to 660 million tons in 2011 from this year's level of over 600 million tons, while crude steel apparent consumption will reach 640 million tons. Steel product exports will likely drop from just over 40 million tons to 36 million tons, while imports will remain at around 14 million tons. Domestic iron ore output, meanwhile, will reach 1.15 billion tons, while iron ore imports will total 660 million tons. Imported iron ore prices are predicted to hover between $120 and $190 per ton throughout the year.

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Sino-Tech International to acquire iron ore ships for $5 bln

Hong Kong Stock Exchange-listed Sino-Tech International Holdings Ltd. is to purchase a fleet of 15 iron ore transport ships for $5 billion, state media reported Jan. 5.

According to a Chinese-language China Business Daily report, CITIC Pacific Ltd., whose sister company, CITIC Automobile Co. Ltd., holds a 6.5 percent stake in Sino-Tech International, will use the ships to transport 2 million tons of iron ore from Australia to Zhanjiang Port, Guangdong Province.

Sino-Tech International previously acquired a 90 percent stake in CITIC Logistic Lo. Ltd., also a CITIC Pacific affiliated company, for HKD 1.84 billion ($236.81 million). It intends to purchase the remaining 10 percent for HKD 226 million ($29.09 million), according to an Oct. 25 company announcement.

Sino-Tech International is involved primarily in the manufacture and trade of electronic products, as well as logistics.

Interfax commentary: Chinese steel mills reported an average profit margin of just 3.5 percent last year, totaling roughly RMB 77 billion ($11.61 billion). These profits came in much lower than the cross-industry national average of 6 percent. Meanwhile, imported iron ore costs increased by RMB 170 billion ($25.63 billion) in the first eleven months of 2010, despite the fact that import quantities decreased by almost 6 million tons. The majority of these cost increases derive from hikes in freight rates.

From January to November of 2009, iron ore freight rates between Brazil/Australia and China rose by $40 and $10 per ton, respectively. Moreover, China remains dependent on international shipping companies for transport. The country owns only 30 of the 720 vessels of 130,000+ ton capacity that transport iron ore worldwide. In the future, Chinese steel mills will aim to build their own shipping fleets in an effort to control import costs and increase their competitiveness. Without government assistance, only the most profitable will be able to pursue this cost-minimization strategy, in turn boosting their competitive advantage as China's steel industry continues to consolidate.
Shanxi Minmetals gets go-ahead to develop Mexican iron project

Shanxi Minmetals Industrial & Trading Co. Ltd. has received approval from China's National Development and Reform Commission (NDRC) to develop a 1.45 million ton iron ore project in Mexico, state media reported Jan. 4.

The project requires a total investment of RMB 510 million ($77.02 million), of which RMB 467 million ($70.53 million) is earmarked for construction, Shanxi Evening News reported.

Located in Mexico's western state of Jalisco, the mine has a lifespan of 14 years. It holds iron ore resources of 58.8 million tons and has a designed annual mining capacity of 1.6 million tons. Once operational, it is expected to generate annual sales revenue of RMB 376 million ($56.78 million) and net profit of RMB 16.84 million ($2.54 million).

Shanxi Province-based Shanxi Minmetals focuses primarily on the import of steel products, nickel sheet and propylene, and the export of coke, iron ore, alumina, manganese and chrome.

Sources: Interfax China Metals & Mining, 14 January 2011 and 7 January 2011

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CISA forecasts steel exports decline in 2011

Interfax China Metals and Mining

28 January 2011

China can expect to see weaker steel exports in 2011, according to a China Iron and Steel Association (CISA) market analysis report released on Jan. 26 and featured in state media the following day.

An industry association representing China's major steel mills, the CISA attributes the expected decline in exports to increasing global steel output.

According to Beijing Business Daily, steel production capacity in South Korea will likely increase by 15 million tons this year.

In 2010, China's steel exports to South Korea, India and ASEAN (the Association of South Asian Nations) member countries accounted for approximately 48.2 percent of the country's total steel exports.

Central government policies to tighten regulation of energy-intense industries and their emissions will also impact steel exports in 2011, as will the appreciation of China's currency, the renminbi, according to the news report.

China exported 42.56 million tons of steel products in 2010, an increase of 73 percent year-on-year, according to statistics issued by the General Administration of Customs (GAC) on Jan. 10.

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China's steel mills advised to partner with coal producers in hunt for resources

Interfax China Metals & Mining

28 January 2011

China's steelmakers would do well to partner with domestic coal producers when seeking overseas coal resources in order to compete with foreign companies, Xu Zhongbo, a professor at the School of Metallurgical and Ecological Engineering at the University of Science and Technology Beijing, told Interfax Jan. 26.

In June 2010, Wuhan Iron & Steel (Group) Corp. (WISCO) signed a non-binding agreement with Australian coal miner Riversdale Mining Ltd. to acquire both an eight percent Riversdale stake, at a per share price of AUD 10 ($9.96), and a 40 percent stake in the Australian company's Zambeze coal project in Mozambique.

In December of the same year, however, Rio Tinto made an offer to fully-acquire Riversdale for a per share price of AUD 16 ($15.94), thereby putting a halt on the WISCO deal.

A recent Reuters report states that India's Tata Steel Ltd., Riversdale's largest shareholder, has approved the Rio Tinto bid.

Xu said WISCO can take the lessons learned from the Riverside deal and apply them to future deals, improving chances for success.

"Africa has abundant coal resources, as does Canada," Xu noted.

"As a steelmaker, however, WISCO could use the experience of large-sized domestic coal producers," Xu said. "The company should cooperate with firms such as China Shenhua Group when seeking acquisitions."

A partnership would also mean a greater pool of capital, making WISCO more competitive.

And such alliances would also prove beneficial to the coal producer, said Xu.

"Such deals will give domestic coal companies the chance to expand their business and enrich their product portfolio," he said. "They can also sell directly to the steel mills they have partnered with."

Dou Liwei, director at Anshan Iron & Steel's (Angang) Economics and management Research Institute, said at a conference in December of last year that China's reliance on imports of high-quality coking coal could increase to such an extent that it could hinder the development of the industry. He urged domestic steel mills to develop upstream resources, including coking coal and iron ore, in order to complete the supply chain.

Mysteel analyst Ma Zhongpu, meanwhile, said that China's steel mills not only need to source raw materials overseas, but should also build mills there.

"Setting up bases in other countries contributes to the local infrastructure construction, thereby gaining support from the local community," Ma told Interfax.

Chinese companies can learn from the example of other Asian companies, Ma added, many of whom set up shop overseas some time ago.

South Korea's Pohang Iron & Steel Co. Ltd. built a 10 million-ton steel mill in both India and Vietnam, and is planning to build a 6 million-ton base in Indonesia, Ma said.

Interfax commentary: The successful completion of the Rio-Riversdale deal will further concentrate the global coking coal industry. Currently, just five companies dominate worldwide coking coal trade: BHP Billiton, Teck Resources Ltd., Anglo American Plc., Xstrata Group and Rio Tinto. Industry consolidation will continue to push raw material prices up, straining profitability in the domestic steel industry.

In 2009, China's coking coal imports stood at more than 30 million tons. In 2010, this figure rose to nearly 50 million tons. China's coking coal imports will continue to increase in 2011.

Meanwhile, prices are also increasing. Coking coal prices agreed upon by Australian coal miners and Japanese steel mills for the first quarter hit $225 per ton, up 8 percent quarter-on-quarter. With India's coal imports expected to reach 40 million tons this year, tight global supplies will continue to push prices up.

Fortunately, China's reliance on imported coking coal is far less than that of iron ore. With new efforts to increase overseas resource acquisitions and expand domestic exploitation, China will be able to weather price hikes in the coming two years.

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China produced 44.36 pct of global crude steel in December - WSA

Interfax China Metals & Mining

28 January 2011

China produced 51.52 million tons of crude steel in December 2010, or 44.36 percent of the total global output in the month, the World Steel Association (WSA) announced Jan. 21。

Crude steel production increased 6.3 percent year-on-year and 2.7 percent month-on-month in the month, according to the WSA.

The 66 countries that report to the WSA produced an aggregate total of 116.16 million tons of crude steel in December, up 1.79 percent from the previous month and 7.8 percent on an annual basis.

While European Union (EU) and South American members witnessed a month-on-month decrease in crude steel output, all other member regions increased production levels in December. Non-EU European members saw the largest rise, with overall output up 8.5 percent from the previous month to 3.09 million tons.

Asia, the world's largest crude steel producing region, produced 73.63 million tons of crude steel in December, an increase of 3.35 percent from the previous month and a year-on-year increase of 6.2 percent.

The following table shows global crude steel output figures in December 2010.

Global crude steel output, December and the first 12 months of 2010

Region	Output, Dec  ('000 tons)	M-o-m change (%)	Output, Jan -  Dec ('000, tons)	Y-o-y change (%)
European Union (27)	12,953	-11.79	172,906	24.5
Non-EU European countries	3,090	8.50	33,079	15.2
CIS (6)	9,640	6.93	108,425	11.2
North America	9,515	5.65	111,798	35.7
South America	3,431	-5.53	43,775	15.9
Africa	1,556	7.02	17,151	15.8
Middle East	1,658	4.28	18,980	11.3
Asia	73,628	3.35	881,197	11.8
Oceania	686	6.19	8,149	35.5
Total 66 countries	116,157	1.79	1,395,459	15.2

Source: WSA

Note: Monthly changes were calculated using statistics previously released by the WSA.