China's iron will alone is not enough

China's iron will alone is not enough

By Stephen Bartholomeusz

Business Spectator

2 May 2011

There's nothing new in the reports that China wants to reduce its reliance on iron ore supplied by the three major producers, but the ambition looks as unrealistic today as it did when it was stated in China's latest iteration of its five-year plan in early March.

In that plan China outlined a three-tiered strategy for breaking the dominance of Vale, Rio Tinto and BHP Billiton over the supply of iron ore to its steel mills. At present those three producers, which control about two-thirds of the global seaborne trade in iron ore, account for more than half China's iron ore requirements.

Agitated by the soaring price of iron ore and the shift to the market-related pricing imposed on it by the big producers, China's plan involves a massive increase in domestic production, gaining control over offshore iron ore deposits and a substantial consolidation of its steel-making sector to try to gain improved negotiating leverage.

In terms of domestic production, the five-year plan is targeting an increase of about 20 per cent, which would enable it to meet more than half its iron ore requirements.

It wants to develop two or three new mines with capacity of more than 100 million tonnes a year, half a dozen more with capacity of about 30 million tonnes a year and a raft of even smaller projects producing a few million tonnes of ore each.

It also wants to more than double the production it sources from offshore mines over which it has control or influence, to the point where those mines supply more than 40 per cent, and as much as half, its import requirements.

It wants to consolidate its steelmaking capacity so that the top ten mills control about 60 per cent of total capacity and it wants to create a much larger strategic reserve of iron ore to also give it more influence over prices (although building a stockpile at high prices in order to drive the price down is an interesting concept).

While it is understandable that China, having watched the price of iron ore soar in response to its own demand and given that it blames a producer oligopoly for that spike in prices, would want to undermine the pricing power of the three big producers, it is easier said than done.

China's domestic reserves of iron ore tend to be relatively small deposits of quite low-grade ore - typically with less than half the ferrous content of the deposits being mined by Rio, Vale and BHP. That means Chinese producers have to mine and process more than twice the volume of material to produce the same amount of iron ore as the big three - which means that even though the production is domestic it is higher cost.

Also, new projects - whether within China or elsewhere - will inevitably have higher cost bases than the massive brownfields expansions that BHP, Rio and Vale have underway, which leverage off existing high-quality low-cost deposits and established infrastructure.

The sensitivities surrounding Chinese state-owned companies acquiring high-quality resources in developed resource economies also makes it difficult for China to get control or influence over large low-cost mines offshore, except in higher-risk jurisdictions with limited existing infrastructure.

A flood of new production from China and China-controlled resources outside China would, of course, have an impact on price.

None of the big producers, however, is adding capacity on the assumption that the current price of iron ore is maintained.

Their assumption is that, as the vast amount of new capacity in the development pipeline progressively comes on stream, prices will eventually fall quite significantly, although the magnitude of the fall will be tempered by the reality of rising long-term demand in volume terms from China and, increasingly, India.