London Calling the shots - on Aussie mines and China's streets
Published by MAC on 2014-03-03Source: Business Spectator, Dow Jones newswire
China's "excess steel capacity" is "like the sword of Damocles hanging over the country's steel industry" - to such an extent that "some of the largest steel mills in China have turned to raising pigs and running plumbing services to stay in the black".
That's according to Peter Cai, a commentator for Australia's eminent Business Spectator.
The country's excess steel production in 2013 (300 million tonnes) is estimated at double the total European output. The coming year will see another 810 million Chinese tonnes thrust into this highly volatile mix.
Despite this, says Cai, China's steel industry association reckons its members will increase their output by 3% during this year, while iron ore imports will rise by 6%.
Why, then, isn't the regime cutting the industry's cloth to fit its shrinking metal jacket?
Cai judges it's because the Beijing leadership greatly fears provoking a wave of citizen uprisings:
"China spends more money on curbing domestic social unrest than its ever-increasing defence budget ... In the absence of a comprehensive social security network, most local officials are not willing and prepared to take the risk of an army of unemployed steel mill workers taking to street. Maintaining social stability is still the number one concern for the party".
To avert the frightening prospect of laid-off workers' blood spilling onto the boulevards, the Chinese Academy of Social Sciences has recommended re-training them as "the top policy priority".
It counsels the government not to forcibly truncate the industry, instead offering "a rescue package ... designed to ensure workers are looked after once the mills are closed down".
Swords into ploughshares?
Even were such a plan to get off the drawing board (a major "if") it's doubtful it could be properly implemented.
The growth rates of Chinese manufacturing are themselves being curbed (that's also government policy). So it's difficult to see that iron and steel workers will easily find employment in other vital sectors, such as agriculture, whether or not they're given the right tools for the jobs.
Nonetheless, this is not a challenge unique to the Peoples' Republic.
It's long been familiar to workers elsewhere, notably in Australia where the biggest iron ore trade union, the combined AWU-CFMEU, is engaged in trying to forge "just transitions" from the mine fields and foundries to sustainable employment in a low-carbon economy.
Says Peter Cai: "Understanding how China will deal with the problem of excess capacity is the key to understanding the future of iron ore mining in Australia. China's social security, environment as well as industry policy will have an important bearing on the demand dynamics of Australia's most important customer".
Meanwhile, those very "dynamics" are exerting costs on Rio Tinto, as it battles to further clear its multi-billion dollar debts.
Dow Jones newswires reminds us that the London and Melbourne-listed company " is the world's second-biggest producer of iron ore ... and relies on sales of the steelmaking material for the majority of its earnings".
Last month, "Rio Tinto said that $US1.2 billion would have been wiped off last year's $US10.2 billion underlying earnings had iron-ore prices averaged $US113 a tonne" at the time. Yet, a week ago, the payment for ore delivered by the company to China had fallen to only US$ 117.8 a tonne.
If this "bear market" continues for long, it will bring misery to thousands of Australians and their families at one end of the industrial cycle.
And it'll result in even bigger pain for hundreds of thousands of Chinese workers at the other end, who can't rely on any social security safety net like their Aussie peers.
Has there been a riper moment for the workers of these two worlds to unite?
[London Calling is published by Nostromo Research. The comment is covered by a Creative Commons Licence and may be reproduced with acknowledgment].
China is caught in a steel trap
Peter Cai
Business Spectator
27 February 2014
China's steel industry - the largest in the world - produced 300 million tonnes of excess steel last year which was twice that of total European production, according to Li Chuangxin, deputy secretary general of the China Iron and Steel Association.
Excess capacity is like the sword of Damocles hanging over the head of the Chinese steel industry, which is under siege on multiple fronts. Profit margins have been squeezed to razor-thin, from around 7.5 per cent before the global financial crisis to less than one per cent last year.
Some of the largest steel mills in China have turned to raising pigs and running plumbing services to stay in the black. Lately, they have also been under pressure to shut down their inefficient plants to combat the ever worsening pollution problem, which the industry is partly responsible for.
The mayor of Beijing even made an heroic promise to serve up his own head on a platter if the problem is not addressed. However, Li from the China Iron and Steel Association said the difficulty of tackling the problem of excess capacity was "extremely difficult" and "more complicated than previously thought."
According to the association's forecast, China's steel production will increase another three per cent to 810 million tonne this year despite huge over capacity. Similarly, iron ore imports will increase another six per cent to 870 million tonnes this year.
Why is it so difficult to tackle excess capacity in China when the business case for reducing production is so compelling?
It's all about employment and social stability. Steel mills are usually some of the largest employers in regional cities. They are not only providers of jobs, but also run social services like hospitals and schools.
If the government shuts down plants, it will cause severe disruption to the social fabric of regional cities where steel mills dominate economic life. For example, the city of Tangshan is one of the largest steel towns in China and it needs to shed 40 million tonnes of steel capacity in the next five years. If the plan is implemented, it means that hundreds of thousands of jobs will be lost.
In the absence of a comprehensive social security network, most local officials are not willing and prepared to take the risk of an army of unemployed steel mill workers taking to street. Maintaining social stability is still the number one concern for the party.
Remember that China spends more money on curbing domestic social unrest than its ever-increasing defence budget.
So in order to solve the problem of excess capacity, the government needs to develop a strategy to retrain and re-employ steel workers. This is a problem that is also confronting Industry Minister Ian MacFarlane at the moment, who is trying to protect livelihoods of laid off workers from Australia's defunct car manufacturing industry.
A special taskforce from the Chinese Academy of Social Sciences (a top government think tank) that is dealing with the excess capacity issue recommends training laid off workers as the top policy priority. The taskforce says the government should not forcibly shut down plants and it should offer a rescue package that is designed to ensure workers are looked after once the mills are closed down.
Understanding how China will deal with the problem of excess capacity is the key to understanding the future of iron ore mining in Australia. China's social security, environment as well as industry policy will have an important bearing on the demand dynamics of Australia's most important customer.
Iron ore prices hit 8-month low
Dow Jones newswires
28 February 2014
Iron ore prices have tumbled to an eight-month low, putting a squeeze on mining companies' profits as they race to repay massive loans used to expand their operations.
A slackening in demand from Chinese steel mills has pressed down iron ore prices in each of the past six trading days. China buys around 60 per cent of the iron ore traded by sea, which it uses to make steel for industries ranging from construction to auto manufacturing. In recent days, China's steelmakers have been spooked by concerns that credit to property developers is drying up, as that could portend a slump in the real-estate market and a tumble in demand for building materials.
Robert Montefusco, a senior broker at London-based Sucden Financial, said iron ore prices may have further to fall as steelmakers are likely to delay new purchases until they can secure cargoes at a heavy discount.
To companies like Rio Tinto and Fortescue Metals Group, which have pledged to cut debt and boost returns to investors, falling prices are a worry. Fortescue, in particular, has been racing to pay down debts with cash flow from record sales of iron ore produced at its Australian mines. Rio Tinto says iron ore prices averaged $US126 ($A139) a metric tonne last year, which enabled it to shave $US4 billion from its debt load in the latter half of 2013.
But with prices of ore with 62 per cent iron content delivered to Beijing's Tianjin port -- the industry benchmark -- falling to $US117.80 a tonne on Wednesday, miners may have to slow their debt repayments. Iron-ore prices haven't been lower since July 1, 2013. Prices edged 0.2 per cent higher Thursday to US$118 a tonne.
Fortescue built up massive debts during a decade-long campaign to break the dominance of rivals such as Rio Tinto, BHP Billiton and Vale SA in supplying China with iron ore. At its peak, Fortescue owed more than $US12 billion.
The miner began paying off its debt last year, but still had $US8.6 billion in debt after subtracting cash on its balance sheet at the end of December.
Chief Financial Officer Stephen Pearce said Fortescue wanted to pay back "another couple of billion" dollars by year-end, but acknowledged the pace at which the miner would be able to repay its debts would depend heavily on the strength of iron ore prices.
Australian broker Morgans forecasts Fortescue could reduce its debt-to-equity ratio to 41 per cent by December versus an estimated 57 per cent a year earlier if prices hold around $US124 a tonne over 2014. At an average of $US100 a tonne, the miner would only be able to cut its gearing to 53 per cent by December, it estimates.
"If the iron ore price holds up our profit will be strong...but it depends on where the price sits" as to how fast Fortescue can repay its loans, Mr Pearce said.
Rio Tinto has also made debt reduction a priority amid an industry-wide push to cut spending and make mines more profitable. Executives want to rein in the debt pile that built up as the Anglo-Australian company expanded its mines and infrastructure in dozens of countries around the world, including Australia, the US and Mongolia. It also used loans to help fund several ill-timed acquisitions, including the $US38 billion purchase of Canada's Alcan.
Rio Tinto is the world's second-biggest producer of iron ore, after Vale, and relies on sales of the steelmaking material for the majority of its earnings. Underscoring the risk that volatility in prices poses to its bottom line, Rio Tinto in February said $US1.2 billion would have been wiped off last year's $US10.2 billion underlying earnings had iron-ore prices averaged $US113 a tonne.
Rio Tinto wants to cut its net debt to the "mid-teens" of billions over the next few years, from around $US22 billion in mid-2013.
To be sure, some analysts don't expect iron ore prices to keep falling.
Perth-based Morgans analyst James Wilson attributed recent price falls largely to seasonal changes in demand, as China's construction activity slowed during the northern hemisphere winter. He expects prices of between $US110 a tonne and $US130 a tonne in the coming months, supporting mining sector profits.
"Even at current prices it is still a reasonable profit for these guys," said Mr Wilson.
Still, if prices do start to fall below $US110 a tonne "then that's when you'll probably see people starting to re-evaluate their expectations," he said.