February 22,2008

Iron Ore Price Hikes Will Force China's "Going Out"

By Ma Wenluo
China, the world’s largest steel producer, consumer and exporter, as well as iron ore importer, will have to accept at least the 65% boost in the price of iron-ore reached between major steel producers in Japan and elsewhere and the behemoths that control iron-ore production.
   
 
On February 18, it was announced that Companhia Vale do Rio Doce (CVRD), the Brazilian mining giant, had reached an agreement with Japanese steelmakers Nippon Steel Corp. and JFE Steel Corp. and South Korean steelmaker Posco on the 65% price hike for 2008. A day later, CVRD announced the same price hike for 2008 supply contracts with four other Japanese steelmakers and the largest steelmaker in Germany.
 
CVRD, BHP Billiton and Rio Tinto control 70% of the world’s iron-ore output, placing them in a commanding position. Although Baosteel and the China Iron and Steel Association, negotiating on behalf of Chinese steelmakers, have not yet accepted the price hike, in reality China has no choice. Since 2005 Chinese steelmakers have had to put up with successive hikes of 71.5%, 19%, 9.5% and 65%. Rio Tinto has even suggested it may seek a higher rise, as much as 71%. The company said that since Australia, home to its operations, is so much closer and more convenient to Asian steel producers than Brazil, countries such as China and Japan could bear to pay the higher price.
 
Over a year ago, Baosteel, on behalf of Chinese steelmakers, first reached an agreement with CVRD and BHP Billiton on a 9.5% price boost in 2007, which became a benchmark price for the global market. This was regarded as a symbol of China’s bargaining power in global price negotiations. But 2008 sees China again in a more passive role.
 
The 65% price hike this year is much higher than the earlier 30%-40% estimates of most market professionals. It was first agreed to by Japanese companies such as Nippon Steel Corp. in a situation similar to that in 2005 when the price for ore increased by 71.5%. Japan, without resources of its own, is not daunted by the high price because Japanese enterprises many years ago acquired high quality mines in Brazil, Australia, India and Canada. Since 2003, when China’s iron ore imports started to exceed Japan’s, Japanese enterprises have shared in the profits. Sumitomo Group alone now controls 45.285 million tons of iron ore, accounting for 7.87% of the world’s total trade.
 
For the past ten years China has been the world’s largest steel producer, but it mines only half the iron ore it needs. Both the government and steelmakers realize that Chinese enterprises have to get out into the world to strengthen their bargaining hand in international negotiations. On February 1, 2008, the Aluminum Corporation of China, Ltd., bought a 9% stake in Rio Tinto for $14.05 billion to scotch any merger between it and BHP Billiton, indicating that industrial investment had not disappeared from China’s overseas investment strategy. And recently, the Shougang Group, China’s sixth largest steel company, bought a 20% stake in an iron ore mine in Australia. Sinosteel Corporation is also working on a purchase of Midwest, based in Australia, in order to acquire more resources in the ground, but so far the offer has been refused by Midwest as too low.
 
The Chinese government is also promoting consolidation in the industry by encouraging mergers of many smaller steel plants, producing M&A opportunities for both domestic and international companies. Mittal Steel Co., the world's biggest single steel maker, made a move in the Chinese market in January 2005, buying a 37 percent of stake in Hualing, a steel pipe maker in Hunan Province. Meanwhile, it also bought into China Oriental Group though the Hong Kong stock market. Recently, Evraz, Russia’s second largest steel company announced the purchase of up to a 51% stake in Delong Holdings and will thus indirectly control several Chinese private steel companies. Delong, based in inland China, is short of mines. Evraz, with its abundant iron ore resources, will be welcome in China’s steel industry.  
 
It is murmured by some Chinese analysts that by pushing up iron ore prices, Japan aims not only to gain profits but also to weaken Chinese companies producing low quality steel, but that’s unlikely.
 
Most Japanese products are high-tech steels, high in added-value, and they have strong pricing power for such products. Moreover, the industrial concentration in Japan’s six largest steel companies is as high as 81%, so they can easily transfer incremental costs from the price hike to downstream users by lifting the price of their products. In China, however, there are over 40 steel companies whose annual output exceeds 2 million tons, and the total output of these companies accounts for less than 75% of the total. Most products are crude steel, and advanced production capacities for special steel and auto body sheet can not meet domestic demand.  
 
China’s steel industry is now at a critical place. "A turning point for the market may occur at any time." said Xu Lejiang, president of Baosteel the same day the 65% boost in iron ore price was declared. Xu believes that the bigger worry lies in the lack of concentration in the domestic industry, in contrast to the global trend of merger and acquisition. Production capacity is spread among small scattered enterprises. In recent years the total output of these enterprises has risen from less than 10 million tons to 100 million tons. Xu said this situation not only prevents any industry upgrade and optimal allocation of resources, but will further affect industrial security.  
 
The Chinese government is moving to eliminate laggard production capacity, including 100 million tons of iron production and 55 million tons of steel production. In 2008 alone 4 million tons of iron production capacity and 14 million of steel production capacity are to be shut down. If this policy can be realized, China will be much less dependent on imported iron ore and may be able to move beyond its passive position in international iron ore price negotiations.

 

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