As the world's largest steel maker and consumer, China's urbanization and industrialization has fueled demand for iron ore and driven up prices domestically and globally.
Private and small-scale steel makers have suffered the most from the price surges, when the market demand is showing signs of decline. Coupled with the government's tighter credit controls to calm an overheating economy and reduced export tax rebates to cut trade surplus, their maneuvering space has been further squeezed. Fresh willpower is needed by such beleagured steel-makers to ride out the times.
The problem is not just a simple supply-and-demand imbalance. As the EO dug further into the trade, we found that monopoly in the industry – both at the local and international level- is a key contributor to the upward spiral prices. In this special focus, the EO deciphers steel from three angles – a case study of the Chinese iron capital, the pricing mechanism, and the monopolies.
Domestic Market: Dark Clouds over Iron Capital
Wu'an, a small city in north China's Hebei province and the iron capital of China, has become the epitome of China's economic boom. The country's rapid urbanization and industrialization during those years brought explosive demand for iron, driving up production output by five-fold and giving rise to the proliferation of private small-scale iron and steel companies.
However, the good times for small private plants seemed to have passed. With fewer visiting investors and customers, more locals have been idling about in the streets. According to Wang Youtian, director of a local metal refinery, more than ten iron companies had ceased production, forcing a great many out of jobs. Some small companies under construction were impelled to stop work as banks had withdrawn their loans following the central government's tighter macro controls.
To make thing worse, raw material prices have gone up, with the spot price for iron ore reaching 1,800 yuan per ton, nine times higher than five years before, with prices of coal used in production too having increased. The higher production costs on the contrary were met by shrinking market demand, thus plunging many companies into the red.
On the other hand, as part of the central government's efforts to prevent the economy from overheating, the steel industry has been deemed as "too hot" and directed to reduce capacity. Under such policy, small iron and steel companies became the first casualties.
Li Xinchuang, chief engineer of Chinese Academy for the Planning of Steelmaking, said the closure of small iron businesses did not reflect a decline of the entire industry, as these players ought to be eliminated. He added the government should instead guide these small players to undergo transformation to become more efficient and attain economies of scale.
International Pricing Mechanism: Rules Broken
Each year, miners and steel makers negotiate a benchmark iron ore price for 12 months through painful tug-of-war. This year, the negotiations turned out to be especially tough as conventions were being broken.
In early February, Brazil's Vale, the biggest miner in the world, agreed to a 71% price rise for iron ore in its northern mines and 65% for the southern mines with the Japanese steel makers. Different pricing irritated the next two biggest iron ore miners, Australia's Rio Tinto and BHP Billiton, as by convention, their mines would be priced according to Brazil's southern mines. They thus argued with the Chinese for a 71% price rise and later demanded spot transactions, which cost buyers much more than contract supply.
Baosteel, one of China's leading steel makers, was also considered as a rule breaker. The company announced in late January that it had signed a long-term supply contract with BHP Billiton, by which the latter would supply yearly 10 million tons of iron ore at "a price acceptable to both sides" for the following ten years. Signing a private agreement instead of sticking to traditional open negotiations triggered various speculations, and the price unknown to the public became a focus.
"If we can't reach an agreement, we will provide only spot cargos. China has the right not to buy them, but 40% of China's iron ore depended on imports from Australia," said the chief of an Australian mine.
While the Chinese admitted they were in an unfavorable position, they doubted that the Australian miners could afford to offend buyers in China, analyzed Li Xinchuang, chief engineer of the Chinese Academy for the Planning of Steelmaking.
According to a source with BHP Billiton, Australian miners could no longer be patient with the traditional pricing mechanism, and suggested a reference price index be set and iron ore be priced according to the index every three months in the future. However, the index was only at a conceptualization stage, said a source close to Rio Tinto.
Monopoly: One Product, Varying Prices
Though the largest steel maker in the world, China's imports of iron ore through long-term contract is the lowest in terms of percentage, only covered 50% of its total imports, as opposed to the 95% coverage of Japan and Europe imports.
The scenario is an outcome of a regulation introduced by the Chinese Ministry of Commerce in 2005, which limits the numbers of companies permitted to conduct imports through long-term contracts. The reason behind the ruling is apparently to prevent rush purchase that could potentially drive up prices. At present, around 110 companies, mostly state-owned, are qualified for the permit.
As spot prices are much higher than long term contract pricing, small and medium steel-makers have long complained that they have been put in disadvantaged against the big companies. On the other hand, big companies have been making huge profits by re-selling imported iron ore through long-term suppliers to their smaller counterparts in the trade. A senior manager of Shougang Group, China's leading steel maker, argued that such trading was legal and reasonable, as the government had granted it qualified status for their quality products.
The biased policy once led China Iron and Steel Association to propose the establishment of a trading center, where ore supplied under long-term contract to be traded at a price no higher than 105% of the spot price. The proposal was brushed aside by big companies unwilling to give up their interests.
As the annual iron ore price negotiations have always led to price rises since 2004, the Chinese steel market is trapped in a price rise cycle--spot prices rise, bringing higher long-term contract prices, which in turn pushes up steel prices. The high steel prices become an incentive for steel makers to increase output, thus driving up iron ore demand and subsequently the long-term supplier contract prices again.
According to a source with Rio Tinto, the iron ore price surges stem from the demand-supply gap and monopoly of imports right. While Li Xinchuang, chief engineer of Chinese Academy for the Planning of Steelmaking, believed the fundamental reason rested in the monopoly of mining operations. He pointed out that the world's three biggest miners controlled over 80% of the global iron ore shipment market. He added the only means for Chinese companies to escape the high-price cycle would be to acquire stake in major miners.
Abridged Translation by Zuo Maohong
