Steel is now the hottest part of the Chinese economy, it’s creating billions of dollars of business for Australian iron ore and coking coal exporters, generating a rising level of corporate activity, not to mention exploration.
It has been as much a driver of the economy as any sector: the booming car industry and heavy spending on railroads has seen demand for steel jump, leading to rising demand for iron ore and coal.
Shortages, weather, taxes and other vagaries have pushed iron ore and coal prices higher at the same time as demand from non-Chinese steel makers has been picking up.
Hence a boom (bubble?) in iron ore for the second time in three years
But we have had a warning that China’s steel surge could cool later in the year.
For how long? Well, it could be short as demand eases and adjusts to the expected price rises for raw materials like iron ore and coking coal and higher selling prices.
But it could damage demand for iron ore and coking coal in some markets.
That in turn could stop the rise in spot prices for coal and iron ore (but not before we see more price rises in the next couple of months).
The warning has come from a leading London-based forecaster (see below).
This week Rio iron ore boss, Sam Walsh, was very optimistic, forecasting another 10 years of gains. Earlier this month Rio forecast another 15 years of strong demand for commodities because of China, then India.
Global spot iron ore prices continue to rise and are edging towards $US150 a tonne including freight. The current contract price in much of Asia is around $US60 to $US62 a tonne, so any price rise is going to boost the trading income for BHP and Rio and hurt the buyers.
Australia will be a beneficiary with a senior Reserve Bank official yesterday reminding us to take note of the coming rebound in our terms of trade.
The Bank’s head of economics, Assistant governor, Phil Lowe told a Sydney conference yesterday that the expected sharp improvement in our business investment "is underpinned by the strong outlook for the terms of trade.
"Recently, the spot prices of iron ore and coal have risen, and the prices that exporters will receive over the next year look likely to be substantially higher than those received over the past year. As a result, a significant rise in the terms of trade is expected over the year ahead."
So all’s on the up then for Australia and China?
Well in the medium term, yes. But in the short term watch for this weakness, according to one of the major forecasts, GFMS of London.
In a report this week their steel analysts pointed out that "In our view, China dropped down a gear from top gear in February as it cruised into the Chinese New Year.
"Domestic inventories rose and purchasing slowed, so export offers were cut to shift material. In turn, this depressed Asian and emerging producers.
"Nevertheless, we expect that China will motor out of the holiday period back into top gear and the current pricing weakness in the region will consequently be short-lived."
GFMS pointed out that the Chinese government is aware that there is a risk of overheating and continues to damp down the economy.
"For now, the market’s high speed will keep sucking in raw materials and keeping international prices elevated, but we continue to identify this as the key factor in global prices.
"Spot iron ore prices are back up again as China returned to purchasing out of its New Year break.
"Spot prices on an fob level are now double what contract levels are.
"A 50% increase seems the minimum and, given the money that iron ore companies have left on the table in the last 2-3 years, they may be reluctant to sign any contracts at all.
"Coking coal spot prices are also higher and the Japanese have sent the benchmark by accepting a 56% increase to $200/tonne fob Australia and this is only valid for a quarter, with the potential for further increases."
BHP has declared force majeure on shipments from Hay Point in Queensland where much of its Bowen Basin hard coking coal is exported from (its coal from the BMA Alliance with Mitsubishi).
This will send prices higher as the company said it will be six week or so before exports resume, such was the damage from the cyclone last weekend.
GFMS said that a "50% increase in iron ore and coking coal would add approximately $US90/tonne to steelmaking costs, although moving to fully spot would be even more expensive.
Moreover, higher iron ore and coal prices will push up scrap prices.
"We have noted extensively in the past the increasing substitution by Chinese buyers in particular between pig iron and scrap depending on price," GFMS said.
"Steelmakers have been able to push prices higher in the second quarter in most regions as the market recovers, and most regional are now above this level, so the majority of the increase in iron ore noted above has already been achieved.
"Raising prices further simply adds to profit margins.
"Yet our thesis this year is that China will weaken in the second half.
"Should that be the case, then iron ore spot prices will drop – dramatically improving the relative cost position of Chinese producers and making capable of providing low-cost steel to the global market.
"We believe steel prices may be more volatile in the years ahead," GFMS concluded.
That’s a bit of good news and bad news for the likes of BHP and Rio: spot prices come under pressure, China starts selling more steel into global ma
