China plans to secure lower iron ore prices and develop high-grade material offshore through its new state-backed entity to facilitate its decarbonization plans and diversify from Australian supply, but that is easier said than done.
After trying to limit record iron ore prices in May 2021, which have since cooled, Beijing wants to counter the heavy supply-side influence of BHP Group Ltd., Rio Tinto Group, Vale SA and Fortescue Metals Group Ltd. through consolidation on the buying side.
To do this, China, which accounts for almost three-quarters of global seaborne iron ore trade, established the China Mineral Resources Group on July 19. The group now handles mining, ore processing and trading; international freight services; asset management services; and supply chain management.
However, three of the "big four" producers' output comes mainly from Australia, whose share of iron ore trade to China has increased year-to-date to about 66% from about 61% in 2021 due to lower exports from Brazil, India and Ukraine, according to S&P Global Commodity Insights analyst Ronnie Cecil.
Lessons from the past
China's past attempts provide some salient lessons.
"A similar plan to unify China's iron ore purchases [in the early 2000s] ultimately failed when smaller and medium-sized steel mills opportunistically sought to lower costs for themselves than work as one large buyer. This remains a key challenge even now," Commonwealth Bank of Australia mining and energy commodities research director Vivek Dhar said in a July 19 note.
In 2005, China's Ministry of Commerce launched an iron ore import licensing system to cap raw material prices. The government allowed more than 100 of the biggest steelmakers and traders to import iron ore. However, some middlemen took advantage of their licenses by hoarding and speculation, which pushed up domestic prices and squeezed the profit margins of small mills. The authority scrapped the system in 2013.
Under the latest iteration, Chinese steel mills would be required to report consumption plans, which would then be consolidated into a combined figure that could be used in negotiations with big overseas suppliers.
"While the larger state-owned steel mills are capable of this forward planning and accepting the risks that come with that, it is unlikely that private steel mills will be in the same boat. Private steel mills would particularly be hesitant to forward plan if steel mill margins are low to negative," Dhar said.
There are also challenges in imposing steel production and iron ore demand discipline on non-China Iron and Steel Association members, private sector mills, smaller capacity mills and the raft of China's iron ore trading community, Cecil said.
"Being skeptical about this centralized purchasing plan is valid," considering the history of iron ore price settlement from yearly to spot, David Cachot, head of short-term analytics, metals and mining at Wood Mackenzie, told Commodity Insights in an email interview.
"Centralized buying only works when there is structural oversupply and no market-based price clearing system. We are in an environment where market dynamics dictate the price of iron ore. Unless you have all this very large tonnage going through this new centralized buying entity, no spot transaction takes place," Cachot said.
"This is where the difficulty lies, where the central buying entity will bear the exposure in terms of taking delivery of negotiated allocation. We know that considering the size of the market, it will be extremely hard to manage."
China's centralized approach to iron ore purchases is likely to be more successful now than two decades ago due to the recent consolidation among its state‑owned steel producers, and its steel sector may be able to act in a unified way, given nationwide success in cutting steel production in the second half of 2021, Dhar said.
Because most of China's steel producers are state-owned, they are well suited to a centralized purchasing effort, Cecil said.
To reduce reliance on iron ore imports, China Iron and Steel Association outlined a cornerstone plan: increase China's domestic production by 100 million tonnes, boost steel scrap usage by 70 million tonnes, and raise equity output in overseas projects by 100 million tonnes by 2025 from 2020.
Overseas options
China imports over 1 billion tonnes of iron ore each year, of which 60% comes from Australia and 20% from Brazil. While the new China Mineral Resources Group will house outbound investments, China does not have a viable alternative to Australia in terms of volume, efficiency and reliability of supply, Cachot said.
Many of China's offshore investments are based on magnetite ore, which mirrors its own domestic resources: the ore is generally lower grade in situ, but it can be processed to a very competitive product with a higher grade than the more hematite-based ore from the Pilbara region in Australia, CRU senior steel analyst Ian Warden said.
"The downside of these projects is they are more capital intensive and have higher operating costs due to the need for power intensive grinding and beneficiation to produce the product," Warden said in an email interview.
Hematite ore from Simandou, China's major investment in Guinea, is expected to grade at over 65% iron, a high grade for this type of ore. It is also similar to the product from Vale's Northern System in Brazil, which receives a quality premium over lower-grade Pilbara ores, Warden said.
Yet Guinea's high country risk was painfully clear when its mines minister halted work after the key parties involved in the delivery of mines in the Simandou area, including Rio Tinto and the Societe Miniere de Boké-Winning consortium, failed to form a mandated joint venture.
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