Central purchasing and a slowing Chinese housing market could have major effects on Australian iron ore producers – and beyond, Alexandra Colalillo writes.
China has been Australia’s top consumer of iron ore for decades, accounting for 80 per cent of our exports of the mineral in 2021.
Export revenue has delivered long-standing profits to Australian miners and boosted the country’s tax revenue. However, Australia’s iron ore profits are threatened with the recent development of the China Mineral Resources Group (CMRG), set to act as China’s central iron ore purchaser.
This central purchasing power is designed to control demand and enhance Chinese steel producers’ negotiating power over prices. As the expected principal Chinese channel for buying imported iron ore from international third parties, the CMRG also assumes responsibility for raw material supplies to China’s steel industry, which absorbs approximately 70 per cent of global production, largely from Australia.
The formation of the CMRG, in combination with the recent weakness in China’s residential property sector, is set to place downward pressure on prices and dampen Australia’s iron ore export earnings, projected to fall from $133 billion in 2021–22 to $116 billion in 2022–23, and by a further $85 billion by 2023–24.
The establishment of CMRG stems from the retaliation of China’s Iron and Steel Association (CISA) against a perceived iron ore producers’ cartel. The push for centralised buying is in response to a period of high iron ore prices, which hit a record $US240 per tonne (t) in May 2021, delivering significant profits to a set of concentrated iron ore majors, whose production costs at the time were less than $US15/t.
The threat to Australia’s iron ore demand is further exacerbated by China’s objective to reduce steel production in line with its goal of cutting carbon emissions.
This central purchasing program is part of China’s wider strategy to achieve 45 per cent iron ore ‘self-sufficiency’ by 2025. China’s senior government officials set a goal to boost domestic iron ore production by 30 per cent, increase investments in overseas mines, and strengthen scrap steel recycling.
But domestic production of Chinese iron ore isn’t the real problem for Australia. China’s ore grades are far lower than Australia’s and expanding its output will also increase carbon emissions, which will be counterproductive to emission targets.
While China’s steel industry will likely always need Australian iron ore, the country’s attempt to shake up the global iron ore market could have obvious ramifications for Australian exporters.
The world’s four biggest suppliers of seaborne iron ore – Rio Tinto, BHP, Fortescue Metals Group and Brazil’s Vale – account for approximately 70 per cent of global trade and 80 per cent of China’s imports.
But Australia’s big iron ore players, for their part, haven’t demonstrated any signs of public panic, and in early November, Vale, Rio Tinto and BHP signed agreements with CMRG to explore iron ore supply chain and green technology opportunities. However, the specifics and extent of these agreements is not yet known.
Iron ore hasn’t been the only commodity at threat. China has already established informal central purchasing groups like large state-owned oil refiners who collectively buy crude oil or copper. As such, it seems very likely China will apply this type of structure to additional critical resources in the future, particularly if the CMRG proves successful.
The other critical factor threatening Australia’s iron ore profits is China’s sluggish gross domestic product (GDP), which grew just 0.4 per cent in the second quarter of 2022, largely as a result of extensive lockdowns as part of its COVID-zero response to the pandemic.
In September, the south-western Chinese metropolis of Chengdu announced a lockdown of its 21.2 million residents for citywide COVID testing. Other major cities are simultaneously tightening restrictions, ranging from work-from-home requirements to the closure of entertainment businesses in some districts.
While there has been a small rebound in activity as lockdowns ease over time, the economy will need to grow by 8.5 per cent in the second half of the calendar year to reach the nation’s 2022 GDP target of 5.5 per cent – a highly unlikely outcome.
According to the World Economic Forum, every percentage point decline in China’s GDP results in a 0.3 per cent reduction in global GDP.
In contrast to other major economies, China has reduced interest rates to counter the economic impacts of its COVID-zero policy, high debt challenges, weak income growth and, importantly, the property crisis.
While China enjoyed growth in the property sector since the early 2000s before reaching a peak in 2018, hundreds of thousands of home-buyers are now refusing to pay mortgages for pre-sold properties as developers struggle to complete housing projects on time. In fact, Chinese developers have only delivered 60 per cent of homes they pre-sold between 2013 and 2020, and Chinese mortgage debt grew by $US4 trillion over the same period.
There are three key reasons buyers are striking on mortgage repayments. First, there are concerns property developers such as Evergrande will head into administration before projects are completed. Second, there is a possibility of financial destabilisation of the banking sector that is at risk of mass loan defaults. Lastly, the recent plummet in housing value suggests properties are likely to be worth less than what consumers originally purchased them for.
These factors strike parallels with the financial unrest in the lead up to the global financial crisis and should therefore be a cause for concern.
The liquidity crisis stemming from the property sector, which accounts for approximately 30 per cent of China’s steel demand, has squeezed profits from Australia’s large miners and sent iron ore stocks into a bear market amid falling demand and rising costs.
Iron ore prices have shown some signs of revival in recent weeks, however, and were edging up to $US100 per tonne on November 16, according to Mysteel, after falling below $US80 per tonne in late October.
More broadly, the impact of China’s property crisis is likely to impact Australia’s terms of trade.
Since 2005, Australia’s terms of trade (the ratio between the index of export to import prices) has been on the incline, largely catalysed by China’s accelerating demand for resources, while the cost of Australia’s manufactured imports has been simultaneously falling. As a result, every tonne of Australian exports was buying a greater value of imports.
However, with China’s GDP growth well off their target, a return to the long-run average for the terms of trade could affect $250 billion of Australia’s national annual income, with implications for government budgets and Australian living standards.
This feature appeared in the October issue of Australian Resources & Investment.
*The article has been updated to reflect current market conditions on November 17.