There were 3 developments at the weekend, which overall will have a negative bearing on China’s steel sector and steel stocks. Two of them have long-term significance, as they represent obvious attempts by overseas iron ore suppliers to force a collapse in the 27-year system of annual benchmark iron ore price-fixing, which Beijing is fighting to uphold.
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Three developments at weekend to hurt China steel sector
There were 3 developments at the weekend, which overall will have a negative bearing on China’s steel sector and steel stocks. Two of them have long-term significance, as they represent obvious attempts by overseas iron ore suppliers to force a collapse in the 27-year system of annual benchmark iron ore price-fixing, which Beijing is fighting to uphold.
These events are:
BHP - one of the three major global seaborne iron ore suppliers - signed a 10-year contract with an Australia-listed steel mill, Bluescope Steel, under which it will sell new ore supply to the latter based on quarterly, not annual, price reviews. The quarterly prices will be based on the volume-weighted average price of BHP’s Asian tonnage.
China’s steel umbrella organisation says Brazil’s Vale has stopped shipping iron ores to the country to retaliate against Beijing’s refusal to meet its demand for higher contract prices of its iron ore exports, although the contract prices were previously agreed upon early in the year. Vale wants to raise Asian iron ore prices by about 11% to match that paid by its European customers.
Baogang, China’s largest steel mill, is cutting the November prices of 13 products, its second announced cut in about a month, which is likely to be matched by other steel mills. It did not formally or publicly announce the cuts, but has reportedly told end-users that it would slash prices by Rmb700-800, which is estimated to be >10%, a sharp reduction.
Stock impact
Until last Friday’s dramatic jump in their share prices, the steel stocks were very attractively valued. Unless China and Washington announce further moves to prop up the stock markets, we do not expect a sustained rise in the prices of steel and other H-share stocks seen last Friday.
Indeed, these three weekend developments serve to heighten the risks of further product price declines and, if Vale and BHP get their way, there will less than expected easing of cost pressures to help soften the cut from falling product prices. Thus, we will stay away from the steel stocks after last Friday’s dramatic price rise.
First comments
These three developments came about two months before China is to due to commence its 2009/2010 annual price talks with Australia’s BHP and Rio Tinto and Brazil’s Vale (previously known as CVRD). So, do they reflect a certain amount of brinksmanship?
In the first two instances, cetainly yes. China depends on imports to meet 50% of its iron ore needs, with Australia supplying 38% of its total imports, Brazil, 22%, and India, 23%. (See table below.) We’ll not be surprised that the last big supplier, Rio Tinto, will join the fray. Together, the three control about 75% of the global seaborne trade in iron ores, and thus are able to bring China to its knees.
Thus, China does not have many options to play around with, particularly since the imported ores from Australia and Brazil are, even by China’s admission, superior in quality and more stable and are preferred by the big Chinese mills.
To a limited extent, China can buy time to work out a response to Vale’s demand as it has 75m tonnes of ores sitting at its ports, which is about 10% of its effective iron ore consumption last year. That works out to about 1.2 months of ore consumption. Still, it is more likely that the three big ore suppliers have the financial resources to slug it out with China, whose steel industry is highly fragmented, with the top 10 mills having a market share of <40%, and thus not effectively united. So, China is likely to be forced to meet them halfway, unless policy makers in Beijing decide to slap a quota on iron ore imports.
(Even assuming a very drastic but unlikely scenario of flat steel output growth this year in China, given its dependence on imported ores, it will likely to have made some compromise. Last year, it consumed about 750m tonnes of iron ore (384m tonnes from imports) for 467m tonnes of crude steel produced from pig iron.)
True, spot iron ore prices are falling - China’s average spot ores has fallen 24% from 2008’s high - suggesting weak demand from mills. But the big ore overseas suppliers still prefer more frequent price adjustments based on spot, as contractual obligations often involve discounts to the spot prices.
Risk of BHP’s and Vale’s move. The risk, though, is they may misread the extent of the weakness in China’s steel demand and Beijing’s mounting displeasure that may trigger an unexpectedly strong response, such as import quotas on iron ore. So far, China has yet to be tempted to resort to this move. But who knows?
Surprisingly weak end-user demand has wiped out all the price rise of key steel product categories of a 6-m basis. The two tables below are instructive, as they give you an idea of how far steel prices have fallen.
If you take a look at the price change on Sep 19, all key product categories had fallen by 1.3% to 7.4% over 6 months, which may seem immaterial. But contrast that to the table of Jul 29, you will note that nearly 7 weeks ago, the 6-month steel price change were up 20-30%, even though 1m prices first began to soften. Thus, the softer prices preceded the release of August’s steel demand, which was weak at 6%, against 13% from Jan-Jul, according to China.
In this context, Baogang’s latest decision to slash prices sharply for 13 product categories for November delivery shows an even stronger deterioration in demand. We expect other steel mills to follow in its footstep.
One bright spark. Several global steel producers have stated that they will cut output to stem the slide in prices. ArcelorMittal, the world’s biggest mill, said it would cut by 15%. Assuming not an unreasonable assumption of a 5% output cut worldwide for six months, based on last year’s global crude output of 1.34b tonnes, that would be 34m of supply cut. Based on an average Fe content of 65% (Australian and Brazil ores are at least of this grade),that works out to about 52m tonnes of iron ore reduction or 7% of 2007 global seaborne trade in iron ore, not an insignificant amount that could depress spot iron ore prices further.
FOO Choy Peng
Associate Director (China Research)
UOB Kay Hian (HK)
Tel (852) 2236 6798
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