China’s iron ore death knell, or ultimate deception?
The spectacular plunge of the iron ore price has headlined global commodity markets for the past two months.
After soaring to a record high of US$233 per metric ton in May, the benchmark Dalian Commodity Exchange spot price for iron ore has since posted a series of new records instead for the sharpest declines in history.
On August 19, iron ore plunged 15% in 24 hours – the largest single-day decline on record. While the month of August re-wrote the record for the largest ever one-month decline with the spot price losing around 30% of its value.
Today, the spot price is hovering around US$130 per metric ton – a 12 month low.
Iron ore’s stunning rise
When looking at the iron ore price plunge, first it’s worth considering what caused the historic rally that commenced in the second half of 2020.
It was a perfect storm of tightening supply and surging demand.
On the supply side, global supply was dramatically cut when a dam wall burst at a massive mine in Brumadinhom, Brazil in 2019. The disaster killed at least 270 people. The mine was owned by Brazilian mining giant Vale – the largest iron ore miner in the world. There were flow-on effects that impacted production at its other mines too.
This would soon conflate with a major spike in demand.
During 2020, Central Banks attempted to save their economies from COVID-19 by unleashing never-before-seen levels of fiscal stimulus. Country’s stimulate by building infrastructure, which requires iron ore – most of which comes from mines in Brazil and Australia.
This resulted in new wave of post-COVID demand hitting markets, and it was led by China.
With Brazil’s biggest miner crippled, Australian mining companies and their shareholders have been the biggest beneficiaries. The share prices of mining companies such as BHP Group (LON: BHP), Rio Tinto (LON: RIO) and Fortescue Metals Group (ASX: FMG) all hit new record highs.
As the prices the miners received for their product has surpassed production costs by extraordinary multiples, they have become flushed with cash and recently paid out huge dividends to investors.
Last month alone, the aforementioned three companies paid out a combined US$7.5 billion in dividends and special dividends to shareholders.
While the price of iron ore has dropped close to 40% since the May 2021 record high, most established iron ore miners still remain very profitable, highlighting just how significant the post-COVID rally was.
Iron ore’s stunning fall
The reasons for the dramatic fall in the iron ore price aren’t as clear-cut as the rise.
On the supply side there have been some big changes with Vale starting to increase production and exports.
In an interview in July, Vale’s executive vice president for ferrous minerals, Marcello Spinelli, announced the mining giant’s lost output resulting from the dam disaster would be back to normal by 2022.
“Vale is the only company that can bring back almost 100 million tonnes in the next two years… We’ll be back,” proclaimed Spinelli.
He had good reason to be bullish, the comeback was already in motion. The same month, official Brazilian Government data showed the county’s iron-ore exports totalled 33.68 million tonnes in June, the highest monthly volume in nine months, with Vale increasing exports in response to record prices.
But the demand side is far more ambiguous.
The iron ore price is widely viewed as a barometer for the health of Chinese economy as such as large chunk of global iron ore demand is consumed by China (as highlighted in the UBS graph above).
There has been some concerns amongst global investors about the slowing of the Chinese economy as its Government maintains a tight monetary policy stance. So, an effortless explanation about the plunging price of the bellwether commodity might be a slowing Chinese economy.
But there’s much more to the story, particularly as the price of cocking coal (also a key ingredient in the production of steel) has surged to new all-time highs in recent months.
Throughout this year Chinese Communist Party officials have announced a series of steel mill closures in order to curb carbon emissions and rationalize power, all of which have made global headlines.
The party has ordered the industry to maintain 2020’s level of steel output in 2021.
In March, in response to pressure from the Party, officials in the steel-making city of Tangshan in the Hebei province announced a new target to reduce overall steel emissions by 40% year-on-year in 2021. Seven huge blast furnaces were shut within days.
The following month, officials in the Shandong province announced plans to shift or cut just over 21 million tones of crude steel capacity and 22.38mn tones of pig iron capacity by 2022.
A further 15 steel mills in the Guangxi, Guangdong and Sichuan provinces were forced to cut operations to help boost power supply, following power shortages caused by surging demand amid hot weather in July.
There have been other similar announcements and Chinese authorities have continued to talk tough publicly about reducing steel mill output.
Is China fooling the world?
Many have speculated that the very public announcements by Party officials on steel production (which are somewhat uncharacteristic) are aimed at talking down the price of iron ore.
Dialogue aside, the data paints a different picture to what markets would suggest.
Despite the so-called tough output cuts, Chinese crude steel production remains near record highs.
Chinese crude steel production
“Really all it has (China’s 2021 steel production cuts) done is reduce the level of steel production from stratospherically high levels to a lower level of the stratosphere,” said Michael Knox, the chief economist at Australian financial services firm, Morgans.
“This year China reached an all-time record monthly production of steel of 99.5 million tones in May. Since then production has declined to 93.9 million tones per month. Now if we compare that to previous years, last year the previous all-time record high was in August at 94.8 million tones for the month.
“So really, all that has happened with Chinese steel production this year is they’ve reduced it from this year’s all-time record high, down to about the same levels as last year’s all-time record high.
“These very, very high levels of Chinese steel production continue to generate very, very high levels of demand for iron ore.”
As the price falls, China’s iron ore imports have surged
Data released in recent days shows China imported 97.5 million tones of iron ore in August, up 10% from July. The value of the imported ore hit a monthly record of US$20 billion.
“It’s unsurprising to see a rebound in China’s iron ore imports, given the impressive recovery in Brazilian run rates over the past eight weeks,” Atilla Widnell, managing director at Singapore-based Navigate Commodities, told Reuters.
“Larger iron ore arrivals have resulted in the expansion of port inventories above 131 million tonnes, due to the government-mandated reduction in steel output capping iron ore consumption.”
“By August 26, iron ore port inventories belonging to the traders swelled to the highest since Mysteel commenced the survey on December 25 2015, reaching 73.4 million tonnes after gaining for the fourth week by 1.4 million tonnes or 1.9% on week. The proportion of the total stocks also grew for the fourth week by 0.5 percentage point to 56.8%,” said Mysteel.
So, whether or not it was deliberate, it appears China’s public declarations about its steel mill operations have enabled it to buy iron ore at a significant discount than what it could have prior to the production cuts.
The question remains, for how long will the iron ore price continue to be driven down and will there be more buying to come from China?