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The spot price of iron ore has had a torrid time lately, caught between short-term concerns about the economic health of top buyer China and a longer-term threat to the current market system as Beijing seeks to permanently lower costs.
Benchmark 62% iron ore for delivery to north China MTIOQIN62=ARG, as assessed by commodity price reporting agency Argus, dropped to $121.95 a tonne on June 17, the lowest price since Jan. 1 and down 24% from the peak so far in 2022 of $160.30 on March 8.
China’s domestic iron ore contract has also slumped, ending last week at 838 yuan ($124.70), down 10.3% from its closing high so far this year of 934 yuan on June 6.
The immediate catalyst for the sharp declines in recent weeks is falling profit margins at Chinese steel mills amid a cloudy outlook for demand.
Some Chinese steel mills are reportedly cutting output, and Sinosteel analysts estimate that steel inventory rose 316,700 tonnes last week to 22.2 million tonnes.
China buys about 70% of global seaborne iron ore volumes, so any steel-demand concerns will flow through to the price of iron ore, a raw material for steel.
The lingering effect of COVID-19 lockdowns and the threat of more to come as Beijing sticks to its zero-COVID policy are also casting a shadow over the world’s second-biggest economy.
The risk for China is that the current negative sentiment overcomes an expectation that Beijing’s stimulus measures will fire up the economy in the second half of the year.
The outlook for spot iron ore prices for the rest of the year largely rests on how successful China is at containing COVID-19 and how quickly the stimulus measures start to boost steel-intensive activities such as housing and infrastructure construction, and vehicle manufacturing.
Beyond that, the iron ore market may have to deal with a potential reworking of the spot pricing system that has largely been in place since 2008, when former BHP Group BHP.AX chief executive Marius Kloppers moved his company, the world’s third-biggest iron ore producer, away from the earlier contract system and the other miners followed.
WHO HAS THE POWER?
China wants to set up a central group to control iron ore imports by the end of the year, believing this will give it the power to force cheaper prices, the Financial Times reported on June 16.
This wasn’t the first time such a plan has been mooted, but the difference this time is that there appears to be some real momentum in moving to a central system of buying iron ore by the major state-controlled steel mills.
On the surface, it may seem like a no-brainer to try and set the terms of purchases if you are the buyer of 70% of global supply of a commodity.
But while iron ore is a concentrated market on the demand side, it’s almost as concentrated on the supply side, with two top producer countries, Australia and Brazil.
For example, China’s imports from the two countries in May totalled 83.7 million tonnes, which is 87% of seaborne arrivals, according to data compiled by commodity analysts Kpler.
There are several miners in each country, but, once again, supply is concentrated – among a handful of major companies.
Rio Tinto RIO.AX, BHP and Fortescue Metals Group FMG.AX accounted for 58 million tonnes of China’s May imports, or about 61% of the total.
Brazil’s Vale VALE3.SA supplied 14 million tonnes of China’s May imports, for a 14.6% share.
Adding the big-three Australian producers to Vale means that four companies are meeting 75.6% of China’s imports, given that the May import figures are largely typical of the longer-term supply trends.
While it’s unlikely these companies would collude, or form a sellers’ cartel, they also exercise significant power over the market.
China could try to lessen dependence on Australia by seeking to buy more from Brazil and the handful of smaller suppliers, such as South Africa and Canada, but miners in these countries would have little incentive to sell at prices lower than those of their Australian competitors.
The loss of exports from Ukraine since it was invaded by Russia, and the Indian government’s ban on exports has further concentrated the seaborne iron ore market, making China’s challenges even greater.
If China really does try to end the current spot system, it may come down to a case of who blinks first in what is likely to become a Mexican standoff.