Reuters carried an interesting analysis on the conflict between China’s moves toward short term iron ore pricing and their longer term aim of generating more sales on long term contracts rather than spot pricing. The article rightly points out that the two trends are in conflict. As China buys more raw material on the spot market and tries to get the iron ore majors to supply on shorter term quarterly or twice yearly pricing, it allows greater flexibility for China’s steel makers to react to trends in the market, such as capturing price savings in a falling market. However, as mills try to generate a greater proportion of their sales on long term contracts, a feature of Japanese and western mill sales, the Chinese reliance on short term raw material contracts will leave them exposed to rapid cost increases in the future. Fixed sales price with fluctuating raw supply costs can be a recipe for disaster ” ask the banks involved in mortgage lending.
This in itself is an interesting issue but the article went on to state, almost in passing that Chinese steel mills are inherently less competitive than their Asian neighbors like the Japanese and South Korean producers. According to the article this can be illustrated by the fact that China saw low-cost producers in Russia and Eastern Europe flooding its market this year, while exports of its pricey products tumbled 60%.
But at the same time, production in China hit 1.522 million tons between June 11 and June 20, equivalent to an annual output of a record 555.5 million tons (more than 10 percent above 2008 levels). Reuters puts the price differential between Chinese product and Russian or imported metal as down to the uncompetitiveness of Chinese mills and in part also on their reliance on slightly higher spot price iron ore purchases but we see this differently. Why would production be running at record levels and China move to becoming a net importer if demand was not driving it? Surely Chinese mills are pricing their product above regional competitors precisely because they can secure those prices on the domestic front. If they couldn’t, production would be cut back and you can be sure mills would be selling at break even or less in order to fill capacity. This would suggest the surge in infrastructure investment and an increase in consumption from industries like automotive is, for the time being at least, creating sufficient demand to keep mills busy. The question of Chinese mills efficiency is an interesting one and contributions from readers who have data to support or disprove the comparative positions of China vs.’ other regional players would be very welcome.