Chinese Steel Production and the Iron Ore Price

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Is the chinese steel industry — and, by extension, the seaborne iron ore market — a train crash happening in slow motion?

Some are beginning to believe this is the case.

Bucking pretty much the whole global commodities trend, iron ore prices in Asia have risen 4.7 percent in the past two weeks to $139.25 per metric ton for 62% Australian iron ore, the highest since early May and in stark contrast to crude oil, which has fallen 7 percent over the same period on the back of widespread fears of a global slowdown and a rise in risk aversion.

The FT suggests the iron ore market is supported by the marginal cost of production in China (said to be around $130 per metric ton) but that doesn’t explain the strength of prices or the stockpiling. For that we have to look at steel production, particularly in China, which has been running at record levels, rising 2.5 percent in May to 61.2 million tons.

Indeed, it is rising Chinese production that’s behind much of the 1.8 percent increase in global production during March and 1.2 percent increase in April, according to Reuters. Steel production in Japan was up 2 percent to 9.2 percent and in the US by 7.4 percent year-on-year in May to 7.7 million tons, but both are a fraction of China’s output.

The European Union by contrast fell 5.5 percent to 15.3 million tons and Brazil has been bemoaning the level of (mostly Chinese) imports undermining the home market for steel products, falling by 11 percent in May.

China meanwhile is continuing to produce steel in record quantities with the surplus going overseas. Exports hit an all-time high of 5.23 million tons in May as domestic finished steel prices appear to be easing with Baosteel recently announcing a price reduction. The HSBC Flash Purchasing Managers Index, the earliest calendar indicator of China’s industrial activity, slid to a seven-month low of 48.1 in June, with exports, the construction industry and automotive all showing signs of a sharp slowdown.

You have to ask: with just about all other commodities in decline, with so much uncertainty impacting investment decisions and the threat of Europe slipping into recession (German manufacturing has slumped to a three-year low, according to Markit Economics), how long can Chinese steel production buck the trend and continue rising?

Beijing does not seem ready to let the construction sector loose as it did in 2009, so where is the demand for all this steel going to come from? Rising exports are not the answer. They are already causing trade tensions and demand in most markets is stagnant or falling with the exception of the US. With exports at less than 10 percent of total Chinese production, the country’s steel producers could afford to dump excess steel overseas providing they made a profit on metal consumed at home, but neither Europe nor the US is going to stand by and allow that to happen.

The logical conclusion has to be that Chinese steel production, and by extension iron ore consumption, must slow in the second half with a corresponding fall in prices; the longer the current situation prevails, the greater the likely reaction will be and steeper the price falls.

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