The unexpectedly quick resurgence of China’s crude steel production in 2009—and the resulting spike in spot prices for iron ore—killed the unpopular benchmark pricing system but left many uncertainties
By Magnus Ericsson, Anton Löf and Olle Östensson
World production of iron ore fell by 6.2% in 2009 and did not quite reach 1.6 billion mt—the first drop in production after seven consecutive years of growth. Output decreased in most countries, with a few notable exceptions such as Australia and South Africa. Developing countries accounted for a little less than 59% of world iron ore production in 2009 (down from 60% in 2008), the CIS republics for 12% and the industrialized economies for 29%. The increase for the industrialized economies was due almost exclusively to growth in Australia. China produced 234 million mt on a comparable grade basis. China, which once was the largest producer, has dropped to third place behind Australia at 394 million mt and Brazil at 300 million mt.
Chinese production is crucial to understanding the dynamics of world iron ore markets. However, analysis is complicated because there are serious questions about the reliability of Chinese data for iron ore production. We recently decided to revise our method for estimating Chinese production: having previously used Chinese statistics as a basis, we have found this method no longer yields reasonable results, probably because of shortcomings in the way the statistics are collected and compiled. Instead, we now estimate iron ore production in China by calculating the iron ore content in the pig iron produced and deducting the iron content in imported ore to arrive at a figure indicating need for domestic ore in terms of iron content. This method appears to be relatively safe from errors since both the production of pig iron and iron ore imports can be checked against other numbers. Most importantly, the pig iron production is included in statistics published by the World Steel Association and is checked through its procedures.
The change in methodology has significant consequences for our view of how Chinese and world iron ore production has developed; we’ve concluded that Chinese iron ore production was under-reported up to 2007 and over-reported in 2008 and 2009. According to our revised estimates, Chinese iron ore production increased from 147 million mt in 2000 to 400 million mt in 2007 (production converted to Fe content of 63%). In 2008 and 2009 it declined, probably partly because of lower profitability, partly because of exhaustion of reserves. The revised figures for 2005, 2006, 2007 and 2008 Chinese production are 285, 356, 400 and 321 million mt.
It is difficult to identify the reasons for the over- and under-reporting without detailed insight into the procedures used to produce the statistics. While one can speculate about reasons for double counting (two sources reporting the same production, for instance) or motives (taxes, access to government subsidies) for reporting parties to adjust numbers, little is known with any certainty. The number of iron ore mines in China is vast, and nobody, not even the Chinese themselves, is likely to have a good overview of the situation at any given time. What is certain, however, is the gross figures provided are not consistent, either over time or with other statistical parameters such as pig iron production. We intend to further refine our analysis of Chinese iron ore production in 2010.
China Drives Crude Steel Comeback
An unexpectedly quick recovery in world crude steel production in the second half of 2009 was almost entirely due to China, where production began increasing in late 2008 and matched earlier monthly production peaks by April 2009—while the rest of the world still had not achieved pre-crisis production rates by May 2010. It is Chinese production that mainly drives growth, but there has been growth in most other larger crude steel producing countries as well, compared with production in 2009. If the production rate of the first four months of 2010 continues, total output of crude steel in 2010 will be approximately 1,410 million mt, the same as in the record year of 2007.
World crude steel production decreased from 1,326.6 million mt in 2008 to 1,219 million mt in 2009, a dramatic fall of 8.1%. But while most of the world saw falling production, crude steel production in China increased by 13.5%, compared with 2.3% growth the year before. China now accounts for almost half of the world production of crude steel (47%). In Europe, production fell by 24% and Africa experienced a decrease of 11%. In the Americas, production declined with 30% and in Oceania, production was reduced by 29%.
Ore Trade was Up, Led by Aussie Exports Despite the recession, iron ore trade reached a new record in 2009 as exports increased for the eighth year in a row to 955 million mt, up 7.4%. The increase was the result of higher demand in China combined with a fall in domestic production. Total iron ore exports have increased by 88% since 2000. Developing countries accounted for 49% of total iron ore exports in 2009. Developed market economy countries accounted for 43% and the CIS countries for the remaining 7%.
Australia is the largest iron ore exporting country at more than 360 million mt and its 2009 exports increased by 17% over 2008’s figure. In contrast, Brazil’s exports decreased by 3% to 266 million mt in 2009. Indian exports grew for the tenth consecutive year and the country is now, at 116 million mt, the third most important exporter.
Seaborne iron ore trade is estimated to have increased by 11% in 2009 to 895 million mt. The increase was entirely accounted for by Chinese imports, which rose by much more than the increase in total trade. Other importers registered large declines. China is by far the largest importer and its imports grew by a massive 41% in 2009 to reach 628 million mt, or 67% of total world imports. Japan is the second largest importer at 105 million mt, a decrease of 25%. European imports (excluding the CIS countries), fell by 45% in 2009 to 100 million mt, representing 9.9% of world imports.
The Death of Benchmark Pricing
The annual iron ore benchmark negotiation process died in early 2010, despite vocal opposition mainly from Chinese steel companies. With strong support from Japanese and European steel industry organizations, there was nothing that could make it survive. When Chinese steel demand recovered surprisingly quickly at the end of 2009 and early 2010 and iron ore spot prices soared, there was simply no real support for the old system. Baosteel and CISA, representing the Chinese steel industry, tried to hold out and even called for a boycott of the “Big Three” producers, but this proposal was more indicative of the powerlessness of the Chinese steel industry and its inability to change the course of events, than a real threat. A quarterly semi-negotiated price is now the norm.
The new model has brought uncertainty and reduced transparency to the iron ore market. Prices are no longer announced as they were previously, and the published series of spot prices are still not 100% reliable. The spot price into China is used as a basis for pricing in all parts of the world and although there are three main series available—Metal Bulletin, SBB and Platts—it is still unclear how representative these series really are and how secure against manipulations they are. At least one company, Swedish exporter LKAB, has negotiated annual contracts but its model of pricing has not been published.
It will be a long time before iron ore prices are set as those of copper, nickel or other base metals are, on a completely transparent exchange under full control, protected against any type of manipulation, but hopefully this is the direction in which iron ore is moving. When looking back it took between five to 15 years when aluminum and nickel moved away from so-called producer prices and became fully integrated and traded on the London Metal Exchange. There is really nothing stopping either an iron ore contract or using a steel contract as the basis for iron ore trade. The latter, for example is how copper concentrates are traded.
The new model has resulted in price hikes in the second quarter of 2010 of about 100% compared with the 2009 benchmark. Australian hematite fines to Japan increased by 99.7% and there were expectations of a further increase for the third quarter. Vale reached an agreement with its Japanese customers at an 86% increase for Itabira fines and 92% for Carajas fines.
Corporate Production Concentration Increases
The three largest iron ore companies—Vale, Rio Tinto and BHP Billiton—increased their control over global iron ore production to 35.4% in 2009 (See Table 2). The market share of the so-called “Big Three” increased for the first time since 2004. Brazil’s Vale still holds the position as the largest iron ore producer, and although it controls some 255 million mt its position as the undisputed industry leader is seriously challenged. Not only have the volumes controlled by Vale decreased from a peak of 308 million mt in 2007 while its closest rival Rio Tinto has increased its controlled production from 150 to 172 million mt, but Vale’s market leadership has also been successfully challenged, primarily by the third largest producer, BHP Billiton. BHP Billiton has been in the forefront against the benchmark negotiating process while Vale has been its most fierce defender, while Rio Tinto has been ambivalent. Many small Chinese producers reduced output in 2009, and that, together with the quick ramping up of production in Australia after the slump in early 2009, resulted in an increased market share for the Big Three.
The trend over the last four years of diminished production concentration seems to have been broken. Against the background of the cut in production by Vale of some 50 million mt it seems most likely corporate concentration in production will increase in 2010 when Vale tries again to recapture market share. It is further likely a continued fall in Chinese domestic production with widespread mine closures—the Great Chinese Shakeout—will continue over the next few years. As we stated in last year’s review these two factors would help catapult the total share of production controlled by the Big Three back to or even beyond the highest levels of 2003–2005, but it actually happened much faster than we anticipated.
To measure corporate control at the production stage underestimates the concentration of the iron ore sector because large parts of total production do not enter the market due to vertical integration. An alternative is to look at respective shares of seaborne trade. Measured this way, the shares of the major companies are considerably higher. While it is true Vale’s control has decreased in 2009 from 33% to 26%, Rio Tinto and BHP Billiton increased their control and the three largest companies together still control 61% of the total seaborne trade of iron ore. This number is quoted by those who argue that concentration may lead to control by major producers over prices, particularly under the present benchmark negotiating system. While the proposed merger between BHP Billiton and Rio Tinto failed, it was announced in early June 2009 Rio Tinto and BHP Billiton had entered into a non-binding joint venture agreement covering the entirety of both companies’ iron ore operations and infrastructure in Western Australia. This agreement has also raised concern in some quarters about the growing bargaining power of the large producers. The trend on the part of steel producers toward creating a network of captive mines, both iron ore and coal, which started in the CIS, has strengthened. The largest steel producer, Arcelor Mittal, has built a strong holding in the iron ore sector and other steelworks have followed suit.
Capacity May Increase by 2012
New iron-ore mining capacity coming on-stream in 2009, as identified at the individual project level, reached almost 75 million mt globally. This is slightly lower than the 2008 figure of 90 million mt. The project pipeline in May 2010 included more than 685 million mt of new production capacity to come on-stream between 2010 and 2012. Of this total, about 270 million mt falls into the “certain” category, with 145 million mt “probable” and 270 million mt “possible.” Of the projects labeled “certain,” 61% are located in Oceania, while Latin America has 19% and Africa 16%.
We have been doing these estimates for a number of years and over this period an average of some 75% of the projects in the certain, probable and possible categories have been recorded as completed. Despite the uncertainties of each individual project it may, with some degree of confidence, be assumed that some 400–500 million mt of new capacity will come on-stream in the period up to and including 2012. In a three-year period after 2012, more than 400 million mt of additional iron ore capacity have been assigned completion dates. Given the present circumstances, with extreme optimism in the market most of the projects in the pipeline will progress and many new ones will be announced. Were it not for the capacity of the Big Three to regulate the pace at which their projects are taken into operation, the risk of future overcapacity would seem considerable, particularly if there are any hiccups in the growth of steel production in the next three years.
Outlook: Ore Producers Control Prices Now
The World Steel Association’s short-term forecast for world steel use, presented in April 2010, anticipates a rise in steel use by 10.7% in 2010. In June 2010 when this report was written, the iron ore market was tight and spot prices were approaching 1,200–1,300 RMB/mt as Chinese steel production continued to grow. Nevertheless, the events over the past year lead to two conclusions, both of which are important to the future of the world market for iron ore:
- The Chinese economy is capable of changing direction toward endogenous growth and is in the process of doing so, which means it will be less dependent on growing world demand for its manufactured exports.
- Domestic Chinese iron ore production is sensitive to prices and will probably not be able to increase output beyond present levels.
Meanwhile, the new pricing system gives major iron ore producers more leverage. While the international steel industry is fragmented and does not act in a cohesive manner, the three large iron ore producers do not have to collude in order to exercise considerable control over the market and ensure that they are pursuing mutually consistent strategies. Their objectives are obvious—maximizing profits—and their method of achieving the objective equally so: keep the price high enough to pay for new investment and low enough so that new entrants do not become realistic alternative sources of product. The control exercised by the Big Three will, to some extent, counteract the tendency to greater price instability that will result from the new pricing methods.
The world iron ore market will be characterized by tight conditions and the next few years will be characterized by a gradual adaptation of supply—by way of addition of new capacity—to continuously growing demand. Accordingly, Raw Materials Group believes supply will gradually catch up and prices will decline from the present extreme levels, but will stay at a higher level than in the period before 2008.
Magnus Ericsson is a senior partner and co-founder of Raw Materials Group, Stockholm, Sweden (www.rmg.se). Anton Löf is a research analyst with RMG, specializing in the global iron ore trade. Olle Östensson is a senior adviser at RMG.
The background material for this article was extracted from The Iron Ore Market 2009–2011, published by UNCTAD in June 2010. This study was researched and compiled by Raw Materials Group (www.rmg.se) for UNCTAD, and can be ordered by e-mail from: [email protected] or by fax from +41-22 9170509.