Iron Ore Beholden to China's Great Clean-Up as Quality Wins

(Bloomberg) -- Something’s changed in China this winter as businessman Fei Weimin finds the usually smog-laden skies have turned a welcome shade of blue. The shift, driven by state-mandated curbs on steel mills and industrial plants to fight pollution, matters a great deal for the global iron ore industry.

“I’ve found the air to be much better,” said Fei, who’s worked in Beijing for more than a decade and likens breathing the dirty air most of the time to sucking on an exhaust pipe. “When it got really bad in the past, visibility inside your own apartment is reduced and you could literally taste the pollution.”

Iron ore is capping a tumultuous year that’s seen wild swings as China’s unprecedented crackdown on its noxious smog by cutting steel supply and curbing other activity has become one of the most important factors shaping the global market. The campaign has buffeted prices, roiled shares of miners including BHP Billiton Ltd., Rio Tinto Group and Vale SA and blown out the spreads between high and low-quality ore. Moreover, the new policy that has Fei seeing blue skies may remain a feature for years to come.

“Curtailing steel supply to clean the environment will become standard practice,” said Zhao Chaoyue, an analyst at China Merchants Futures Co. “Authorities may order the suspension of certain steel-making activities during important events or winter to reduce pollution. That’ll be the new normal.”

While prices are set to cap a modest annual drop, the decline masks 12 months of volatile trading. Spot ore with 62 percent content was last at $72.62 a dry ton, according to Metal Bulletin Ltd., after swinging between almost $95 and just above $50. The gap between top quality, 65 percent ore and lower-grade material, which was about $10 at the start of 2016, is now closer to $50.

China is the largest importer of iron ore, shipping in more than 1 billion tons a year to feed the country’s mammoth steel industry, with most cargoes coming from mines in Brazil and Australia operated by Vale, BHP, Rio and Fortescue Metals Group Ltd. The zealous anti-pollution drive follows a related push to curb overcapacity that’s seen some illegal mills shuttered.

The policy makers’ efforts target the north, zeroing in on the so-called 2+26 cities, a region that refers to Beijing and Tianjin plus other centers. The drive is crimping nationwide steel output even as mills in the south enjoy free rein, and spurring demand for cleaner, higher-grade ore that’s more efficient.

With dwindling steel stockpiles, steel prices have jumped, aiding mills’ profitability, boosting their ability to pay more for inputs, including ore. Domestic mine output has dipped, supporting demand for foreign cargoes.

‘Higher for Longer’

“If steel mills’ margins stay higher for longer, mills’ appetite for mainstream iron ore products will also be higher for longer,” Citigroup Inc. said in its annual metals outlook. “The high-grade ore market could shift to deficit.”

The impact of the curbs is showing up in the data. Nationwide steel production has slowed, with mills making 66.15 million tons last month, the smallest since at least February, and down from a record in August. At the same time, stockpiles of ore at ports are at an unprecedented level above 145 million tons. In 2017, flows into China will set a record, aided by lower local supply.

There’s a knock-on effect beyond China. As mainland mills cut steel exports to keep more at home, that’s easing pressure on U.S. and European rivals, which are already benefiting from solid global economic growth. In November, China accounted for 48.5 percent of global steel output, from 52 percent in August.

This year’s curbs are unlikely to be a one-off event. China’s leaders have said they are taking a three-year approach to winning “critical battles,” including against pollution. Separately, Yang Weimin, an official from the Communist Party committee overseeing economic policy, said a goal of doubling the size of its economy by 2020 can still be hit even if expansion slows, signaling a greater willingness to tackle pollution and debt at the expense of growth.

Goldman’s View

That means figuring out the impact on iron ore of China’s curbs, including what’ll happen when they are relaxed in spring, is as critical as gauging the consequences of more global production. Goldman Sachs Group Inc. has said the shift toward high-grade ore is probably structural given the mainland push. Still it’s forecasting a drop in 2018 to an average of $55 a ton as output rises.

“Policy changes in China will have a profound impact on both the iron ore and the steel market in the coming years,” Erik Hedborg, a senior consultant at CRU Group in London, said by email. “It is possible that similar cuts will return in the future if it turns out the measure had a positive impact on the environment without hurting the industry too much.”

In its latest outlook, the state government of Western Australia -- home to the largest iron ore supply hub -- noted the “impact of restrictions requiring steel mills in key steel producing cities in north-eastern China to reduce output and iron ore sintering.” It too sees slightly weaker prices in 2018. Australia’s federal administration will deliver its latest market assessment next month.

In the meantime, Beijing-resident Fei is optimistic the blue skies that’ve come from mills being forced to make less steel for a while, will remain to the Lunar New Year in February, and beyond. “Whatever steps the government is taking seem to have worked,” Fei said. It “has made Beijing a nicer place to be.”

--With assistance from Alfred Cang

To contact Bloomberg News staff for this story: Jasmine Ng in Singapore at jng299@bloomberg.net, Sarah Chen in Beijing at schen514@bloomberg.net.

To contact the editors responsible for this story: Jason Rogers at jrogers73@bloomberg.net, Jake Lloyd-Smith, Alexander Kwiatkowski

©2017 Bloomberg L.P.

With assistance from Jasmine Ng, Sarah Chen