Fall in Chinese steel demand sees price of iron ore buckle

News was prepared under the information support of Online Daily Newspaper on Hellenic and international Shipping "Hellenic Shipping News".

31 Oct 2008

Chinese steel production has been dropping along with the steel price for weeks. But the situation in Tangshan, China's steel capital, shocked even a seasoned steel market analyst recently: "The statistical data sound depressing, but what we observe on the ground is more devastating," says Bonnie Liu of Macquarie Bank. "Nearly all independent rollers have suspended production since the beginning of October, and most integrated steel mills are running at 30 to 50 per cent of their normal capacity, with large layoffs taking place," she says.
Against a background of collapsing steel production, dramatically falling prices and rapidly softening demand from the Chinese car, appliance and construction industries, it is small wonder that analysts, traders and executives are predicting the toughest annual iron ore pricing negotiations for many years.
The talks for the annual benchmark agreements started informally last week with an industry conference in the Chinese port city of Qingdao, where representatives of the Chinese steel industry made several aggressive comments in favour of a price cut.
"It's clear where iron ore prices will be going," Liang Shuhe, deputy director of foreign trade at China's Ministry of Commerce, said at the Qingdao conference. "Iron ore demand may drop next year with falling demand for steel."
Sales of iron ore are highly dependent on Chinese economic growth as the country consumes almost half the world's seaborne traded ore. But the problems extend beyond its frontiers as steelmakers in Europe and the US are also cutting production sharply.
Ferrexpo, a small iron ore producer based in Ukraine, this week said that its regional customers were deferring contracts for November and December into next year because a significant reduction in both steel demand and output.
"The deterioration in the demand outlook has been marked and is exacerbated by customer de-stocking of iron ore," said Simon Wandke, Ferrexpo's head of marketing. Other executives agree that steelmakers from China to Germany are running down their stocks amid an uncertain outlook.
Steel Business Briefing, the consultancy in Shanghai, says it is unusually difficult to predict the outcome of the annual round of iron ore price negotiations because of the chaotic situation of the global economy.
"No one knows what will happen," says Tina Wang of Steel Business Briefing, a former iron ore trader. "Things are much more unpredictable than usual." Contract prices could fall by 10 or 20 per cent - or even more, she says.
"People are waiting for steel prices to bottom out, and that hasn't happened yet," she says, noting that spot iron ore prices in China have fallen to under $70 a tonne from a record $200 a tonne earlier this year. "A month ago, no one could have predicted that spot prices would fall so far," she adds.
Chinese steel production is forecast to be flat this year, rather than rising 5-10 per cent as expected, the head of a steel industry group said recently. Shan Shanghua, Secretary General of the China Iron and Steel Association, said he expected China to produce about 500m tonnes of steel this year, up 10m tonnes from last year, and short of forecasts for an increase to 520m-550m tonnes.
Other analysts and bankers agree that current market conditions favour buyers over sellers. The consensus among traders, bankers and analysts is for a price cut of 10 to 20 per cent for the contracts starting in April 2009 as today's Chinese ore spot prices of less than $70 a tonne is well below the estimated cost of $90 a tonne in the annual contracts.
Steelmakers executives talk about larger cuts - 30 per cent is often mentioned - while mining executives, who are likely to delay the negotiations until well into next year hoping that the market will have recovered by then, say prices could settle each side of a 10 per cent cut to a 10 per cent increase.
Du Wei, analyst at Umetal, a Chinese steel consultancy, says that Chinese steel makers are determined to pursue a price cut in this year's negotiations.
"Falling demand for steel and the reversal of the gap between the spot price and long-term contract price will enhance the bargaining position of Chinese companies," he says.
The timing of the price settlement will be critical. Miners hope that ore demand will recover early next year just as Chinese domestic supply tightens.
They believe today's low prices will force Chinese mines to cut capital spending or close production altogether. Up to a third of China's domestic iron ore production is lossmaking when spot prices drop below $100 a tonne, according to some industry estimates.
Some ore producers have been so concerned about the prospect of low prices that they have recently bought protection in the iron ore swap market, bankers say. But consumers and speculators remain on the sidelines of the swap market.
Nevertheless, current ore prices could soon lure some consumers into the swap market as spot prices at $70 are seen as a blip rather than trend, bankers say. Adam Knight, co-head of global commodities at Credit Suisse, says: "Today's low prices offer an opportunity for consumers to hedge some of their medium-term needs at attractive prices."
For iron ore consumers in Tangshan, such hedging seems unlikely: after all, it will only add to their costs at a time when production has collapsed.

Source: Financial Times