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Will China’s Tax Cut Be Enough to Save Its Iron Ore Industry?

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Tax rate cut

China’s state council announced on April 8 that it will cut the resources tax on iron ore by 40% of its original level beginning May 1, 2015. This would be equivalent to a cut of six yuan, or $1.27, a ton. Resources tax is charged as a percentage of value rather than a flat rate.

This move is China’s bid to save its embattled iron ore industry, which has a chronic problem of lower grades and higher costs than the imported Australian and Brazilian iron ore. Currently about 75% of the Chinese iron ore mining capacity is operating at a loss.

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Displacing Chinese capacity?

It is still unclear if this effort will be enough for the domestic Chinese iron ore miners, since the cost of production for bigger iron ore producers, like BHP Billiton (BHP), Rio Tinto (RIO), and Vale (VALE), are relatively lower than their Chinese counterparts. This could, however, prolong the pain the iron ore industry has been going through over the past couple of years.

Big miners have a stated strategy of flooding the global seaborne market with low-cost iron ore so that high-cost domestic capacity in China and elsewhere exits the market. This exit would have maintained big miners’ relatively strong positions in the market, giving them the leeway to increase the prices once again.

However, it doesn’t seem like the exit as envisioned by these miners will happen anytime soon, as China’s move would sustain the high-cost units for some more time. This will maintain the supply glut in the market, which in the face of weak demand growth from China and other regions, will likely keep the iron ore prices under pressure. Prices have already hit a ten-year bottom of $47.1 per ton last week.

Iron ore miners are negatively impacted

China’s tax cut is negative for iron ore prices and in turn iron ore companies involved in seaborne trade, including BHP, Rio, Vale, Fortescue Metals Group (FSUGY), and the Asia-Pacific division of Cliffs Natural Resources (CLF). Vale forms 2.6% of the the iShares MSCI Global Metals & Mining Producers ETF (PICK). The SPDR S&P Metals & Mining ETF (XME) also provides exposure to companies in the metals and mining space.

In the next part of this series, we’ll see how the iron ore companies are doing in this price environment.

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