Chinese demand is key for iron ore
China consumes about 70% of the globally traded seaborne iron ore. In 2014, seaborne iron ore trade was close to 1.3 billion tons. The top four iron ore miners—Vale SA (VALE), BHP Billiton (BHP) (BBL), Rio Tinto (RIO), and Fortescue Metals Group (FSUGY)—share about 70% of the seaborne-traded iron ore.
In this article, we’ll see how China’s steel consumption is expected to pan out in the next few years. That can give an indication of the demand appetite for iron ore.
Weak domestic steel demand
According to the World Steel Association (or WSA), China’s steel demand in 2014 saw negative growth for the first time since 1995. This is mainly due to the government’s rebalancing efforts, which had a significant impact on the real estate market. The WSA noted, “This situation is likely to remain unchanged in the short term and Chinese steel use will continue to record negative growth of -0.5% in both 2015 and 2016. In the medium term, no strong rebound is expected.”
According to the China Iron and Steel Association (or CISA), China’s crude steel output could decline by as much as 2% in 2015. For the first eight months of the year, Chinese steel production has declined by 1.7% year-over-year (or YoY) to 540 million tons. The above chart shows the declining trend in Chinese steel production.
The excess domestic steel capacity is already finding its way to other countries, including the United States, in the form of steel exports. In the first seven months of 2015, steel exports have grown by 27% year-over-year. This has led to the proliferation of trade cases filed by domestic steel producers, including Nucor Steel (NUE), US Steel (X), and Steel Dynamics (STLD). US Steel forms 3.8% of the SPDR S&P Metals and Mining ETF’s (XME) holdings.
Assuming a 2% reduction in crude steel output YoY (almost an inline trend year-to-date), China should produce close to 800 million tons of steel in 2015. Holding everything else constant, this should lead to a decline of iron ore requirement—approximately 1.45 tons of iron ore is needed to produce 1 ton of steel—equivalent to 23 million tons. This figure in itself doesn’t seem daunting, but the extent of supply expansions planned amid this declining growth does seem to be something to be worried about for iron ore prices. We’ll discuss this in detail later in the series.
However, to understand the implications of this weak growth, there is one more variable to consider—China’s domestic iron ore production. In the next part of this series, we’ll see how that is progressing.