How China drives the Australian iron ore boom (and bust)

Chinese investment in smaller iron-ore suppliers in Western Australia not only presents challenges for the market power of the Big 3 mining companies, but also for the viability of iron ore projects in Australia. AAP

With several major mining projects being put on ice this week, talk has quickly turned to whether the Australian mining boom is about to go bust.

Jumping on comments by the Resources Minister that “the resource boom is over”, the federal opposition has blamed the government’s mining and carbon taxes for BHP’s recent decision to shelve its $30 billion Olympic Dam extension project.

However, developments in the all-important iron ore industry suggest the drivers of the boom – and possible impending bust – lie not in Australia, but China.

A China-driven iron ore boom

Recent growth in the Australian iron ore sector has been driven by the rapid industrialisation of the Chinese economy.

China has, is recent years, begun the transition from “light” to “heavy” stages of industrialisation, with a focus on manufacturing industries such as machinery, ships and automobiles. To supply the raw materials required to accommodate these steel-consuming industries, the predominantly state-owned Chinese steel sector has almost quadrupled in size over the last decade.

Due to China’s lack of access to self-produced, high quality iron ore, its steel firms have had to look abroad in order to source their principal mineral inputs. Iron ore imports soared from 70 million tonnes in 2000, to 685 million tonnes in 2011. As a result, Chinese investment now accounts for close to 80% of the Asia-Pacific steel market market.

However, investments in the mining industry traditionally have very long lead times. Consequently, global supply failed to keep pace with Chinese demand

By mid-2011, the value of iron ore had increased nine-fold in comparison with prices in the year 2000.

China’s resource security strategy

Heightened iron ore prices caused major anxiety in China over resource security – would the steel industry be able to survive this “iron ore crisis”?

Given the high levels state-ownership in the Chinese steel sector, it was the government who led the response to the shortage. In 2005, it issued a new policy which laid out a national strategy for iron ore resource security.

This strategy had two distinct elements. Firstly, it proposed the development of a Chinese import cartel to challenge the dominant market power of the Big 3 iron ore firms (BHP Billiton, Rio Tinto and Vale) during annual price negotiations. Secondly, it aimed to promote Chinese investment into new entrants in the Asia-Pacific iron ore market, thus increasing available supply.

The cartelisation strategy ultimately proved disastrous. After several years of arduous talks, annual price negotiations between firms broke down following the Stern Hu Affair of 2009-10. Their replacement with a quarterly index pricing system has done little to soften China’s pain, with iron ore prices still well above their level five years ago.

Investing to break the Big 3

The Chinese investment strategy, however, may prove successful where the cartelisation strategy failed. With government support, Chinese firms have invested $29 billion in sponsor of thirty-five new entrants to the regional market, the majority of which are based in Western Australia. These investments were expressly designed to “break the monopoly” of the Big 3 and lower world iron ore prices.

While most of these projects are still in the “development” stage, they collectively plan to produce some 425 million tonnes of iron ore annually. When added with expansions planned by the Big 3, almost 900 million tonnes of new capacity is currently on the drawing board.

This will go a long way in levelling out the imbalance between regional supply and demand and in response, iron ore prices are certain to fall in the coming years.

The magnitude of the effect of this strategy remains debated, with some predicting only moderate falls while others have forecast a halving of prices. But in either scenario, the federal Resources Minister is correct in claiming the boom times for iron ore investment are now over.

Lean times ahead?

What does this mean for the Australian iron ore sector? Will the boom turn to bust?

Probably not - but the boom is unlikely to be as big as many have predicted.

Price falls will prove a difficult obstacle for the new iron ore players. Nearly all of the China-sponsored projects are modest in size, planning for production of between five and fifteen million tonnes of iron ore annually.

In comparison to the Big 3 – who produce between 155 and 323 million tonnes per year – these companies are perilously small. In the scale-dependent iron ore industry, many will prove uncompetitive in the wake of reduced prices and are likely to be abandoned. Sinosteel Midwest’s shelving of its Weld Range project last year may prove to be just the tip of the iceberg in terms of project cancellations and roll-backs.

However, some new entrants – such as Fortescue Metals Group – have managed to make the transition from small development project to large-scale export operation. So there is still space for new players, even if it is unlikely that all those planning new mines will ultimately succeed.

In the meantime, Australia’s iron ore juniors are now “racing to market” in the hope of avoiding the fate of Olympic Dam and Weld Range. While the China-driven iron ore boom is far from over, it will likely prove more modest than prior expectations.