China's Challenge With Iron Ore

AT-A-GLANCE

• China’s zero COVID policy and slowing economic growth could affect its demand for iron ore

• Iron ore prices have been volatile since hitting a record in May 2021

Iron ore prices have remained volatile since hitting a record high in May 2021. With uncertainties persisting on both the supply and demand side, price fluctuations look set to continue.

China’s Iron Ore Dependency

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China is the world’s largest consumer of iron ore, and despite being the third largest producer, it still imports around 80% of the iron ore it uses each year. The biggest producers of iron ore are Australia, Brazil and China, which collectively account for around two-thirds of global output, with India, Russia, Ukraine and Canada also significant producers, according to the U.S. Geological Survey Mineral Commodity Summaries 2022.

China imported a total of 1.12 billion tons of iron ore in 2021, down slightly from 1.17 billion tons in 2020, according to government data. The drop in demand was largely driven by lower steel production in China, as the government placed constraints on the industry in a bid to reduce carbon emissions.

Going forward, China’s demand for steel, and by extension iron ore, could be impacted by conflicting factors. On the one hand, the country’s zero-COVID policy could lead to ongoing lockdowns, particularly in the face of the highly contagious omicron variant, which would impact economic activity and reduce demand. On the other hand, with data for March 2022 pointing to slowing economic growth, the government is set to introduce stimulus measures to boost the economy. The Communist Party’s Politburo recently stressed the importance of meeting annual economic goals, and increasing infrastructure construction to help boost growth. A rise in infrastructure construction would boost demand for steel, and its raw ingredient, iron ore.

Over the medium term, China has set the goal of significantly increasing its iron ore self-sufficiency. In the 2021-25 Raw Material Development Plan, it set out plans to increase domestic mining and raising the use of scrap steel. Until this goal is achieved, China remains heavily dependent on imports, with 60% of shipments coming from Australia.

Price Volatility Drivers

Iron ore prices have been volatile since hitting a record level in May 2021, when they reached $237 per metric ton (MT) on the back of rising demand from China. In November 2021, they slumped below $100 per MT, before recovering to a seven-month high in March 2022.

On the supply side, prices had gained some support due to concerns about production. Australia has seen a fall in its iron ore output due to labor shortages, partly as a result of Omicron outbreaks. Mining giants BHP Group and Rio Tinto both posted lower first quarter output than expected, while Brazil’s Vale posted a 6% decline, although it expects production to pick up going forward.

At the same time, the onset of war in Ukraine put further upward pressure on iron ore prices in late February to early March 2022 due to its impact on exports from both Russia and Ukraine. Ukraine accounted for 3% of global iron ore production in 2021, but exports have been disrupted by the military action. Meanwhile, western producers have also been seeking alternative suppliers amid economic sanctions.

Despite these supporting factors, iron ore prices have continued to be volatile in recent weeks, with fluctuations partly driven by changing expectations for demand as China continues to pursue its zero-COVID strategy.

The Portside and Seaborne Spread

Price volatility extends to the spread between China’s seaborne and portside iron ore market. Seaborne iron ore has a lead time of one to two months and reflects future supply/demand, with prices quoted in U.S. dollars per dry metric ton. By contrast, portside iron ore has a shorter lead time, typically of just a few days, meaning its price reflects the current supply/demand situation, while prices are quoted in renminbi (RMB) per wet metric ton, with VAT and port fees included in the price.

The portside market has been growing in importance in recent years both for price discovery, as the portside market reflects domestic demand more closely, and direct RMB-denominated sales of landed cargoes by international companies. Another advantage is that trading of portside iron ore can be done for smaller volumes and with less onerous financing arrangements, while the market tends to move faster than the seaborne one, making it more responsive to changes in demand.

The spread between the portside and seaborne market for iron ore can be volatile, due to factors ranging from shipping times, to foreign exchange rates, to financing. In recent weeks the discount of portside prices to seaborne ones has narrowed significantly, largely due to weaker than anticipated demand for iron ore in China following COVID-19 lockdowns. The situation is a significant reversal of much of 2021, when portside iron ore traded at a premium to seaborne, before a build-up of portside stocks triggered the shift to a discount.

Managing Price Risk

CME Group has launched two new China portside iron ore futures contracts to help market participants manage their exposure to landed iron ore cargo prices on-shore in China.

The Iron Ore China Portside Fines CNH fot Qingdao (Argus) futures and Iron Ore China Portside Fines USD Seaborne Equivalent (Argus) futures are the first internationally traded derivatives linked to China’s portside prices. The contracts help market participants manage their onshore iron ore price risk at Qingdao Port in China.

It is one tool to help participants along the supply chain manage what remains an uncertain situation. With both the supply of iron ore and demand from China remaining uncertain, iron ore price volatility could continue for at least several more months.

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