Chinese Steel Production Driving Demand for Australian Iron Ore

In 2007 Australia is exporting iron ore-and coal, and gold, and other commodities-to the tune of $117 billion in earnings, according to the Australian Bureau of Agriculture and Resource Economics (ABARE).

What almost happened in the early 1970s-an Asian boom leading to a golden age for Australia – is happening now. And it’s giving investors a rare second chance to make an epic fortune in the Pilbara.

Existing companies are doing as well as they have ever done. You’d know this right away from the fact that Rio Tinto’s (ASX:RIO) recent $44 billion bid for Canadian aluminium producer Alcan was all cash. That’s a lot of cash.

But then, earnings are rolling in across the board. ABARE projects export earnings of $18.5billion for iron ore producers alone. Metallurgical coal (for steel making) is set to come in at $15 billion, and gold export earnings (Australia is the third-largest gold producer in the world) should come in at $11 billion (higher, of course, with a higher gold price.)

This boom in export earnings has kicked off an exploration boom. If you want to sell more stuff you have to find it first. Aussie mineral exploration budgets grew by 20.6% in the last year, according to Geoscience Australia’s Australian Mineral Exploration, 2006. Some of those budgets were funded by the 75 IPOs on the ASX for exploration companies (many of them uranium companies). Incidentally, “the 10-best performing [Aussie] IPOs were all in the resources sector and averaged a 764% increase,” according to accounting firm Deloitte’s annual IPO report from 2006-07.

In addition to exploration the big boys are expanding as fast as they can (and contracting out to mining services firms). There are no less than eight planned mine expansions all over Australia that could add as much as 100 million tonnes of production capacity in the next 2-3 years.

Big projects include BHP’s long-term Rapid Growth plan, Rio’s $1.3 billion expansion of Hope Downs to eventually produce 30 million tonnes per year, and Fortescue’s planned development of Christmas Creek and Cloud Break. All this capacity might, just might, meet China’s demand for new iron ore.

What is driving the demand, especially for ore?

Chinese steel production. China has gone from being a net importer of steel to a net exporter in the last six years. According to the China Iron and Steel Association, China produced 151 million tonnes of steel in 2001. This year, China is on track to produce nearly 462 million tonnes of steel, a 205% increase in six years.

What’s remarkable about the Chinese demand for iron ore to make steel is that it continues to grow despite rising iron ore prices and smaller profit margins. For the last four years, the price change for the annual iron ore contract negotiated between producers and the big consumers has been in double digits, with a huge 71% increase in 2005. A recent report by Credit Suisse suggests that iron ore prices could go up by another 25% next year alone.

These rising prices have eaten into profit margins, especially for Chinese steel makers. But profit growth is still amazingly strong in China. According to the China Daily, “The nation’s top 99 steel companies reported a combined profit of 34.53 billion yuan in the first three months, rocketing by 282 percent from a year earlier…China imported 100.2 million tonnes of [iron] ore in the first three months of this year, up 23.1% year-on year.”

China needs all that ore to make all that steel because its economy is still rocketing along at 11% growth, according to the latest figures. You can never quite trust government figures, of course. It could be more. It could be less. But either way, it’s a lot!

The composition of that growth is important if you’re trying to forecast demand for Australian iron ore. Fixed asset investment in China-usually the kind of investment that involves heavy industrial infrastructure or commercial building-grew by 25% in the first five months of 2007. Over US$94 billion was spent on urban fixed assets. This growth rate is lower than in previous years. But it doesn’t look like China’s heady boom will end as soon as the Beijing Olympics begin next year.

Dan Denning
Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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Coffee Addict
The eastern Chinese economy is undergoing significant growing pains. In 20 years time there will be a higher standard of living there with higher costs of production as greater attention is given to environment, industrial regulations, industrial property rights, product safety and so on. The East will move up the feeding chain as a lot of the cheap production moves to the poorer provinces in the West. I agree that the very long term prospects of Australian resource companies are therefore very positive as a consequence. Unfortunately, I cannot benefit from this personally as I have NO superannuation fund choice… Read more »
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