China cracks down on over capacity. World rejoices.

5 10 2009

China has announced this week that it would deal with over capacity with regards to steel, cement, aluminium, and wind power. At present China is only being mindful that the economic recovery is fragile and hopes to avoid the drastic factory closures and job losses that over capacity could lead to. China’s will to resolve this problem is not new and its pledge to attack the problem is only a reiteration of previous policy goals whose application have not always been consistent.

China’s industrial policy goal for the aluminium sector has for long aimed at consolidating around fewer greener and more efficient facilities while phasing out smaller inefficient smelters. Between 80 and 130 smelters, some of which with nameplate capacity of only 20 000 tonnes per year, are assumed to be in operation in China. The Cabinet repeated pledges announced in May to ban for three years new capacity and to remove small plants scaled at 800,000 tonnes per year or below, according to Reuters. Such a high threshold for nameplate capacity is surprising as no smelters with a capacity above 800 000 tonnes per year has been reported in China by Light Metal Age. A smelter above 800 000 of capacity can only be found in Russia and the Middle East. In sum, the meaning of the Cabinet statement is at best nebulous.

In the case of steel, China has decided to crack down on the 10 per cent output capacity that it deems illegitimate, It has also decided to no longer support new projects or expansion plans of current facilities. Not authorising new projects is not a guarantee that output will be reduced as some regions have illegitimacy approved construction as local authorities are not always following Beijing.

As the targeted industry sectors are energy intensive, the only affected party to China’s decision to reduce industrial output may be Australia who has been benefitting from China’s surge of coal imports. For the countries that have had to set up safeguards, impose corrective tariffs and file WTO cases, this comes as good news. Western steel mills restarting capacity are also benefitting from this move. So is Noranda who just restarted capacity at its Evansville smelter.


China and iron ore this week

5 09 2009

Well it seems that the authority that CNN is does not agree with my reading of the China/Fortescue deal. Some really see the potential in Fortescue being a disruptive force in the iron ore triad’s “freeride”. That is based on the assumption that the company could possibly reach an output of 200 million tons a year. At present the capacity of Fortescue is estimated at 45 million tons a year. You can do the math; Fortescue is far from reaching the 200 million tons threshold which leads me to question the timeframe under which such a grand master plan can be implemented.

Fortescue current supply agreement of 20 million tonnes will cover only 5% of China’s expected iron ore demand for 2009 which confirm my initial view that the deal between Fortescue and China is overpriced.

On other iron ore news, Baosteel admitted earlier this week that it was paying provisional benchmark prices to Vale and Rio Tinto. The prices match what was offered to Japanese and South Korean steel mills. Baosteel also took a stake in Aquila Resources, an Australian iron ore explorer, last week.

Iron ore politics

23 08 2009

You know sometimes governments are so keen on pursuing a specific agenda that no matter how much opposition and obstacles they may face they will push their policies through eventually calling the outcomes a victory, a win-win solution even though they lead to little or no benefits besides face-saving. China’s iron ore quest fits that pattern quite well.

Here’s the grand debacle in a nutshell. Earlier this year China started to negotiate contracts for iron ore seeking to achieve a 40-45% reduction from the previous year’s contracts. As the price of iron ore picked up, the top iron ore suppliers were reluctant to agree to such a cut considering that Japanese mills had set up contracts reducing benchmark prices by 33% from the previous year. As contracts expired, Chinese steel mills had to purchase iron ore at spot prices for more than they would have paid had they settled for a 33% reduction. Some mills even defected the national contract negotiation scheme to secure their own individual contracts. One would think the four Rio Tinto officials jailed on accusations of bribery related to the iron ore negotiations would crown the whole Chinese endeavour as a fiasco. It truly did but I suggest that it is the deal reached this week with Australian miner Fortescue Metal that allows the scenario explained in the first paragraph to materialize.

Fortescue Metal is an up and comer in the field of iron ore. It started mining at its Pilbara project in 2008 and is contemplating expansion activities to compete with bigger Pilbara neighbours Rio Tinto and BHP Billiton. As such, the deal reached between Baosteel and China Iron and Steel Association (CISA) and Fortescue, involves a 35% price cut from the previous year contract prices in exchange of US $6 billion in funding whose terms have yet to be detailed. This deal applies to about 20 million tonnes of iron ore and will allow China to save $35 million according to a Reuters’ calculation which makes it an expensive deal but allows for CISA to save face with a deal that is slightly better than what is offered to mills in South Korea and Japan. MasterCard’s slogan :”There are some things money can’t buy ..” seems to have lost its meaning all of a sudden. Of course China could be attempting to breed a rival to the top iron ore suppliers but the extent to which those may be influenced by this deal is still unclear. According to Macquarie this deal will prevent Fortescue from taking advantage of higher spot prices. Also as a result of this deal, Fortescue will be loaded with debt issued by its only trading partner may become problematic in the longer term.

In sum, this deal is far from being as rosy as China and Fortescue would like to hail it. The deal also comes across as second best to the failed Rio Tinto- Chinalco deal in which Chinalco would have secured stakes in Rio Tinto iron ore assets.