It must be a source of increasing frustration for China’s bureaucrats that its own economic successes are overwhelming their efforts to sanction Australia for our less than diplomatic commentary on the origins of the pandemic and China’s treatment of the Uighurs in the Xinjiang region.
While the sanctions on barley, wine, lobsters, coal and other products have bitten, they have been far more than offset by China’s insatiable demand for iron ore and LNG and the spiking prices – in iron ore’s case, soaring prices – of both.
If this is a trade war, Australia is winning its first phase quite handsomely.
The iron ore price is above $US200 a tonne and LNG prices have rebounded from the pandemic to levels last seen two years ago.
In coal, the Australian producers have responded to China’s bans by shifting their exports elsewhere, particularly to India. While the producers might not be getting the same prices as before, China is being forced to buy lower quality coal at higher prices while its competitors benefit from the windfall of high quality Australian coal at lower prices.
It’s not that China hasn’t tried to do something about its reliance on Australian iron ore and LNG.
Last month it announced a series of changes to tariffs on raw materials used in its steel industry to encourage imports of pig iron and scrap steel, along with moves to reduce domestic steel production and encourage domestic iron ore production.
In the context of record steel production – and a function of China’s success in recovering quickly from the worst of the pandemic last year and the strengthening economic recovery emerging in other major economies – the measures are likely to have only modest effects.
In the longer term scrap metal might have a more material role in China’s steel industry – China wants to double production from its electric arc furnaces over the next four or five years – but its ambitions will have only modest impacts on its demand for iron ore and iron ore prices in the medium term.
Along with a crackdown on iron ore futures trading last week – the authorities vowed to punish market manipulation – the actions helped slightly lower the iron ore price, from more than $US230 a tonne to around $US210 a tonne. Iron ore started this year priced at less than $US160 a tonne, having traded down to around $US60 a tonne just over a year ago.
The US is watching Australia's back over growing tensions with China
China’s reliance on Australian iron ore for almost two-thirds of its steel industry’s requirements and Vale’s continuing struggles to restore production after its tailing dam disasters and pandemic-related disruptions in Brazil means there is little it can do to curtail purchases of Australian iron ore without hurting its steel industry and economy.
Even if it can develop new sources of supply, with the giant Simandou resource in Guinea the most obvious, they would be higher-cost (development of the infrastructure for Simandou could cost the best part of $US20 billion), are nearly a decade away and would in any event probably represent only about 10 per cent of China’s existing demand.
The big Australian producers – Rio Tinto, BHP and Fortescue – are the low-cost producers and have a significant cost advantage over Brazil because of their proximity to China and therefore their lower shipping costs.
Recognition of that freight advantage and the move to index-related – market, rather than contract -- pricing of iron ore in the last decade transformed the market for iron ore, undermining the leverage buyers had when determining the volumes and prices of contracts in the past.
LNG has different issues. Australia is almost neck and neck with Qatar as the world’s leading producer as China looks to LNG to reduce its usage of coal for energy production.
Despite the damage it has done to some export categories with its tariffs and other sanctions, China hasn’t been able to hurt the Australian producers of the two big commodities that really matter.
China could buy more LNG from Qatar and the US (it has a commitment under the Trump era trade truce to buy more LNG from the US, is in talks with Qatar about taking equity in the world’s biggest new project and has been expanding its relationship with Turkmenistan) but LNG is an internationally-traded commodity and demand within the Asia Pacific is strong enough for Australian cargoes to be redeployed elsewhere, as has happened in coal.
A subsidiary complicating factor is that China’s state-owned energy companies have big, multi-billion-dollar equity stakes and long term contracts with the major Australian LNG exporters, so damaging the Australian industry would damage China’s own SOEs.
Two of the three big export projects on Curtis Island in Queensland, for instance, have Chinese SOEs as foundation shareholders and customers.
Sinopec has a 25 per cent interest and was the foundation customer in the Origin Energy-led GLNG consortium while CNOOC has a 50 per cent interest in the first train of Shell’s QGC project. PetroChina is a partner with Shell in the Arrow Energy joint venture. Woodside has long term contracts with Chinese companies.
China has been trying to withdraw the pandemic-related stimulus it injected into its economy last year as part of a wider effort to deleverage and decarbonise and improve the productivity of its industrial base.
That includes efforts to limit steel production. It has targeted a reduction in steel output from the record 1.2 billion tonnes it produced last year and has threatened mills that don’t conform to its directives.
That hasn’t, however, stopped production from setting monthly records this year, probably because the mills are experiencing strong margins.
There’s also a suspicion that China is building up its stocks of vital commodities amid rising geopolitical tensions which, if true, might mean the spikes in commodity prices have a transitory element to them.
It is not in the long term interests of either Australia or China for the diplomatic and trade relationships to continue to deteriorate but in the meantime, despite the damage it has done to some export categories with its tariffs and other sanctions, China hasn’t been able to hurt the Australian producers of the two big commodities that really matter.
Indeed, apart from its purchases of near-record levels of Australian iron ore and LNG at, in iron ore’s case, near-record prices, its actions have prompted Australian companies -- from wine makers to coal miners to LNG exporters – to seek out new markets and reduce their dependence on China which, given the recent relationship, is probably a positive for Australia’s long term national interests.