Officials from the China Iron and Steel Association are projecting that the country's crude steel production will fall by 1 percent in 2015 — the first year of negative growth in decades — after growing a paltry 0.9 percent in 2014. By comparison, China's steel production growth in 2013 was 7.5 percent. The lower production is largely a result of sustained declines in housing-related construction.
China's importance to the global steel and iron ore market cannot be overstated. China produced and consumed about half of the world's crude steel in 2014. To sate its appetite, China is prioritizing the procurement of steel and iron ore abroad in lieu of inefficient production at home. Any of Beijing's steel-related policy measures cause significant ripple effects across the world. Moreover, China's steel demand has yet to peak, though the housing sector slowdown in 2015 could bring about the first dip in an overall trend of increasing demand.
Steel and iron ore were critical components of China's infrastructure-fueled construction boom in the 2000s. As China begins rebalancing economically, demand for steel is dropping rather quickly. The Chinese housing sector accounts for about 25 percent of China's steel demand, and the construction sector makes up another 25 percent. With the real estate and construction sectors slowing in 2014 and early 2015, iron ore prices fell precipitously from $135 per metric ton in December 2013 to about $60 per metric ton currently. Moreover, as Stratfor has noted, 2015 will be a difficult year in the Chinese housing sector. The steel and iron ore markets will not find relief from the price pressure they have been under in the Chinese economy, or any other economy.
China is trying to contend with market conditions with two broad, long-term policy shifts. First, Beijing is focusing on consolidating the steel and iron ore sectors in order to rein in production overcapacity and excessive iron ore demand. Second, Beijing is encouraging China's steel and iron ore producers to move abroad. China's State Council released a policy document in January pushing for the steel, shipbuilding, metals and other industrial sectors to move abroad and partner with foreign companies.
There are about 5,000 steel mills in China, most of which have a small annual capacity. The smaller ones often use outdated technology that contributes to higher operating costs, pollution and tremendous inefficiency. Beijing is using policy decisions — such as not bailing out unprofitable companies and adopting strict environmental standards — to run these smaller firms out of business. The cost of this tactic is increasing unemployment; approximately 3 million Chinese citizens work in the steel sector.
China's iron ore sector faces many of the same problems. Compared to the world's other major iron ore producers — Russia, South Africa, Australia and Brazil — China supplies high-cost, low-quality ore. Some deposits have more impurities and less iron content than normal and require expensive processing for use in a steel mill. The cheaper and less mined deposits are in inland China, while most of the iron deposits near the steel mills are old and costly. As in the steel sector, many of China's mines are small, and Beijing wants to consolidate the sector and move to larger integrated mines to drive down operating costs.
But unlike its coal industry, for example, China knows it has no chance of freeing its iron ore sector from global markets. China's demand is too high, and approximately two-thirds of the world's reserves are located in just four countries: Russia, Australia, South Africa and Brazil. Instead, China needs to reduce the pricing dominance of the "Big Four" iron ore companies: Vale, Rio Tinto, BHP Billiton and Fortescue Metals Group. To this end, China flooded the market with Chinese iron ore when prices were high and began encouraging Chinese steel and iron ore producers to move abroad to take advantage of cheaper production costs.
With prices low and demand falling, China is in an interesting position. The Big Four have secured the world's lowest operating costs in countries such as Australia and Brazil, and they are expanding production to drive out competition. Meanwhile, a yearlong decline in iron ore prices has created difficulties for Chinese companies investing in higher-cost production areas abroad, such as Guinea, Chile, Liberia and Gabon.
However, the problems in China's steel and iron ore sectors are both a blessing and a curse for Beijing. Even though China is more reliant on foreign iron ore markets than before, the low iron ore and steel prices provide much-needed relief for the country's troubled construction and real estate sectors. The situation also is a good example of China shifting its policy — rooted in the era of Mao Zedong — away from its concern about dependence on external sources of raw commodities and industrial goods. Now China realizes it has outgrown its production potential in many sectors and must use its crucial role in global markets to manipulate those markets to support the Chinese economy as it undergoes a significant structural change.
