BHP Billiton and Rio Tinto Not Worried About Chinese Contracts

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There is an air of mystery surrounding China, particularly when it comes to demand for iron ore. 

Recent reports suggest that China has defaulted on a number of iron ore contracts, but the reasons behind China’s reluctant behaviour are not entirely clear. Some analysts feel that China may have a growing stockpile of steel, while others attribute the defaults to a sharp drop in their need for steel, and other yet suggest that China is simply trying to re-purchase contracts at a lower price.

Whatever the motivation, the downward pressure on prices in the last few weeks has been marked. 

Over the last few years the Chinese government took several measures to cool a dangerously red-hot housing market; by putting tight restrictions on property ownership and on property development the government in China was able to control the risk of an asset bubble. This seizure resulted in a flood of Chinese property investors snapping up assets in areas like Vancouver, sending property values soaring, thereby skewing national prices. 

The other effect of these property restrictions were extended to property developers, to cool supply of stock coming on to the market. Simply put, less construction requires fewer materials – namely, steel and iron ore. 

Given some of the other economic activity in the last week, there is heavy evidence to suggest that this industrial global super power is experiencing a deeper slowdown than most had anticipated. The Chinese government, in an apparent move towards economic stimulus, made a surprise interest rate cut last week. This is the first rate cut for China since 2008. This rate cut had the immediate effect of giving commodity prices a boost, which analysts largely feel will be short-lived. 

It’s not just the analysts and economists that are trying to piece together this puzzle. As China is the biggest global consumer of steel, iron ore producers are taking notice. 

There are indications that China, despite this slowdown, will continue to fuel demand.  At the end of May 2012, China approved $23 million in steel projects. Major players like Rio Tinto and BHP are hoping to get a piece of this shrinking pie. Iron ore is responsible for generating a sizeable chunk of revenue for both of these companies. 

At the recent Bank of America Merill Lynch 2012 Metals, Mining and Steel Conference, BHP Billiton said in their presentation that China still holds just under 60% of the global demand for iron ore. Additionally, long term drivers for steel demand include the influence of demographics, including increasing urbanization, a trend which they expect to continue in China. The need for steel increases in centres where populations are denser, so it makes sense that China’s demand for iron ore will continue to grow. That said, BHP also believes that “Steel intensity is expected to peak first as the construction cycle matures.” 

BHP acknowledges that there is still a tremendous opportunity for iron ore, both for them and for their competitors.

This article was originally published on EPCM World and is re-published here with permission.