Chinese Iron Ore: Continuing to Climb

Despite some recent news concerning the pressures of slowing Chinese economic growth and weak conditions in the domestic steel industry, China's iron ore imports are still projected to grow firmly by 8% to reach 779mt this year. While this is slightly slower growth than in 2012, prospects for higher seaborne iron ore demand remain fairly positive.
Blasting Upwards:
As shown on the Graph of the Month, Chinese steel production has been ramped up significantly in 1H 2013. In early May, output peaked at a rate of 800mtpa, up 15% compared to the end of 2012. This increase has been despite the recent weakness in domestic steel prices which has resulted in continued pressure on the margins of steel mills. In Q1 2013, the total profit of large and medium mills was reportedly 90% below average quarterly profit in 2010, with a third of these mills posting losses.
Passed the Peak
Since many Chinese mills have state support, they have been able to continue to produce at high volumes despite the financial difficulties, while concerns of losing market share may also have played a part. But the continued overproduction of steel relative to demand has led steel prices to soften further in the year to date, and steel stocks to build up. At their peak in mid-March 2013, stocks of five steel products at major Chinese cities were up 22% y-o-y.
These factors have led sentiment at steel mills to weaken, and in recent weeks many have indicated intentions to cut production and raw material purchases. Indeed, by early June, China’s steel output had already slowed to around 780mtpa.
Time for Another Take-Off?
A significant cut in output clearly poses a large risk to China’s iron ore imports. But mills do not always cut output as much as planned. Last summer it seemed apparent that mills were about to sizeably reduce output, but production fell only 8% by Q4, much slower than expected.
Yet even if output falls notably this year, other factors could support Chinese iron ore imports, which have grown 4% in the year to date. Iron ore prices have fallen so far this year as mills have reduced iron ore stocks to the lowest level since late 2009. Prices may come under more pressure from increasing Australian supply, as mining projects come online in 2H 2013. Australian iron ore accounts for some 48% of China's seaborne imports, and due to its good quality is preferred by mills to domestic ore, which may be increasingly priced out of the market. Low iron ore stocks, low prices and higher Australian supply could thus support imports in the coming months.
While any cut in steel output is a downside risk, several factors are still supporting the projection for firm growth in China's iron ore imports this year, especially the potential for iron ore restocking. In prior years, restocking has lifted the Capesize market, and if Australian output rises as expected, conditions may be in place for this to occur again this year.

Source: Clarksons