Demand for met coal imports in China sensitive to iron ore procurement strategies

The increasing consumption of scrap and a potential shift toward the electric-arc furnace (EAF) steelmaking route from the basic oxygen furnace (BOF) route in China are medium- to long-term threats to demand for steelmaking raw materials, while in the near team coking coal import volumes will continue to be affected by iron ore procurement strategies.

This was the basis of Fastmarkets research team’s presentation on the metallurgical coal market in Asia at the 25th Coaltrans Asia conference in late June. It focused on interconnections between coking coal, iron ore and ferrous scrap markets.

Despite scrap-based steelmaking being viewed as environmentally friendly, there are a number of limitations and challenges to it. Firstly, profitability is not to be discarded when considering the shift to EAFs from an environmental point of view. On the global scale, an average BOF mill had crude steel production costs exceeding those at an average EAF mill in the fourth quarter of 2018 for the first time since at least 2010, and the gap widened in the first quarter, according to our Steel Cost Service. This is an important sign that the shift toward EAF-based steelmaking is starting to make sense from the cost point of view.

However, the situation in China is the opposite. Scrap prices in China fell below hot metal costs only when iron ore prices jumped above $100 after being more expensive than the latter for a year and a half, which suggests the turn may not be sustainable.

Other challenges to the BOF-to-EAF switch include build-up of residuals in scrap over time that makes it less preferable for certain applications, as well as the fact that many BOFs in China are fairly new that makes justifying investment into new EAFs more difficult. Electricity availability and costs are also to be considered. And while China remains BOF-dominant, there is a technical limit of scrap intake by a BOF.

In the near team, and as we have observed over the past few years, demand for coking coal (and especially so demand for imported material) correlates with iron ore procurement strategies. Those, in turn, are a function of operating margins at steel mills, demand for finished steel products and capacity utilization rates at BFs.

The share of coking coal imports increased with higher demand in China in this year-to-date and a corresponding period of 2017. The share dropped in the same period of 2018 when total demand was broadly flat year on year. These changes are related to iron ore buying strategies. Fluctuations in coking coal imports are more dramatic compared with demand and iron output because China relies on imports for first-tier coals (see chart). A drop in coal imports last year, despite strong iron production, was accompanied by elevated margins and higher usage of 65% Fe ores, which require less fuel compared with 62% fines.

Availability of scrap in China is expected to increase. Should this put pressure on scrap prices and make the secondary raw material more attractive compared with hot metal, this would be an additional incentive to increase scrap use at integrated mills, as well as consider switching to an EAF-based route if the trend persists. In the near term, the tight-margin environment at steel mills puts pressure on steelmaking raw materials prices, but for met coal it is cushioned by the fact that mills are encouraged to use lower-grade iron ores, which require more fuel to remove impurities, supporting demand for import met coal.