FOCUS: Iron ore grade differentials may narrow, but not drastically

While the winter season begins in China, the ferrous market is wondering whether Chinese steelmakers will continue to move toward higher-grade, lower-impurity iron ore - an affinity they have demonstrated over the last two years.

This affinity is the result of the Chinese government’s policy shift that put more focus on protecting the environment as well as its supply-side reforms for the steel industry, which made iron ore of higher grade and containing lower impurities the preferred raw material for blast furnaces while steel mills seek to increase their productivity and lower their emissions.

This preference is well demonstrated by the gap between the daily MB 65% Fe Iron Ore Index and the MB 62% Fe Iron Ore Index, both published by Fastmarkets MB.

Since this gap exceeded $10 per tonne in October 2016, it has not returned below that level.

Environmental protection measures implemented over the last two years have been in the form of curbs on blast furnace operations, iron ore sintering and iron ore pelletizing – activities that produce harmful emissions.

While such restrictions are in place throughout the year, they were particularly strict during the winter months last year due to air quality typically worsening during the colder months.

This year, many market participants expect steelmaking production cuts to not be as strict as last year’s on the belief that the Chinese government is keen to avoid an overarching policy.

While milder steelmaking restrictions are expected to continue to underpin demand for raw materials such as iron ore, a segment of the market thinks the looser restrictions on steel output could erode end users’ tolerance toward iron ore costs.

What’s different?
China is taking a more case-by-case approach with its measures to protect the environment this winter, market participants have said.

This is underlined by the classification of steel mills in the country’s steel production hub of Tangshan into four grades based on their emissions. Production cuts are based on which grade a mill falls under.

Mills in the top grade, among which is one major steelmaker, are exempt from any restrictions.

Such measures are more refined than the government’s approach last winter when more broad-stroke restrictions were implemented.

Li Ganjie, China’s minister of ecology and environment, said late last month that his ministry would overrule measures instituted by local authorities to cut emissions that were considered too crude, such as a blanket ban on industrial production.

He said that local authorities responsible for implementing environmental protection measures needed to ensure that businesses were allowed to operate in a fair environment.

In Tangshan, blast furnace production will be lowered by 18.59 million tonnes between October 1 and March 31, according to a government notice reported by local information providers last week.

These targets are actually “much smaller than expected” on a monthly basis, since they are spread over six months instead of four previously, according to sources.

The other change this year is the region affected by the cutbacks, which is now bigger.

While most of the steel production restrictions were targeted at the Beijing-Tianjin-Hebei region and its surrounding areas last year, this has now been widened to include the Fenwei Plain in north China and parts of east China.

But market participants caution that a wider region may not necessarily translate into a bigger overall cut in production. This is because the newly added areas are not as steel-intensive as Beijing-Tianjin-Hebei.

Beijing, Tianjin and the four provinces surrounding them collectively make up the heart of China’s steelmaking capacity. They accounted for 44% (or 270.53 million tonnes) of the 617.4 million tonnes of crude steel produced in China in the first eight months of this year, according to data from the country’s National Bureau of Statistics.

An official scheme released recently to tackle air pollution in the Fenwei Plain from October to March requires a 4% year-on-year decrease in pollutants. This compares with the 6% required in an earlier draft.

In east China’s Jiangsu province, a few mills were asked to trim blast furnace production in November, likely due to the China International Import Expo held in Shanghai over November 5-10.

The province’s major steelmakers Shagang and Yonggang are required to suspend the operation of several small and medium-sized blast furnaces over selected periods this month, but these measures are less severe than previously expected, sources said.

Productivity drive
Steel production cuts last year, combined with robust downstream demand, resulted in strong mills’ margins, which have been at the heart of demand for high-grade and lower impurity ore.

Fastmarkets MB Research senior analyst Marina Maliushkina expects steel prices in China to weaken in the last quarter of this year, “keeping steel producers’ margins below the average level we have seen in 2018 so far.”

“Long steel products benefitted from a very strong performance in the residential construction sector, with rebar prices outperforming hot-rolled coil, but we are now approaching a period of seasonally weak demand from the construction industry in China,” she said.

According to Fastmarkets MB’s assessments, the domestic rebar prices in China had been trending upward since August, moving in an opposite trajectory to HRC prices.

East China’s rebar prices rose from 4,300-4,350 yuan ($618-625) per tonne on August 13 to 4,670-4,700 yuan per tonne on October 31, while HRC prices fell from 4,320-4,340 yuan per tonne on August 13 to 4,080-4,100 yuan per tonne on October 31.

But in November both prices dropped. Rebar prices fell to 4,480-4,520 yuan per tonne on November 9 while those for HRC tumbled on to 3,900-3,930 yuan per tonne.

“The downside risks to [iron ore] prices are looming with shrinking operating margins for steel mills, an anticipated slowdown in crude steel output and dampened construction activity over the winter months,” Fastmarkets MB Research senior analyst Miriam Falk added.

Expecting narrower margins amid less stringent restrictions, some mills are already paying more attention to cost-effectiveness when choosing iron ore products.

Sales of high-priced Brazilian iron ore fines, which had been quite popular earlier this year, have slowed down while cheaper Australian materials such as Jimblebar fines and Super Special fines are finding favor again among buyers.

Cost concerns over iron ore can be explained by the spread between the MB 65% Fe Iron Ore Index and the MB 62% Fe Iron Ore Index, which narrowed to $20-22 per tonne since late October, after staying around $26-29 per tonne in the July-September period.

At ports in Tangshan in northern China, the transaction price for Super Special fines rose by over 16% in a month to 363 yuan per wet metric tonne on November 9, or about $44.85 per tonne cfr China in the seaborne market – outperforming the benchmark Pilbara Blend fines’ 12% increase to 595 yuan per wmt.

The movement in Fastmarkets MB’s weekly iron ore pellet index demonstrates end users’ sensitivity toward high-priced ore.

“As we anticipated, the soaring premium for iron ore pellets has reached a turning point while Chinese buyers have developed some resistance to the surging prices,” Falk said.

Macro-economic concerns
The Chinese Communist Party’s politburo – a 25-member policymaking body headed by President Xi Jinping – last month said that there was “growing downward pressure” on the economy with “profound changes” in the external environment, state-run news agency Xinhua reported.

China’s macro-economic data also highlights the pressure on its economy, with the country’s gross domestic product (GDP) growing 6.5% in the third quarter of this year, the slowest since 2009.

“It was specifically the construction sector that helped China reach its GDP growth target, as the recent third-quarter results showed, but the question is how long this growth can be maintained,” Falk added.

Pressure on the Chinese macro-economy and the country’s trade war with the United States have adversely weighed on the Chinese yuan in recent months, a factor that some participants have cited to explain the pressure on seaborne ore prices.

The macro-economic situation, however, may find support now that the politburo has made it clear that infrastructure spending to stimulate domestic economic activity is a priority.

Will demand for high-grade ore persist?
Even though market participants unanimously expect steel mills’ margins to come under pressure during the winter months, they also believe demand for high-grade iron ore will continue to find support.

The MB 65% Fe Iron Ore Index has steadily risen since August this year when it averaged $94.65 per tonne cfr China.

In October, the index averaged $97.33 per tonne cfr, and this month, it is averaging just under $97 per tonne cfr so far.

“The spread between the 65% Fe index and the benchmark 62% Fe index is narrowing but it could find support at around $20 per tonne,” a Chinese trader said.

The spread between Fastmarkets MB’s indices for these two grades has stayed above $20 per tonne since May 31.

“Even at the ports, though sales for higher-grade ore have been much slower than we had expected, prices are not performing badly,” a Chinese trader told Fastmarkets MB.

The MB 62% Fe Low-Alumina Iron Ore Index, which was launched on August 27, averaged $77.33 per tonne cfr China last month, up from $74.24 per tonne cfr in the preceding month. It has risen to an average of $78.75 per tonne cfr so far this month.

The recent strength in the domestic metallurgical coke market in China amid coking restrictions and robust coking coal prices also make a strong case for high-grade iron ore demand to remain underpinned in the winter months.

The longer-term outlook on Chinese acceptance of higher-grade ore also looks positive.

Supply-side reforms implemented in China’s steel industry have brought Chinese mills’ capacity utilization to 70-80%, and while market participants expect margins to retreat in the winter months, they are unlikely to drop to levels before these reforms, when mills were barely breaking even.

Several global miners have described China’s environmental focus as a structural change and responded to it by investing in the production of higher-quality ore.

Upcoming iron ore projects are also focused on meeting demand for higher-grade ore from the world’s top steel producer and iron ore importer.

Chinese steel production may be approaching its peak but it is unlikely to show any significant drop, at least in the short term, many market participants said.

In the first seven months of this year, China’s steel production reached 533 million tonnes, up 6.3% year on year, with the country’s steel production in a “stable peaking stage” with little volatility, Liu Zhenjiang, secretary general of the China Iron & Steel Association, said in September this year.

“This ‘peak stage’ will not pass quickly because steel demand from China will remain supported. The stability in steel demand will also result in fewer ups and downs in demand for iron ore,” he added.