***SPOTLIGHT: Eastern Promise

Last week’s Far East Steel and China Iron Ore conference in Beijing provided some welcome relief from the woes of the west.

MB’s Far East Steel and China Iron Ore conference in Beijing provided some welcome relief from the woes of the west.

Held by MB for the seventh year, it would be an exaggeration to say the conference was marked by the same levels of optimism, projections of massive growth and bullish prices as in previous years.

But there was certainly an atmosphere suggesting, at least somewhere in the world, there is the potential for demand, and prices, to rise in the coming year.

A great deal depends on China.

News that China’s iron ore imports rose progressively in the first quarter, reaching record highs in March as steel mills and traders sought to take advantage of low prices, indicates steel production in the country is set to rise, if it has not begun to do so already.

And ship brokers report that, while freight rates are still at low levels, tonnages remain high.

This information could provide iron ore producers with a wild card at this year’s annual benchmark negotiations – already postponed as miners keep their fingers crossed for an increase in demand later in the year, helping them to avoid agreeing a large discount.

The fact that many shipments are already being made at discounts of at least 20% (some say 40%) on last year’s prices, however, should put the ball firmly back in the steelmakers’ court.

And the trend away from imports of Australian ore – evidenced by a 1.7% decline in March as overall Chinese imports rose – shows that many importers are savvy-enough players to operate extremely efficiently in the spot market.

The market has changed significantly since last year – not least because demand for steel, and therefore iron ore, has collapsed.

Vale’s approach to Chinese steelmakers last year, asking for an increase on annual settlements agreed earlier in 2008, was not only ill-timed, but has also undermined the benchmark pricing mechanism.

China’s steel industry knows there is much political capital to be made from this unfortunate episode, and many are calling for the benchmark pricing system to be dismantled.

How Cisa and its members intend to use this capital is as yet unclear – they may well be happy to secure a discount rather than to abolish the benchmarking system altogether.

But what of the alternatives?

As this year’s annual price remains un-decided there has already been a shift to the spot market, as steelmakers seek to tailor their purchasing more closely with demand.

Early pioneers in the over-the-counter iron ore swaps market are quick to remind these players that, by using these price risk management tools settled by an index based on spot market transactions, they are able to fix a price for the year ahead, if not longer, and still secure the most competitive price for delivery.

Of the three miners dominant in the seabourne iron ore market, Vale, certainly, has undermined its commitment to the benchmark system. But all surely recognise that if China’s steelmakers insist on change it will have to at least meet them halfway.

Some things will definitely change this year.

In recent years of growth, China’s prudency has left it well armed. Beijing is one of the few governments with sufficient depth of pocket to enable it to spend its way out of the present downturn.

Beijing’s target of 8% gdp growth is ambitious, but with its 4 trillion yuan stimulus package, it is certainly not impossible.

There is still enormous potential for development in China, a country where the shining monoliths of the new Shanghai skyline stand right next to the five-storey apartment blocks of Shanghai’s previous existence.

A large portion of this package will be channelled into infrastructure development and other steel-intensive projects, so the country’s steelmaker will doubtless benefit.

They won’t be the only ones.

Many predict China will become a net importer of steel in 2010, and perhaps beyond. With many export-focussed steel mills around the world now without a market, they will welcome the chance to ship their wares to China’s hungry construction sites and factories.

But, in the longer-term, there are problems for China.

Despite sustained investment, the country’s steel industry is still fragmented. MB’s Top Steelmakers list is dominated by Chinese companies, but only a few have been party to consolidation in recent years.

Without more integration between firms to create steelmakers the size of Hebei Steel and Baosteel, China’s mills will remain intensely competitive and, ultimately, unprofitable.

Equally important, the industry is also deficient in value-added steel production.

A short-term infrastructure spend will support the steel industry for the next few years, possibly the next decade. But beyond that, these mills will need to find a way to cater to different markets and the new wealth that evolves in China.

China’s auto industry, after all, was one of the few to report growth in light vehicle sales last year. It was minimal, but in a country where poverty is still rife, impressive.

Beijing can probably afford to spend its way to 8% gdp growth in 2009. What it will do in 2010 and beyond is less certain.