Iron Ore Price Hike to Swallow Chinese Steel Producers' Profit

China imports about 250 million tons of iron ore from Brazil, Australia, South Africa, and Canada -- prices are set in long-term contracts. With the 65% price hike that is about to come into place, iron ore prices will increase by $33 to $34 per ton, and the total production cost of China’s steel industry will increase by at least $8.4 billion annually (60 billion Yuan). Presently, total annual profit of large and medium-sized Chinese steel companies with long-term supply contract hovers around 140 billion Yuan.

Apart from the iron ore price hike, the coking coal price rise will also lift the production cost of domestic steel producers.

The price of coking coal produced in Shanxi recently increased by another 300 Yuan per ton, and the price of coking coal has already risen by as much as 600 Yuan per ton in the last 6 months. This month’s price hike is the highest monthly increase in history, pushing up prices to a level 127% higher than what they were at beginning of this year. The coking coal price increase is even more dramatic than the ones that have been affecting domestic iron ore, imported spot iron ore, and steel scrap, which stand at 53.4%, 50.4%, and 38.1%, respectively. With steel companies facing increasingly high production cost, profits are expected to slide in the near future.

Apart from the iron ore price hike, the price of coal and coking coal, as well as transportation costs are also increasing. In December of 2007, the average production cost of steel and pig iron in large and medium-sized steel companies increased by 31.05% over the same period in 2006.

Report from the Chinese Iron & Steel Association shows cost pressure varies from one plant to the other according to the source of the iron ore they use. Steel and pig iron production costs increased by about 12% for plants in which domestic iron ores accounted for over 50% of the total iron ore supply; this is also true for companies implementing long-term supply contracts or long-term freight contracts. Production costs increased by about 26% for plants in which domestic iron ore accounted for about 30% of the total supply, or those implementing long-term supply contracts and long-term freight contracts for about 50% of the imported iron ore. Finally, price increased by abut 55% for producers using a high percentage of imported iron ore, or those relying mainly on spot trade and short-term transport agreements.  

The price hike, agreed upon after long negotiations, may help to further exacerbate the gap in profits between large and small steel companies. As of now, smaller steel companies have been breaking even, while big companies are still enjoying high profits, the drastic price increase will likely lead to the elimination of ineffective production capacity, as well as the merger and reshuffling of several players in the steel industry.

The production cost increase of steel companies, a large part of it a result of the rise in iron ore and coking coal prices, will have a profound influence on the shipbuilding industry, the construction machinery industry, and the household appliances industry.