‘Pilbara killer’: What China’s new Iron Ore mine in Guinea really means for Australia
There are grave fears for Australia’s future as China finally opens their controversial Simandou Iron Ore mine in a shocking $30 billion move.
ANALYSIS
Simandou.
Remember the name, for it will bring you pain.
Christened the ‘Pilbara killer’ by my good self several years ago, Simandou is the latest and greatest front opened in the great iron ore war between Australia and China.
This week, Guinea’s $30bn iron ore mine shipped its first cargo and over the next 30 months will ramp up to 120mt per year.
On the surface, this does not seem to be a huge problem at roughly 5% of global supply volumes.
But look underneath, and it is a very big deal indeed for five reasons.
The history
To understand the magnitude of this change, we need to go back in time. Before and after the Global Financial Crisis, great changes transpired within the iron ore market.
RIO and BHP tried to merge to gouge China.
China responded by pushing Chinalco, a state-owned enterprise, to buy a blocking stake in RIO.
BHP reacted by breaking the contract system that negotiated annual price contracts, and since then, a lot more iron ore has been sold on the spot market. This birthed a derivatives market and drove prices sky high.
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Ultimately, China settled into a longer-term strategy of increasing supply to lower prices, and, using part-owned RIO, the Simandou mine is its most outstanding success.
That’s point one: for the first time, China will now have a majority-owned source of captured iron ore that it can wave at the major mining oligopoly to break prices down.
Over the next two years, roughly 170mt of new iron ore will hit the global market from Brazil, Australia and Africa.
Demand weakness
Arguably, the larger problem is the timing of the new supply rush.
Chinese steel demand is dropping 2-3% per annum like clockwork, and this process has years yet to run.
Every time it does, another 50mt in iron ore demand disappears, and there is little demand growth elsewhere to offset it.
This means the swing towards surplus seaborne iron ore over the next two years approaches a formidable 300mt. This glut is similar in scale to the great surplus of 2015, which drove prices down to $37.
Only worse, because China no longer succumbs to flood stimulus to rescue steel demand.
Green gazump
The third reason why Simanou represents a structural shift in the iron ore market is that it is very high-quality iron ore.
Contrary to popular thought, China has not been greening its steel output.
On the contrary, it has been dirtying it by shutting down zero-carbon electric arc furnaces and running filthy blast furnaces flat out.
This has supported iron ore-fed pig iron production even as steel output has fallen.
China is running levels of steel recycling last seen twenty years ago.
The failure of green steel is a multi-faceted problem. One of its key features is that the iron ore oligopoly has so successfully kept prices elevated that steel mills have used cheaper, poorer quality iron ore.
By definition, this lifts the tonnages needed to make the steel (given their lower iron content), so iron ore import volumes have stayed very high.
But Simandou’s 65% iron ore is pure enough to produce direct injection iron ore that can be tipped into blast furnaces without using as much, or any, coking coal, so it is much cleaner.
And it means that larger volumes of lower-quality ore are no longer needed.
Conclusion
Three tempests are converging upon the iron ore market in a perfect storm.
Most analysts use a trend line to predict that the iron ore prices will fall steadily towards $80 over the next two years to push out marginal cost suppliers.
Markets rarely work this way. Rather, when market imbalances hit critical mass, commodity prices spike to incentivise big new mines, then collapse when they come onstream.
The old saying that if you don’t like low (or high) prices for a commodity, then just wait a minute is pertinent again.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geopolitics and economics portal. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review
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