China risks to test its power in iron ore markets

BHP, the world’s third-largest iron ore miner behind Rio Tinto (RIO.AX) and Brazil’s Vale (VALE3.SA), is so far sanguine about the prospect of a unified Chinese purchasing system.

Chief Financial Officer David Lamont said on July 20 the Australian miner remained confident the market would set the price and the aim was to maintain good ties with Chinese customers.

Asked if the plan to set up a central iron ore buying enterprise was likely to succeed, Lamont said, “History would say no.”

Lamont is probably correct in saying that the market will ultimately set the price, irrespective of what Chinese buyers may want to pay and what BHP, Rio, Vale and smaller rivals want to sell at.

The risk is that a centralised buying system brings in inefficiencies and bureaucracy, resulting in a less efficient market as Chinese steel mills battle to get the iron ore they need and at the right time.

It also raises the risk of a more combative relationship between the miners and the Chinese steel mills, with both seeking better deals than the other is prepared to offer.

Much will depend on how both parties approach any change in how China purchases iron ore, but it’s likely that the big three miners will seek to maintain a price linked to the spot market.

If China effectively withdraws from the spot market, that may complicate the issue as the reference price will be more based on what Japanese and South Korean steel mills are paying.

In short, there is a potential for market disruption from any new centralised Chinese purchasing system.

But even if China does set up an effective, and efficient, centralised buying system, it’s unlikely to shift market dynamics much.

The iron ore market is extremely concentrated, dominated by a handful of big miners in two countries, top exporter Australia and number two Brazil.

To put China’s dependence on those two suppliers in perspective, seaborne iron ore imports in July are estimated at 99.61 million tonnes by commodity consultants Kpler.

Of this, Australia is set to supply 66.92 million tonnes for a market share of 67%, while Brazil’s share will be 20.08 million, or 20.1%.