Beijing’s creation of a new state-owned company to centralize Chinese purchases of iron ore and other metal resources is unlikely to have much impact amid tight markets and high prices, but it could become a weapon against Australia in the event of an iron ore glut.

The China Iron and Steel Association (CISA), which is the government-sanctioned body representing China’s major steel companies, has long opposed what it sees as a cartel of iron ore producers. iron and lobbied for a central purchasing body to counter it.

The four main suppliers of iron ore transported by sea – Rio Tinto, BHP, Fortescue Metals and Vale in Brazil – account for around 70% of world trade and around 80% of Chinese imports.

The English-language Chinese nationalist daily, the world timessaid the goal was “to create a centrally-administered state giant to have a greater say in ore pricing by leveraging China’s strength as the world’s largest consumer of ore of iron”.

The new China Mineral Resources Group, launched last month, has received significant start-up capital of 20 billion yen ($4.2 billion) and has a top management team. Its chairman is Yao Lin, outgoing chairman of the Aluminum Corporation of China, or Chinalco, and its operations are run by Guo Bin, former vice president of the world’s largest steelmaker, China Baowu Steel.

BHP has replied with skepticism to the new venture. Chief Financial Officer David Lamont noted that China’s previous efforts to negotiate iron ore prices with one voice had not been successful.

“Let me say up front that ultimately we believe markets will determine where price should be based on supply and demand,” he said at a forum. business in Melbourne.

“So we’re not worried about that. It’s something we’ve been talking about for some time.

When asked directly if he thought the new venture would succeed, he replied, “History would say no.”

It is a reference to CISA’s efforts in 2009 to mount a boycott of the three biggest miners – BHP, Rio Tinto and Vale – as it sought to impose an 82% reduction in the price of iron ore. The boycott was eventually broken, first by the smaller mills seeking to secure their supplies, then by the majors.

The CISA boss was ousted and BHP successfully persuaded China’s steel industry to accept long-term contracts based on the spot price index, rather than negotiated in annual bilateral negotiations.

China has a large steel industry with around 250 large steel mills and thousands of smaller ones. CISA and successive governments have sought to consolidate the industry, but with limited success. Some large mergers have increased the production share of the top 10 steel mills from 36% to 43% in the past two years, but this still leaves a very fragmented industry.

While China has tried to shut down its smallest and least efficient factories, the country continues to build new ones. Followed by a Finland-based think tank found that 18 new blast furnaces with a capacity of 35 million tonnes (about seven times Australian production) were approved in the first half of 2021 alone.

Blast furnaces are critically dependent on a constant supply of iron ore and coal and face massive restart costs if forced to suspend operations. The problem with central purchasing is that smaller factories will fear that the interests of larger factories will be favored and their survival jeopardized if supplies are interrupted.

The push for centralized purchasing was a response to high prices. The price of iron ore reached a record high of US$240 per ton in May 2021, offering spectacular profits to the largest miners, whose production costs were then below US$15 per ton. Although the price has come down a lot, it is still at an extremely profitable level of around US$100 per ton.

Central buying is likely to be more effective when prices are depressed. If a glut of iron ore emerged, smaller Chinese factories would be less concerned about security of supply and would have an incentive to join the central agency if they thought it could offer lower prices.

China’s vast steel industry will always need Australian iron ore, but a central agency could decide to favor non-Australian supplies.

The Japanese steel cartel that operated from the 1960s to the 1990s was considered to have engineered excess supplies and was able to keep the price of iron ore at levels that provided bare profitability for miners. The price of iron ore fluctuated between US$11 per ton and US$14 per ton throughout the 1990s.

Although China’s steel industry is not like the Japanese steel cartel, the story of bulk commodities is that they provide flat returns, like utilities. The only reason they have been so profitable over the past 20 years is the explosion in Chinese demand, which has no equal in history.

The new Chinese resource company has also been tasked with increasing its supply, including the development of the large Simandou iron ore project in Guinea. Guinea’s new government, which took power in a coup last year, has given project operators until 2025 to start production. Formidable technical and political challenges remain, but the likelihood of the project’s realization has increased.

However, the biggest risk for Australia is not an increase in supply but a drop in Chinese demand. It can happen now. China’s steel production fell 6.5% in the first half of the year and inventories are rising.

The conventional wisdom is that a slowdown in the Chinese economy is bullish for iron ore because the government responds with building steel-intensive infrastructure. Infrastructure spending is certainly increasing, but its share in steel demand at around 20 to 25% is lower than that of the real estate sector at 35 to 40% and real estate investment is losing momentum.

It is beyond the scope of this article to examine the major forces at work in the Chinese economy, but a severe recession is possible, given the challenges posed by high debt, falling oil prices real estate, weak income growth and rising global interest rates, which are also threatening a global slowdown.

The Chinese boom has been spectacular for Australia. A key economic measure is the terms of trade, which is the ratio of export prices to import prices and is measured as an index.

For 50 years from the mid-1950s, this figure was fairly constant around 60, but in 2005 it began to rise as China’s demand for resources accelerated and the cost of importing products Australian manufactures was declining. In September 2011, it reached an all-time high of 120, meaning every tonne of Australian exports bought twice as many imports as it did six years earlier or for most of Australia. Australian history.

Although it sounds abstract, a reversion to the long-term average of the terms of trade could wipe out $250 billion of national annual income, with big implications for both public finances and Australian living standards. The China Mineral Resources Group could contribute to this.