China pollution, 'Belt and Road' may aid iron ore, coal amid steel slowdown

Iron ore and coal miners may have been reassured last week as China's National Congress showcased stronger determination to tackle pollution in lifting living standards, a move likely achieved by more higher-grade raw materials and imports.

China is looking to cut pollution by curbing steel output and at domestic processing plants this winter.

This creates the incentive for importing higher grade iron ore to operate at the remaining operating plants, and for boosting productivity when restrictions are lifted during the seven or so months outside winter.

At the same time, China's steel-reliant "Belt and Road" initiative -- a plan to build and strengthen overland and sea logistics routes across Asia and into Africa -- was added into China's constitution. This is the strongest indication for infrastructure shaping China's trade and foreign policy.

A stronger signal for optimism in seaborne steel raw materials trade is that China looks to be taking on pollution cutting seriously.

This year marks the first winter steel and aluminum plants will be idled for months at a time to improve air quality. And this may become a regular seasonal occurrence, Russian aluminum producer Rusal indicated to investors in August.

China may reduce steel production by about 33 million mt between mid-November and the end of March 2018, based on S&P Global Platts estimates published Friday.

These cuts, which comprise 3.9% of China's projected 2017 crude steel output, are taking place across the provinces of Hebei, Shandong, Henan and Shanxi plus Beijing and Tianjin, and may provide longer term support to currently robust steel margins.

As President Xi Jinping stressed at the National Congress, much remains to be done to cut and improve pollution levels.

Processing iron with less slag emitted, and cutting coke and other energy consumption may be a benefit and aid demand for seaborne cargoes, especially at coastal plants.

"We believe environmental measures are more a reality than they were before, this is supportive for iron ore premiums, for higher quality iron ore," a steel and iron ore industry analyst said.

Iron ore prices have been volatile, rising during China's summer, before falling back in September, with a wider price spread between high and low grade ores.

A drop for 62% Fe fines to below $50/dry mt CFR China against current quality-based pricing adjustments may spell danger for cash margins at lower quality Australian mines.

Prices for IODEX 62% Fe fines closed Friday at $59.10/dmt CFR China, dropping $3.20/dmt from Thursday. IODEX averaged at almost $70/dmt in September.

Iron ore miner Fortescue Metals Group said Chinese steel mill profitability remaining at historically high levels "continues to incentivize blast furnaces to maximize production supporting the premium for higher grade iron ore," in an update report Thursday.

"This has maintained the spread in prices between iron ore grades and these are expected to remain in the near term," the Australian company said.

FMG cut its July 2017-June 2018 price guidance for its ore to price at a lower 70%-75% ratio of the Platts 62% Fe IODEX CFR index, from its earlier estimate of achieving 75%-80% of IODEX.

High grade iron ore and pellet prices this year into China have increased premiums over reference import 62% Fe fines to new highs.

For 65% Fe fines pricing, this premium is exceeding 30% on an equivalent iron content and gangue basis in the past month.

S&P Global Market Intelligence expects 62% Fe reference fines to average at $64.10/dmt CFR China in Q4 2017 and prices to fall further in 2018 and 2019.

"Prominent volatility and continued environmental pressures [are expected to] enact stronger downward forces on 58% Fe prices," an S&P Global research report Friday said.

China coking coal imports surged by 24% so far over this year, while China's blast furnace iron output rose around 3.5%.

Additional steel output-tied demand, looks to have prioritized imported raw materials. Potential for a price arbitrage between domestic Chinese materials against imports from spot markets is adding interest.

Without drivers of additional steel demand, analysts are expecting a slowdown in several steel consuming sectors in China next year may lead to flatter steel output growth.

Support from infrastructure may be welcomed. The indoctrination of the Belt and Road infrastructure initiative into the construction may help it to be carried out to a stronger conclusion and implemented at the grandest scale outlined in blueprints, withstanding wider political backing.

Steel-fed railways and other haulage and logistics chains and terminals needing steel, cement, and power may crisscross Eurasia and Southeast Asia.

Beijing has a desire for new markets to help reduce its overcapacity in steel and cement, and this is seen in the Belt and Road's focus on infrastructure, and rail lines, according to Howard French, a China expert, and author.

STEEL LEVER

Beijing and the commodity markets may see the Belt and Road scheme providing China with another lever in managing domestic steel demand and output.

The Belt and Road may serve as a stop gap in a wider transition in China to greater consumerism from the economy's reliance on investing in heavy industry and construction within China.

It may aid demand for raw materials imports as domestic steel usage slows or slips.

"Companies who supply steel, aluminum, cement and other construction-related materials," will stand to immediately benefit from the Belt and Road Initiative, according to HSBC bank's website, with a section dedicated to the project and its financing and investment needs.

Tata Steel Managing Director TV Narendran, in his role as chairman of World Steel Association's economics committee, said this month that Belt and Road will have an impact on countries participating in it, reflected in the steel demand forecast of those countries, rather than China itself.

But China's steel exports could fill some of the neighboring demand generated by the project.

The Belt and Road is not expected to help demand for Russian steel, with the networks in southern Eurasia more likely to be the focus, said a source at an industrial steel and mining group.

It may be good for Chinese steel, and any benefit may be indirect in supporting the seaborne coal and iron ore markets, he said.

"Africa could be the one that needs more steel than Belt and Road," he added.

Hector Forster, hector.forster@spglobal.com

Edited by Richard Rubin, richard.rubin@spglobal.com