Chinese entrench iron ore discount

The looming season of weaker iron ore demand from China will only further entrench the wide discount between high-grade and low-grade materials, Rio Tinto iron ore chief executive Chris Salisbury has said.

China last week announced that half of the steel production in the country’s northeastern provinces would be closed over the winter, as part of ongoing attempts to curb air pollution.

While the shutdown should ostensibly hurt iron ore demand, given China is by far the world’s largest consumer of the material, Mr Salisbury told The Australian the closures would add to an appetite for its higher-grade iron ore production.

“We normally see a seasonal slowdown with the winter, and that will play into iron ore demand,” Mr Salisbury said.

“However, what I would say is that there is still very high demand for high-grade products, particularly with the ongoing environmental restrictions and particularly during winter.

“So I think we are going to continue to see the discount for low-grade continuing, which is good news for companies such as ours that provide high-quality products for premium customers.”

Lower-grade material containing about 58 per cent iron has typically traded at a 10 per cent to 15 per cent discount to higher grade 62 per cent material, but the discount has broadly doubled over much of this year.

Companies with a bigger proportion of high-grade output, such as Rio Tinto, have argued that the wider discount represents a structural shift given China’s crackdown on pollution.

Meanwhile, producers with a greater exposure to lower-grade material — most notably Andrew Forrest’s Fortescue Metals Group — have argued that the discount would only be a temporary phenomenon until price incentives kicked in. Using higher-grade iron ore allows steel mills to lower pollution and improve their productivity and output, which should be increasingly important in China in the coming months given the government-ordered closures of much of the capacity.

Mr Salisbury said a trip to China last week to meet with customers had added to his belief that the wider discount would persist.

“I think we’re seeing increasing evidence that it is structural, because of the environmental concerns and the focus on larger steel mills, high productivity and high profitability — which means leaning towards high-grade products,” he said.

Cliff Lawrenson, the managing director of smaller producer Atlas Iron, told The Australian the company was still receiving healthy interest from Chinese customers in its lower-grade material but was now trying to adjust its business to cope with the wider valuation.

“The discount is the discount, it’s stubborn, so we’re trying to find ways to make our product not be subject to that discount,” Mr Lawrenson said.

“We don’t have a solution yet but we’re going to see what we can do about that.”

China’s steel mill suspension is expected to last through to March next year.

UBS’s commodities team said the impact from the shutdowns should be largely offset by higher output from other Chinese steel mills outside the northeast, as well as a slower ramp-up of Indian iron ore exports and lower Chinese iron ore supply through winter.

Mr Salisbury’s comments came as Rio Tinto announced it would commit $2 million towards Western Australia’s vocational training body TAFE WA, to help develop a new curriculum focused on jobs linked to automation.