China’s transformation demands iron patience

The plummeting iron ore price will continue to put pressure on the likes of BHP and Rio Tinto for the next few years. But there is light at the end of the tunnel.

The fall in the iron ore price below $100 should alert all Australians that the China game has changed. Fundamental transformation is taking place in China, which means that for two or three years at least, the good times for Australia are over.

We are fortunate that, taking away the political bluster, both sides of politics understand this -- which is why Chris Bowen’s KGB interview was so important to the nation (Australia can't swallow any more lies, May 16).

We are also fortunate that BHP and Rio Tinto picked these changes well before Canberra and have slashed their expansion plans. But the world is still awash with over-capacity in iron ore and coal. There are major stockpiles of iron ore and we now price on a spot basis rather than with long-term contracts. This was marvellous when prices were rising but is tough on the way down.

The nation is also suffering because during last year’s election campaign neither Kevin Rudd nor Tony Abbott explained the China situation to voters, and both promised voters spending sprees that were unsustainable.

So let’s look at some of the fundamental changes taking place in China. First and foremost, China has used a large amount of our coal and iron ore to build apartments and infrastructure that are way ahead of requirements. Unoccupied apartments abound. The banks that funded this spending face major losses and are cutting back their lending. That means China needs less steel, and less of its raw materials iron ore and coal (The trouble with China's hot propertyApril 21).

Second, China is trying to move from an export-dominated economy to one that develops much more internal demand. That will not be easy and we are going to see a zigzag path to avoid economic catastrophes. This change in direction will alter what China needs. There will be less steel needed but other metals like copper and tin will be in greater demand.

Third, pollution is a serious problem in China. It is affecting their air, water and arable land.

This year China plans to phase back about 28 million tonnes of polluting steel capacity and there is a lot more to come, including the closure of blast furnaces. On the other hand, China is looking to use more higher-quality ore and coal, which will help to its control pollution.

That means China will cut back its internal iron ore and coal production, and those cutbacks will be accelerated by the fact that Chinese ore is high-cost. This is good long-term news for BHP and Rio Tinto -- and Australia -- and underlines the longer-term outlook once the current glut is absorbed, including the extra 200m to 250m tonnes of iron ore production capacity coming on stream in 2015 or 2016. Meanwhile, Chinese banks have become more careful in issuing letters of credit to steelmakers for iron ore purchases.

And so we have a squeeze on buyers of steel and the makers of steel, which translates to tougher times for iron ore and coal producers. But there is light at the end of the tunnel, albeit that the tunnel is long.