When the president of BHP Billiton’s iron ore division, Ian Ashby, said there were signs of China’s demand for iron ore flattening today, the Australian dollar was sold off immediately. The more significant of his comments, however, weren’t about what’s occurring within China today but what might happen over the longer term.
It shouldn’t be a surprise to the markets that China’s demand for iron ore has cooled, given that China last year took steps to cool its economy and has down-graded its growth target for this year to 7.5 per cent, which would be its lowest rate of growth in eight years. That would have obvious implications for the Australian resource sector, commodity prices, the currency, taxes and economic growth in the near term.
The more interesting aspect of the presentation Ashby gave to a conference in Perth today, however, was his discussion about the long-term outlook for iron ore consumption and the world seaborne iron ore trade.
Demand growth, he said, was going to flatten off and fall into single digits after times that had been "exceptional".
Between 2000 and 2010, according to a slide in his presentation, world iron ore consumption grew 6.1 per cent and the world seaborne iron ore demand 8.4 per cent as China’s steel production and therefore its iron ore consumption exploded.
Between 2010 and 2012, however, with China’s consumption growth rate flattening as the infrastructure investment phase of its development tapers off, world consumption was forecast to be 3.5 per cent and the demand for seaborne iron ore 4.4 per cent.
Despite that, Ashby, like his counterparts at Rio Tinto, still sees a "tremendous opportunity" to grow his iron ore business. BHP has already approved plans to increase its iron ore production from about 155 million tonnes a year to 220 million tonnes a year over the next five years while it has the potential to eventually more than double that level of production if it wishes.
Rio has plans to lift production from 225 million tonnes to 283 million tonnes next year and has the ability to expand its Dampier port infrastructure to handle more than 350 million tonnes a year.
Both major miners appear to be convinced that China can finesse its current managed slowdown in its economy without badly over-shooting. In the longer term the continuing ramp up in their capacity, which involves massive investment programs, is predicated on the demand for seaborne iron ore continuing to rise, albeit at much lower rates than in the past decade.
Those strategies are based on their own positions at the low end of the cost curve and high end of the quality curve and on the reality that the size of China’s economy has been transformed in recent years – the growth will come off a massively enlarged base, given that China’s GDP is roughly 40 per cent bigger today than it was four years ago.
Despite BHP’s expectation that growth in China’s annual steel demand will slow, it also expects that demand to peak at just over a billion tonnes by 2025 compared with 700 million tonnes today.
The Pilbara producers’ increased production should displace higher-cost and lower quality production elsewhere in a lower-growth scenario – a prospective outcome that has been enhanced by the tardiness of the aspiring new iron ore producers in responding to the demand over the past few years. Ashby sees the iron ore price falling back but says there is a floor price of around $US120 a tonne but ultimately it is the volume of iron ore it can sell to China, India and other developing economies in the region that is more important than the price.
The long-established status of BHP and Rio’s key mines and core infrastructure, their low costs and high quality and the sheer efficiency of their businesses is their protection against the implications of less steel-intensive growth in China and a maturing iron ore market.
The rush to participate in the China-inspired resources boom has attracted a lot of marginal production – and sharply pushed up the costs and geographical risk profile of some of the newer mines.
BHP and Rio aren’t immune from the cost pressures, which are particularly acute in this economy because of the sheer scale of the pipeline of resource projects underway, the deteriorating industrial relations environment and the increases in royalties and, perhaps, taxes (if the MRRT raises anything meaningful).
They do, however, have a lot of optionality in terms of how and when they push the button on their various expansion options and fabulous pre-existing margins with which to absorb any significant fall in prices. Rio’s return to financial health since the global financial crisis also means that both have very strong balance sheets as insurance against whatever might develop.