(Image: Supplied)

While today’s budget will benefit from a booming iron ore price as well as a faster than expected recovery from recession, a prudent Treasury will plan for a peak in iron ore in coming months. Prices hit new record highs last Thursday and Friday, and could very well rise for some time to come, but the Chinese government is driving major policy changes that will eventually see crude steel production in China fall, meaning a fall in iron ore imports.

The policy changes are unrelated to China-Australia tensions; instead, they’re driven by the Chinese government’s desire to cut pollution from the steelmaking sector, which has defied government push to curb pollution that began in 2015.

Tax and tariff changes started at the beginning of May that will reduce export rebates and cut tariffs on imports of steel manufacturing input, while increasing export tariffs on high-quality specialty steel products. That will make it cheaper for China to import semi-finished products and even crude steel and retain the less polluting (to make) specialty steels.

The changes were explicitly intended to “reduce domestic crude steel production and reduce total energy consumption”.

The second major change, announced last week, is a shift in policy that will see capacity cut by forcing existing steelmakers using blast furnace technology to move to electric arc systems — but at significantly lower capacity. Areas where any new steel manufacturing capability is banned — whether electric arc or not — have also been expanded. The Chinese government wants to significantly curb Chinese steel production capacity.

The changes helped trigger a remarkable surge in iron ore prices this week as Chinese steel mills try to get their hands on as much ore as possible before the full suite of changes kicks in. The rises have been so dramatic that in the three trading sessions since China came out of its five-day Labour Day break, prices have jumped by up to 25%. The rises for the three main grades of ore traded — 62% Fe fines, 58% Fe fines and 65% Fe fines (from Brazil) — rose by record amounts for a single day on Monday. The former (62% Fe Fines) hit a new record of US$230.56 a tonne, up 8.6% on the day or US$18.31 a tonne.

Move to semi-finished products

The two policies seem designed to drive down consumption of iron ore and coking coal (most of which is currently imported) in local steel manufacturing and move to importing and using semi-finished steel products — even pig iron and crude steel. The aim is lower CO2 emissions by the steelmaking sector, as well as less damaging smog (especially in and around Beijing from fallout from steel plants in and around Tangshan, 180 kilometres to the south-east of the capital).

The crackdown on pollution and capacity started in April in the Tangshan area of China (which is responsible for producing 12%-14% of China’s billion tonnes of crude steel a year). More than 20 plants were ordered to close for varying periods and capacity cuts have also been imposed.

If you’re thinking shifting production offshore won’t actually change the global level of emission, you’re correct: China will limit and then cut some of its emissions from its existing highly polluting crude steel making sector while taking products from other countries — meaning the emissions are produced there, not in China. It’s deliberate “carbon leakage” — something other countries around the world, like the European Union, are desperate to prevent. But it means the emissions won’t appear in China’s column in international negotiations on climate action.

It means China’s appetite for iron ore will diminish — and significantly if the government has its way — as Chinese steel manufacturing capacity reduces. Foreign steelmakers in Japan, South Korea, Taiwan, Europe, India, the US and even Australia (theoretically) will instead be able to make semi-finished steel products and ship them to China. China has issues with Japan, South Korea and Taiwan, of course, but the desire to cut its emissions (and return blue skies to Beijing more frequently) seems to be a greater ambition.

Hopefully foreign steelmakers will buy more coking coal and iron ore from Australia and soften any fall in demand from China. Japanese steel mills have always favoured lump ore (compared to the iron ore fines China demands). Lump ore uses less energy to convert to crude steel and therefore has lower emissions.

Or some visionary might conceive of new steelmaking plants in the Pilbara to replace the exported iron ore with crude and semi-finished steel products to ship to China.