Revenge in the making?

No I am not talking about the current tit-for-tat between Anwar and Najib or Najib and RPK. It is about the rumoured revenge that the Chinese Government is going to take on the two giant Aussie miners for practising double standards. To me, China may have lost in this "negotiation"(also discussed here previously), but it has gained something precious in return. It's called "wisdom" which is a valuable lesson that can be useful in the future. One thing for sure, irregardless what happens between the iron ore miners and the Chinese producers, high steel prices are here to stay.

UOBKayHian:China is upset with BHP Billiton and Rio Tinto for their two tracked pricing policy of their overseas iron ore sales – a smaller increase for European mills and a substantially bigger one for Chinese mills. Now, Beijing is reportedly looking at a sharply higher export tax on coke to rein in coke exports, and ultimately, iron ore prices. China accounts for about 60% of the global seaborne trade for coke, so any cut in its exports will have an impact on global supply, and thus steel output, and – China hopes, ultimately on
iron ore prices.

China fuming

The Chinese are seriously upset with the giant Australian mining groups, BHP Billiton and Rio Tinto. Key Chinese industry and semi-official representatives in the steel industry are now exploring ways in which they can avenge the ”double standards” of the two mining giants. About 10 days ago, Australian newspapers reported that BHP and Rio Tinto have agreed to a 71% rise in the price of iron ores for European mills, which is significantly lower than the 96.5% they extracted from the Chinese mills for lump ores, and 79.9% for fine ores in June. The different pricing policy is especially galling to the Chinese because each of the two groups sells no more than 3% of their ores to Europe whereas China accounts for nearly 50% of the global seaborne trade in iron ores, and are thus their biggest client. Just three players, BHP, Rio Tinto and CVRD supply 78% of the global seaborne trade in iron ores. Press reports suggested that BHP, planning a hostile takeover of Rio, was eager to show to the European regulators that it was a price taker, hoping to ease fears that any merger with Rio would lead to monopolistic pricing practices. Rio Tinto has also reportedly accepted this range of price increase for its European customers. Two options for China. What can the Chinese do? There are two options:

􀁺 Ban China's exports of coke, or

􀁺 Increase the export tax of coke by 5% to 30%

Option 1: Ban coke exports

This is the more radical of the two options. Coke (coking coal accounts for 93% of the COGS of coke) and iron ore account for about 50-60% of the COGS for a tonne of steel. As the table below shows, China is the world's largest exporter of seaborne coke, accounting for 61% of the global total last year. Any ban in exports would have some impact on the overseas steel
trade and, indirectly, on global iron ore trade. One could argue that retaining coke for domestic mills will encourage domestic steel expansion, and could pick up the slack in iron ore purchases abroad. But, China is currently cracking down on more coke and steel expansion. A tonne of steel uses between 0.5-0.6 tonne of coke. China's 15.3m tonnes of coke exports last year would thus affect about 28m tonnes of world crude steel output. Assuming an average iron content of 0.65 in iron ores, then a mill needs 1.5 tonnes of iron ores to produce a tonne of steel. With 28m tonnes of crude steel output, that will affect 42m tonnes of iron ore sales, which was 5% of global seaborne iron ore sales, or 11% of China's iron ore imports last year. This radical option can thus depress the price of iron ores somewhat and should hurt BHP and Rio Tinto more. The key buyers of China's coke exports are Japan (22% of China's overseas sales), Brazil (15%), Belgium (10%), US (10%), and India (6%). China has just set an export quota of 12.1m tonnes for coke this year, down just about 1% from last year.

Option 2: Raise export tax for coke

This is the more likely scenario. Given that China has been raising the export taxes on resource-based and polluting exports, we see a strong chance of it lifting the export tax on coke from the current 25% to 30%. This would reduce the incentive for coke exporters to sell overseas, which will still have an impact, considering that China is the biggest exporter in the world. But the impact will obviously be smaller than an outright ban.

Conclusion

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Will China again prove to be a paper tiger, allowing major mining giants to turn its great demand into a liability? This is a tempting conclusion as it proved time and again that it failed to get what it wants during the iron ore negotiations in the past few years. However, media reports suggest a simmering real anger at the Australian groups, so we believe that something will be done. Of the two options we outlined above, we believe the more likely short-term scenario is to raise the export duties to 30% for coke, and eventually to ban coke exports in two to three years.

* National Australia Bank, the nation's top lender, book another A830m(USD800m) losses from its exposure to US mortgages. Total provisions made todate is currently A1.01b.



* Reuters: China's securities regulator has ordered fund managers to refrain from making public comments about the Shanghai Stock Exchange Composite Index's loss of more than 50% of its value from its October 2007's peak.



* ChinaDaily: The Chinese government will further enforce the price controls on coal used for power generation, in a move to keep the prices in line and to ensure supplies for thermal power plants.