Chinese steelmakers not benefiting from weaker yuan although a sudden cooling in iron ore price offers some relief

PUBLISHED : Sunday, 20 November, 2016, 2:54pm
UPDATED : Sunday, 20 November, 2016, 10:19pm

Chinese steelmakers have seen their profit margins squeezed by surging prices of imported raw materials while the depreciating yuan has dealt an added blow.

A partial relief is on the way, analysts say, at least on iron ore prices, as they expect a price correction that began last week to continue as the speculative boom gives way to fundamentals-based trading.

But coking coal prices are expected to remain elevated for longer as new supply takes time to come to the market.

“The iron ore price of [almost] US$80 a tonne seen earlier this month has gone far out of line with industry fundamentals,” Shanghai-based Sinolink Securities’ analysts said in a recent note. “It was in bubble territory and not sustainable.”

The fact that the yuan is expected to devalue further next year after having depreciated almost 6 per cent against the US dollar so far this year has not helped the bottom lines at steel mills since they primarily sell to the domestic market and their products are priced in yuan.

HSBC’s currency strategists last week forecast the yuan would tumble almost 5 per cent against the greenback by the end of next year.

The price of iron ore delivered to China’s Qinhuangdao port retreated to US$73.50 a tonne as of Thursday as a five-week rally driven by speculation and short-term supply disruption was snapped after the steelmaking ingredient touched a two-year high of US$79.80 on November 11.

The price for iron ore at the Chinese port has risen 26 per cent in the past month.

China relies on imported ore for more than 80 per cent of the needs from its steel industry. Such reliance has been increasing since late 2014, when domestic output started to decline, as weaker prices drove loss-making mines out of production and market share shifted to more cost-competitive imports from Australia and Brazil.

China Investment Securities’ analyst He Xin said that although listed Chinese steel mills had turned around from steep losses last year and reported a total net profit of 8.8 billion yuan in the first three quarters of this year, thanks to rising steel prices, profit margins had been falling due to higher raw material costs.

An index measuring the differential between steel selling prices and its production costs had slumped from above 900 in April to 253 last month, he noted, adding that the steel mills had seen their third-quarter profits fall markedly from the second quarter.

Paul Gray, the Britain-based research director of mining and metals fundamentals at commodities

consultancy Wood Mackenzie, said he expected the correction in iron ore prices to continue next month towards US$60 a tonne on the back of rising seaborne supply.

“The price outlook for the first quarter of next year depends on the extent to which Beijing persists with credit-fuelled stimulus aimed at construction and infrastructure, and the timing and magnitude of the ramping up of new iron ore supply, most notably [Brazilian producer] Vale’s S11D project,” he told the South China Morning Post.

“Our base-case view is that supply growth will exceed demand growth in 2017 with further downward pressure on iron ore prices.”

But he expected coking coal prices to remain relatively firm in the next few months due to supply constraints caused by recent unplanned stoppages at Australian mines and potential summer storm-related production disruptions.

However, prices could fall sharply after March next year with a “rapid return” of Chinese supply, he added.

Industry regulator National Development and Reform Commission said on Thursday that all coal mines in China could resume producing at the legal maximum rate of 330 days annually as long as they met safety regulations.

The blanket 330-day cap, imposed in May to reduce supply and help lift depressed prices amid mounting concerns over widespread bankruptcies at coal mines, helped stoke a rally in coal prices as demand grew more than expected while supply fell.

In the past two months, the NDRC has released supply cautiously as it is still pushing for the reduction and consolidation of outdated capacity, allowing only the most efficient and cost-competitive mines to resume the rate of 330 days a year.

The spot market for hard coking coal in Australia fetched US$314 a tonne on Thursday, up 316 per cent from the record low in November last year, according to a report by ANZ.

The bank raised its price forecast on the material by 72 per cent to an average of US$178 next year, compared with US$117 this year. It is expected to ease back to US$135 in 2018.

China imports just under 10 per cent of its coking coal needs.