Behind China’s steel pricing farce

In late 2008 China was facing European Union dumping charges in the World Trade Organization on steel products. This coincided with the onset of the global financial crisis and subsequent recession and the hurried preparation of Beijing’s massive stimulus package.

In Beijing, discussions also addressed the role of steel in China’s stimulus package, and a proposal to establish a 5 million tonne steel stockpile. By the end of 2008, the 5 million tonne estimate jumped to 15 million tonnes.

China’s steel industry, however, had to face the question of the viability of such a stockpile. A small stockpile will have no effect on the market. If the stockpile is too large, the cost will be prohibitive.

Using December 2008 prices for hot-rolled sheet, a 15 million tonne stockpile would cost about US$8 billion. There was also the unresolved question as to who would underwrite the cost of producing and maintaining the stockpile.

Plagued with inefficiencies, excess labour, rising costs, profiteering by the traders and mounting complaints in the WTO, China’s steel industry needed a serious price advantage over its competition to increase market share. An increase in subsidies would lead to more complaints, rising off-balance sheet expenditure and rocketing bank loans.

Objective

China aims to increase market share to keep its steel industries turning over and making substantial profits. The reason is elementary: to cover the job losses caused by the restructuring of China’s highly polluting, government subsidised, and inefficient steel industry.

The solution appeared simple. Delay the price negotiations until June 30, 2009, force a major reduction in the price of iron ore and secure a strategic advantage over Japan and South Korea.

By the end of June, the negotiating consortium of China’s state steel majors failed to secure the huge cut demanded by China. The signing of new contracts accepting a 33 per cent price cut by Japan and South Korea weakened China’s negotiating position. China demanded a minimum 40 per cent cut.

Politicising negotiations

Beijing had been aggressively denouncing the miners in Chinese and international media, highlighting its hardline “no surrender” policy. The situation then became highly politicised. Beijing took over the lead role in the China Iron and Steel Association, replacing the industry majors as the negotiating authority. In effect, the miners would now be dealing directly with the Chinese Government.

The objective was to use political muscle to force the issue and secure the 40 per cent cut. If countries like Australia wanted to retain China’s trade and goodwill, it should “convince” the miners to meet Beijing’s demands. China’s media dutifully kept its government hard line stand in the headlines.

Contradictions and disunity

A flow of official data from the Chinese Government was confirming that China’s steel industry was in fact showing strong growth and importing record iron ore shipments, and was giving the stimulus package all the credit. Steel was also a major contributor to local GDP growth.

Regional state media, however, was contradicting this position with reports of oversupply, mounting stockpiles, and rising losses.

Evidence of disunity within the industry was also emerging, as well as contradictory claims made by Beijing, regional steel makers, coal and coke production, and electricity generation.

Beijing was infuriated when smaller mills, in order to maintain operations and meet demand, purchased Brazilian iron ore on the spot market.

The failure of negotiations and acceptance by Japan and South Korea of the price cut infuriated the CCP and loss of face was looming. China had been too aggressive in its demands and left no face saving way out.

Domestic cost increases

In China the price of coal, coke, water, electricity, transport, and labour are escalating. China’s intention is to offset domestic cost increases with heavily discounted imported iron ore.

2009 shipments and the spot market

For the 1st half of 2009, crude steel production was up 29.3 per cent to 297 million tonnes and imports were up to 131 million tonnes. Carriers reported being unable to unload ore because of stockpiles at the docks and steel producers yards. There were rumours of impending litigation by a major miner against Chinese steel mills for refusing to meet contractual obligations and accept contracted shipments of iron ore.

An analysis of purchases and shipping movements however reveals that 82.7 per cent of China’s iron ore imports during the 1st half 2009, were on the spot market.

April 2009 spot prices were US$58/tonne while July 2009 recorded prices above US$100/tonne. China’s 2nd quarter 2009 purchases from Brazil totalling 36 million tonnes were spot market contracts (70 per cent of the total purchases.)

Beijing intends to cancel spot market orders placed by smaller mills for Brazilian ore.

Beijing created the pricing problem

While Beijing cries foul, vilifies the ore miners and attempts to pressure the Australian government, the reason behind the push for the 40 per cent cut becomes clear with an understanding of China’s iron ore buying practices.

China intended to play hardball and to up the ante: China’s law enforcement agencies arrested Rio Tinto’s lead negotiator and local executive Stern Hu. The charges ranged from espionage by stealing state secrets, undermining the Chinese economy, corruption and bribery of China’s steel executives.

The way out

Beijing can now claim a timely excuse for failing to succeed in the highly publicised price negotiations; i.e. that Rio Tinto’s Stern Hu had used criminal tactics to steal commercial secrets of China’s steel industry by espionage and the bribery of China steel executives.

Beijing is claiming Rio Tinto’s criminal tactics not only undermined the Chinese government’s efforts to negotiate a fair iron ore price, but it stole highly sensitive secret information that can undermine China’s steel industry and seriously impact on China’s efforts for an economic recovery from the global recession.

Behind the smoke and mirrors in China, it is time to focus on China’s steel majors and consider how the highly publicised restructuring is in fact a diversion to conceal rising concern within the CCP.

Evidence of the extent of this concern was Vice Foreign Minister Liu Jieyu’s hurried visit to Australia to tell Prime Minister Rudd not to interfere in China’s internal affairs, demand that Australia respect China’s legal system, and to claim that Stern Hu and his co-workers would receive a fair trial.

Conflicts of interest in China’s justice system

Senior executives in China’s state-owned enterprises, and especially those in the key industries of energy, steel, coal and power generation, face a clearly defined conflict of interest when giving evidence in China’s courts.

To secure and retain their positions in these industries, membership of the CCP is mandatory and requires absolute obedience and loyalty, whereby duty is first, and foremost to the interest of the CCP, and then China as a whole. Everything else has a lesser priority. There are severe penalties for breaches that can seriously affect the future prospects of both individual and family.

Before answering questions from prosecuting or defence lawyers, all members are bound by their sworn duty and loyalty to the CCP before all else. In China, the CCP is the highest law and that leaves the obvious question of the veracity of evidence given by executives of state-owned enterprises.

This raises the question of the credibility of evidence that could be contrary to CCP and the state’s interest. Can the demand for loyalty and commitment to the interests of the CCP, be used as a form of duress for a member of the CCP not to answer truthfully?

Can China’s legal system be considered credible when it comes to any trial involving the charges facing Hu and his colleagues, and evidence given by senior executives of the major state-owned steel mills who are dedicated members of the CCP? Evidence given under these circumstances has the real potential to be unreliable, at best.

Stern Hu’s own Chinese national colleagues with families in China will also face the same dilemma.

Another weakness is China’s judiciary. All judges are CCP members and charged with protecting China’s interests and national security.

The pricing problem is one of Beijing’s own creations

Since the beginning of 2009, China’s steel mills purchased just over half of all iron ore imports from the miners. Of the 297 million tonnes imported into China during the 1st half 2009, traders purchased 131 million tonnes.

China claims that the decline in mill purchases confirmed falling demand, supporting its claim in price negotiations. It was a juvenile and transparent move to attempt to influence negotiations.

The 131 million tonnes purchased by the traders however, represented a 30 per cent year on year increase. When on-sold to steel mills, the price carries a substantial mark-up, pushing the landed price well above that of the larger mill contracts.

Traders can only survive with government support and this is readily evident when considering that 152 traders are actively importing iron ore, yet there are only 112 valid import licences. Is it possible that the “invisible 40” are in fact major steel mill and/or government proxies?

Trader profiteering, inefficiencies, subsidies and domestic cost increases are the underlying root causes for China’s demands for a 40 per cent price cut, and undermines the credibility of the claims.

Is the real reason for China’s 40 per cent discount claim its apparent inability to compete on a level playing field in the global steel market due to inefficiency, internal profiteering, ore price inflation, and excessive government subsidies?

With extensive data available for independent analysis, China would have to be one dumb or arrogant poker player to try to play such a hand.

China is demanding a preferred position

China can improve the efficiency and competitiveness of its steel industry, simply by removing the profiteering traders and illegal traders and allow mills to negotiate directly with miners.

One would assume that the basis for a level playing field in the global steel industry would be a mutually agreed iron ore price, leaving efficiency, technology, energy and management to dictate the end price in the market place. That in turn would produce the opportunities for employment and downstream industries for each nation’s economy.

Beijing still thinks as a command economy, and imposes its will on the global free trade marketplace and refuses to embrace that system. China is demanding an iron ore price below that of its highly efficient competitors who have negotiated in good faith on the open market without the need to seek political muscle. Why should there be an exception for China when other countries have the same aspirations to increase their market share and provide employment for their workers?

Beijing’s real problem

Throughout the past decade, China’s state media has trumpeted Beijing’s growing power in international affairs. It has forced major trading partner nations to kowtow to Beijing’s demands with threats to limit their access to China’s markets. World leaders cancelled meetings with individuals China claimed to be “enemies of the state”, including such respected individuals as the Dalai Lama and others.

Beijing has gone to great lengths to impress its population of its indisputable position as an international power, to retain respect and confidence in the CCP. Beijing is successfully undermining that image with its bull-in-a-china shop strategy and the Rio Tinto arrest farce.

First, the failure of China’s mighty state-owned steel mills to secure the 40 per cent; Beijing then failed to secure the cut by taking control of negotiations with its hard line and political muscle strategies.

Contrary to international media coverage, China’s state media publishes censored reports of ongoing negotiations and tirades against the capitalist multinationals and their manipulation of global markets. What Beijing cannot accept, is that threats and political pressure failed to secure the desired result.

The drama leading up to the Rio Tinto farce is not about China. It is all about the leadership and the CCP. While Beijing ignores outside criticism, the CCP is paranoid about maintaining the respect of China's population.

That paranoia could reach new levels when a foreign non-government company can demonstrate that it can reject the direct demands of the all-powerful CCP.

Given the extensive state media coverage of China’s global power, how will China’s population comprehend that a private company, relying on China to buy its product, can refuse to kowtow to the Chinese government - the Chinese Communist Party?