Africa and the contestability of the global iron ore market
The scramble to expand iron-ore export capacity in West and Central Africa strongly signals that Australia’s iron-ore luck is at risk of running out.
Pressure from African governments to bring iron ore to market while the price is high, coupled with Chinese investors’ willingness to provide the capital in operationally risky countries has created the potential for significant overcapacity in the market over the next five years. Global export overcapacity could precipitate a dramatic fall in the price of iron ore, which would impact heavily on the Australian economy.
Rapid urbanisation, industrialisation and the demands of its emerging middle class have fuelled China’s demand for steel production. Over the past decade, China’s demand for iron ore has outpaced the expansion of global iron-ore exports and forced the price of ore up from US$12.68/t in 2001 to US$187.18/t in February 2011 as China’s high-cost marginal producers were needed to supply the market.
Over the coming five years China is expected to increase its demand for iron ore at a steady but slowing rate as it pursues economic readjustment. This demand growth, along with India’s receding iron ore exports in the face of recent 30 per cent iron-ore export tariffs, has prompted major exporters in Australia and Brazil to expand and capitalise, but has also motivated investors to look to regions traditionally considered too risky as sources of supply — a move that is now deeply entrenched.
Several countries in West and Central Africa have vast, high-grade iron-ore reserves and low labour costs. But the development of Africa’s resources requires massive capital infrastructure investment in politically and economically risky environments, and Western banks have in the past been extremely hesitant to provide funding.
China, on the other hand, has taken advantage of its non-interference approach to international relations with major iron-ore mining and infrastructure projects underway in places like Guinea, Cameroon and Liberia. China’s relationships with these states provide assurance to its predominantly state-owned resource investors and banks when making large capital investments in operationally risky projects.
In the context of global economic uncertainty and slowing inward investment, China’s Ministry of Commerce has announced that over the next 5 years the aim is for Chinese investors to make US$390 billion in overseas direct investments (ODI) (current global stock of Chinese ODI is around US$170 billion).
This money is not all earmarked for African iron-ore development and the new rules of China’s State Assets Supervision and Administration Commission (SASAC), demanding greater due diligence and risk management on all overseas investment deals by state-owned companies, further disciplines Chinese investment abroad.
To attract their required share of Chinese ODI, African governments will increasingly need to provide a consistent, transparent and supportive business environment. But if 14 per cent of this ODI is directed to African iron ore development it would meet RBC Capital Markets’ estimated capital costs of US$52-54 billion to develop 32 African iron-ore sites by 2016.
Using seven risk categories, I constructed three risk-based scenarios to analyse the potential development of 17 iron-ore mine sites across West and Central Africa — high, medium and low-risk, where high-risk has a greater probability of delay. My analysis, undertaken for the East Asian Bureau of Economic Research (EABER), suggests that by 2018 an additional 481 million tonnes per annum (mt/a) could be available to the global export market in a high-risk scenario (225mt/a in the medium risk and 90mt/a in the low risk). With the addition of global iron-ore export-capacity expansion in other countries, there is a potential for 27 per cent overcapacity in the export market at that time (10.6 per cent in medium- and 2 per cent in the low-risk scenarios).
Export overcapacity on this scale would put significant downward pressure on the price of iron ore. The cost insurance freight (CIF) price to China could drop to around AU$60 per tonne in the high-risk scenario; AU$65 in the medium-risk; and AU$80 in the low-risk.
If the CIF price fell to AU$60-65 per tonne low-cost iron ore producers’ margins would be slashed and expansion plans delayed; marginal producers, mainly in China but also globally, would be pushed out of the market. In the low-risk case, low-cost exporters would still have significant — although heavily impacted — margins, but high cost producers would be pushed out.
These three African iron ore development scenarios have significant implications for Australia’s economy — iron ore is expected to contribute AU$59.7 billion to Australia’s GDP in 2011-12. A drop in prices, particularly in the high and medium-risk scenarios outlined above, would have negative impacts on Australia’s terms of trade; real exchange rate; revenue collected from the Mineral Resource Rent Tax; and would further constrain Australia’s budding magnetite industry, which is forecast to add AU$4.5 billion to national GDP per annum and create more than 4000 jobs over the coming decade.
Luke Hurst is a PhD candidate in economics at the Crawford School of Public Policy, The Australian National University. This essay digests research on, ‘African iron ore: A lesson in the contestability of the iron ore market’. East Asia Forum