BEN HARVEY: Australia considers nuclear option in iron ore war with China

The iron ore game has traditionally never been a particularly risky business.

For most of its 60-year life in Australia, the sector has been steady and one with low margins.

The politicians and business analysts who clutch their pearls at the prospect of a tonne of iron ore dropping under $US100 should remember that up until the mid-1990s the companies mining it were happy to get a fifth of that price.

BHP and Rio Tinto had to deal with the usual risks faced by any exporter — dangers linked to currency fluctuations, the credit worthiness of customers, Government decisions and whatnot.

China’s industrialisation saw the price of iron ore surge up to ten-fold and few executives could see any downside to hitching their wagons to Beijing.

Perhaps they missed the emerging “concentration risk” because they couldn’t see over the stacks of money they were making for shareholders, governments and (most importantly) themselves.

It took a while for the perils of this new risk to come into focus.

We happily tied our economy to the Middle Kingdom in the early 2000s and for a while there everyone seemed happy with the arrangement.

Local politicians even started getting a little pious about how Australian iron ore was creating the steel that was helping Beijing lift 400 million people out of poverty.

We wilfully ignored the fact that Beijing’s flawed policy decisions had kept those 400 million in poverty for far longer than they should have been, just as we wilfully ignored the fact that Australian steel was increasingly ending up not in railways, dams and hospitals, but in tanks, fighter jets and aircraft carriers.

The relationship became fractious only when Xi Jinping cracked it with Australia’s refusal to bow down and become a mendicant state subservient to the People’s Republic.

First came trade restrictions, then came overt military pressure and now China is targeting this country’s most important industry.

The trade restrictions affecting beef, barley, rock lobsters and wine have nothing on the current fight over the price of iron ore. It has implications for Australia’s balance of trade, Federal budget, unemployment rate and standard of living.

In layman’s terms, China reckons Australian miners (and Brazil’s Vale) are taking the piss.

Fortescue chief executive Dino Otranto told the crowd at a recent business event how Beijing delivered the news that the jig was up.

Otranto and a bunch of other mining executives had been invited to China in 2022, at which their hosts put up a slide showing the profitability of Australian iron ore miners versus Chinese steel mills.

It showed margins of up to 80 per cent for the miners as compared with often negative returns for the mills that bought the ore.

It goes without saying that Beijing’s policy makers can make financial numbers do whatever they want (it’s one of the advantages of being able to throw your statisticians in a gulag if they don’t do what they’re told) but there’s no doubt the miners have had it pretty good of late.

To ensure “shared prosperity”, the Chinese formed a buying cartel — the China Mineral Resources Group.

The biggest steel mills now negotiate as one bloc, as directed by the Chinese Communist Party, in a bid to drive down the price.

This is a big problem for Australia because every $1 drop in the price of a tonne of iron ore (when averaged over the year) is $93 million in lost royalties to the WA Government and tens of millions more in foregone tax to Canberra.

The Federal Government is now investigating ways to give the miners a leave pass from competition laws so they can also negotiate as a bloc — which grain growers used to do under the (scandal-ridden) Australian Wheat Board.

The fact the miners have suspended their ardent opposition to Federal regulation (now that their short-term incentives are imperilled) is a sign of how worried everyone has become about the $100 billion-a-year trade.

Canberra sees the creation of an Australian cartel as a nuclear option and knows that like with every nuclear option there will be fallout.

We can expect China to retaliate in other sectors, and Australian farmers will likely become collateral damage.

Australian policy makers should be mindful that the manipulation of the iron ore market from the demand side isn’t the only lever China can pull — they could arbitrarily re-price the commodity.

That seems a big ask, even for China, but if you understand how iron ore is valued you will see how they could do it.

When you see on the finance report on the news that iron ore is trading at, say, $US100 a tonne, where do you think that price comes from?

Iron ore doesn’t have an RRP displayed on the shelf. There are all sorts of different ore types, and not just haematite and magnetite.

There’s high-value lump ore (nuggets that are a couple of centimetres in diameter) and cheaper iron ore fines (granules that need to be bound together to be useful).

And in each of those categories there are different iron concentrations, ranging from 52 per cent to 67 per cent.

Every day, dozens of buyers are ordering dozens of different iron ore shipments in dozens of different markets. So how can anyone say with certainty that it is $US100 a tonne?

Here’s how.

When Alan Kohler is on the ABC talking about iron ore he is quoting something called the Platts Iron Ore Index. It’s named after journalist Warren C Platt, who was an expert on oil prices.

The Platts index measures the value of one dry metric tonne of medium-grade iron ore fines with a 61 per cent iron content delivered to the Chinese port of Quindao.

Each day, staff at Platts collect information on bids, sales and other transactions to create an average price at the close of trade. That’s the “benchmark price” we hear so much about.

Here’s where politics comes into it. The Platts index is administered by the financial services company Standard and Pores, which we know as S&P and is headquartered in New York.

In short, China doesn’t trust it.

Beijing wants iron ore miners to use a Chinese benchmark, which, shockingly, is consistently lower than the Platts price.

If China can heavy everyone to use the new benchmark — and they’re applying the screws now — the price of iron ore would immediately drop by about 15 per cent.

And given Beijing can make numbers do whatever it wants (remember the alleged profitability of Chinese steel mills?) you can bet it’s only a matter of time before the new Chinese index drops another 15 per cent.

Want to know why Anthony Albanese is considering a nuclear option?

It’s because the difference between $US100 and $US72 is $20b less over the four-year forward estimates.