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China to grow but cut prices |
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DATE |
2008-10-09 09:24:02 |
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China to grow but cut prices
Rowan Callick, China correspondent | October 09, 2008
CHINA has a bottom line of demand that will sustain Australia's mining - but at a more modest level, says one of Australia's leading deal-makers with Chinese corporations.
Shanghai-based Paul Glasson, who has been involved in many recent Chinese investments in Australia, and is KPMG's strategic alliance partner in China, warned yesterday: "Without China, it's all over."
Western Australia's peak business group has defied the global doom and gloom by predicting continued strong economic growth in the boom state on the back of surging exports.
The WA Chamber of Commerce and Industry's economic compass, due to be released today, said the state's economy was continuing to "run hot" despite the global financial crisis.
The chamber declined to downgrade its previous forecast of 5.5per cent economic growth in 2008-09, and forecast 6.25per cent growth in the state for the coming two years.
John Pegler, the chief executive of coal-mining company Ensham Resources and the president of the Queensland Resources Council, said demand for Australian minerals remained strong, particularly from Asian countries.
"The fundamentals of the Australian resources products are driven by demand from many Asian countries, China in particular, and it's difficult to see that abating," Mr Pegler said.
"It's possible there might be some lessening in demand for goods made in China and exported from there.
"But there's also a very strong demand within China itself for their own economic development, and that will continue."
Fortescue Metals Group executive director of operations Graeme Rowley said: "China's growth is going to slow down to 8, maybe 9 per cent - we'd all love to have that growth, it's significant growth, and for a country the size of China it's enormous growth in anybody's language.
"I remain extremely positive about Chinese iron ore demand growth," he said, "and obviously from our perspective that means we'll get cashflow and we will continue to grow."
How China responds to the international crisis will be crucial to Australia's fortunes.
The central committee of the ruling Communist Party is starting a crucial four-day meeting in Beijing today, during which leaders will consider China's response to the global economic downturn.
The pressure is immense, from within China's market commentators and blogosphere, to use the country's savings domestically to maintain strong growth.
Reconstruction of Sichuan province following May's devastating earthquake will certainly continue, including the building of 4.5million new homes, 51,000km of roads and 12,000 schools. Other massive infrastructure projects will remain on track, such as the upgrading of China's national rail network and of power infrastructure.
The focus on such developments, absorbing considerable amounts of resources that Australia exports, including iron ore, will be reinforced by the need to deploy Chinese savings at home rather than investing them, more riskily, abroad.
But some of China's recently booming sectors are being hit by the downturn, including A-grade office construction.
As company revenues from exports fall, margins are hit by continuing domestic inflation and cash becomes king, Chinese demand for higher-quality office space is diminishing.
The Government has sought to counter dropping real estate valuations, which are angering the country's army of new-home owners, by allowing insurance companies to invest in the property sector.
China's steel output was up 15.7 per cent in 2007, to 489 million tonnes, four times that of Japan, the next biggest producer. And the China Iron and Steel Association forecast a further 10 per cent growth this year to 540 million tonnes. While this now appears over-optimistic, China is still on course to increase its production to exceed 500 million tonnes.
Mr Glasson said: "The panic in the markets indicates some people think Chinese demand is going to slump away to almost nothing. That's just nonsense. The Australian dollar is also an example of this - being sold off on the basis that commodities demand will diminish to unrealistic levels."
Pricing is another matter. China has imposed price caps on key resource inputs to its still rapidly growing - but slowing - economy, including on oil and coal. And debate is growing, with the hard-hit manufacturing exports sector leading the way, about capping the steel price, coupled with policies to stimulate the export sector, which would help to keep demand for resources buoyant.
The companies dominating the oil and coal sectors are all state-owned, so the Government has at the same time provided them with subsidies - although not enough to fully compensate them.
A steel price cap, similarly applied, would provide strong reason for China's steel corporations to argue for lower prices for iron ore and other key inputs, including nickel.
In the short term, the price of steel has been falling, although it is unclear how far this has been accentuated by the construction halt imposed during the Olympic Games.
China's biggest producer, Baosteel, announced yesterday a reduction of almost 10 per cent in prices for most of its products, which have already fallen about 30 per cent this year.
China has built up a considerable stockpile of iron ore - about 200 million tonnes by last month. This gives the steel industry a buffer from which to press suppliers for lower prices, especially for ore on the spot market, which has already fallen to the same level as the contracted price for ore from Australia, raising questions about the value of entering into longer-term contracts.
The steel industry in China is consolidating, in line with government policy, presenting Australia with fewer buyers. Private Chinese investors had moved into the sector in recent years, in part seeking a share of its high profits, in part anticipating they would be acquired for a premium as the Government drove to consolidate its control of the industry.
Because these private mills have been comparative latecomers, they have been among the keenest buyers in Australia - both of assets and of ore - at higher prices. But as the steel price falls or is capped, they are coming under strong pressure, because they are not going to receive the same subsidies as the larger state-owned operations, and their economies of scale are less able to absorb diminishing returns.
This is another factor, said Mr Glasson, likely to mean ore prices are going to be lower.
"If these companies don't get ore, the industry will contract into six state-owned steel producers, and some of the mid-tier private sector will be out of business or acquired by the larger ones," he said.
"But their situation has changed dramatically from recent times, when they have been running around Australia seeking assets and ore at almost any price."
This will make life tough for some emerging producers in Western Australia, whose mines have come on stream or are being constructed, predicated on a high ore price.
It now looks as if the price obtained this year by market leaders BHP-Billiton and Rio Tinto will prove the peak, at least for the near future.
Thus the emerging producers are likely to enter contracts at lower prices, to underpin their share values - although the lower dollar is one compensating factor, boosting their return from sales to China, whose currency is steadily appreciating.
China, said Mr Glasson, will be expecting to acquire Australian mining assets at better prices because of its capacity to bring in capital that is difficult to obtain in today's global climate from any other source.
While the price of assets and of ore might fall, he said: "The number of successful Chinese investments might actually increase. China will be considering carefully how it will position itself in terms of both financial and energy resources on the back of the economic climate.
"This will probably result in both more and bigger asset plays in Australia, but with fewer players. China is also getting better at concluding transactions. It will be less messy than it has been.
"There is no doubt that China is the answer for Australia's resource industry. Its sustained economic growth and that of India make all the difference from periods of previous downward pressure on commodities.
"In the early 1990s, exploration permits were left at the bottom of people's drawers. That won't be happening again. China and India underwrite a bottom line."
But some earlier approaches from China will not be followed through, and some deals already negotiated will be reopened if the cash has not yet been paid.
Recently, a Chinese steel company renegotiated the price of a contracted iron ore shipment from India after it had already arrived in a Chinese port - a move that sends a warning to Australian suppliers.
Mr Glasson said that having Chinese equity of up to 50 per cent of a project made sense in terms of risk management, helping to guarantee the market and the price. A buyer-only position now has greater medium-term risk. And China is not interested in trading such assets with other countries - although a fall in their book value is potentially damaging to the careers of leaders of the enterprises that buy them.
This deters bold decision-making in volatile times like these.
Broader risks remain. For instance, Mongolia has massive reserves of coking coal, and its only borders are with China and Russia, countries that are increasingly working together.
If China obtains access to a large proportion of this resource, said Mr Glasson, it would place great downward pressure on the price of Australia's biggest single export commodity, although little is bought by China.
Hu Kai, an analyst at Umetal.com, said yesterday: "We are hearing from people in the steel industry that they want at least a 20 per cent cut in next year's contracted steel price.
Additional reporting: Andrew Fraser, Matt Chambers
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