The China Thread

Got coal and ships?

Commodities

The bulk of it goes to China.

To most people the world of commodities conjures up images of precious metals and there is no doubt that the gold and platinum group metals have put on a sparkling performance in 2003. But in fact the real commodity story of 2003 has been the bulk commodities. Unfortunately, iron ore, coal and alumina are not quite so exotic as platinum and palladium. While the price performance of the traded metals has been spectacular in bulk commodities the real story has really been about volume more than price, though prices have been good too.

Data for bulk commodities tends to be released more slowly than for metals traded on terminal markets. Even so, what is available is pretty amazing. In 2002, as in 2001, China produced more steel than any other country. And not just a little bit more. Its 2002 production of 180 million tonnes is twice that of America’s and way above the 108 million that Japan produced. Given that Chinese production rose 23% in November this year to 20 million tonnes it is clear that 2003 is going to break new records. Year to date production is already over 200 million tonnes.

To make steel you need two key ingredients: iron ore and coal. While China has both, especially the later, it is actually more effective for it to import the iron ore from Australia where the large scale operations are very efficient and low cost. That mostly explains why Chinese iron ore imports are expected to rise by 37 million tonnes to 148 million tonnes in 2003 and total Australian iron ore exports are forecast to rise 12% to 203 million tonnes. These are big number and with those sorts of increases it is not surprising to read that analysts expect a 9% price rise to be negotiated next year. But here’s the nasty part. The strength of the Australian dollar means that the revenue from exports will only rise by 4% in local currency terms. That might be modest, but it certainly shows that Rio Tinto’s battle to win the fight for mining company North against Anglo American a few years ago was worthwhile. It also demonstrates that Billiton’s merger with BHP was very timely.

The situation in coal is quite different in that China is a large producer in its own right, something of the order of a billion tonnes a year which is about the same as the US. However, most of the US production comes from large scale, usually open-cut mines that are very low cost. In China by contrast mines are small, labour intensive and not at all efficient. One of my least favourite site visits as a mining analyst was to a coal mine in China that entailed crawling along little rat runs on hands and knees to get to tiny little coal faces. Our hosts were also especially eager to take flash photographs of us. Not something I was very comfortable with. These mines are simply not capable of rapid expansion to supply the massively expanding steel industry, particularly in the higher grade coking coals needed to make steel. With that background it is understandable for international coking coal prices to be forecast to rise by 20% next year. That makes it the biggest jump since the nineteen seventies, the last time there was a serious commodity price boom.

Aluminium is the metal used in the largest volumes after steel. China, as we might expect, is now playing a leading role in producing this metal as well as consuming it. Reported primary production in 1999 was 2.6 million tonnes but this had risen to 4.3 million by 2002 and with output of 4.9 million in 2003 for the year to November it is clear that this year is going to show another large jump. To make aluminium you need alumina, a classic high volume low value bulk commodity. Demand for this raw material will rise in step with aluminium production.

There is one thing that ties all these commodities and China together. Because they are bulky moving them around the world is not easy and the rapid rise in demand and volumes has caught the shipping industry on the hop. A measure of the strength of that market is that the Baltic Dry Index reached an all time high of 4560 at the end of October. Although it has only been in existence since 1985 the shape of the graph of the index resemble a commodity in full bull market form. After bouncing around the 1,000 level for years it started to move up at the beginning of this year and then has just climbed vertically to almost quadruple. That makes the performance of some precious metals look pretty pedestrian.

This boom demonstrates that there is not enough shipping capacity available. A ship building boom can be expected very shortly. And as ships need a lot of steel it is a fair guess that the market for the bulk commodities looks set fair for some time to come.