Will China take the iron ore nuclear option?

Treasurer Josh Frydenberg is on the hustings lording it over China today. Following yesterday’s righteous cancellation of VIC sub-national deals with the BRI, he appeared to fear no reprisal:

  • There will be no disruption to iron ore flows.
  • China needs the iron ore and China will keep buying it

This is the base case. But there is a risk case that cannot be dismissed out of hand. China has an iron ore nuclear option if it wants to take it. Li Keqiang talked two weeks ago about the need to increase regulation to address cost pressures in commodities.

What form could this take? The bilateral trade between Australia and China for iron ore has an element of mutually assured destruction to it.

Without Aussie iron ore, the Chinese economy would see a sudden and very severe economic shock as steel stopped being made.

Likewise, but less so, Australia would experience a sudden income and GDP shock though not an especially large jobs impact.

The key is that the volumes of the mutual trade are a very large proportion of the overall import and export mix for both. For Australia, 80% of its iron ore goes to China.

This means that neither could find replacement markets, which hands both parties a loaded gun in a Mexican standoff.

In China’s case, it could elect to fix the iron ore price that it is willing to pay Australian miners. Let’s say at $120. If it did, Aussie miner’s wouldn’t have a whole lot of choice in the matter. To not ship their product to China is to basically shut down.

Such a price would still be above the entire Australian supply cost curve so everybody would face a stark choice. Make lower if still excellent profits or go out of business.

The Chinese gambit would force all Australian producers to either accept the offer or to act as a cartel in response, probably in tandem with the Morrison Government. That would still leave Chinese-owned operations running.

But would Australia Inc. have the gumption to stop shipments in a face-off against a Beijing that was still offering an excellent price?

Australia would go to the WTO. But does that scare Beijing? Meh.

Long term, it wouldn’t do China any good. The last thing it needs is such stark sovereign risks appearing in commodity supply chains upon which it is immensely dependent.

But it might calculate that such a gamble is worth it to punish Australia as an example for all others.

Or, it might act irrationally, after its thirty-year campaign to buy Australian allegiance so fulsomely foundered on the rocks.

Some prices for ya going into the weekend:

David Llewellyn-Smith
Latest posts by David Llewellyn-Smith (see all)

Comments

  1. Ronin8317MEMBER

    If the price for Australian iron ore is fixed at $120, a new iron ore mine will appear from nowhere in Singapore 😛

  2. My view, like the last great price spike is that China is masking its stimulus, expansion and ore demand with massive military infrastructure like the Spratly Islands, South China Sea Islands etc.

    Its been reported that China is expanding the “Great Steel Wall of China” to defend itself against deep penetrating US hypersonics and weapons like Project Thor along with their own transportation and delivery objectives of their new DF-17, 21 weapons.

    • Australia V China in years to come will be a bit like the US and Iraq (twice over)

      In China (US) they will be asking “How did all of our iron ore (oil) get to be in Australia (Iraq)?”

  3. Over the last decade the iron ore price has fluctuated quite wildly. CCP trying to lower it to $120 hardly seems severe punishment – it has traded well below that point in recent years and would end up well below that price just based on waning demand if China ever weans itself off endless infrastructure investment.

  4. The $120-type action seems most likely…but would the faux-market playing CCP risk being exposed as an actual faux-market player? What are the knock-on consequences?

  5. pfh007.comMEMBER

    Hard to believe the Chinese are not prepared for Australia to do a bit of Koala Kommando in response to Wolf Warrior.

    Who tracks the iron ore once it arrives in China and after it is made into steel.

    You can fit a lot of steel inside a warehouse.

    A one metre square block of steel weighs ? 7.85 tonnes?

    Which means in a warehouse 100 metres long by 10 metres high x 50 metres wide = 50,000 m3

    Equals 400,000 tonnes of steel approx.

    Wouldn’t take much space in China to hoard a few years supply of steel.

    Has anyone traced exactly where all the iron ore ends up once it enters China?

    • I think a reasonable amount goes to wards Chinese naval ship building. Add to this cars, a high speed rail network and building construction

      • pfh007.comMEMBER

        Sure but that doesn’t rule out Chinese preparations for Australia having a set of balls (I know we don’t).

        Why would China get in our face without a plan to deal with Australia cutting their iron ore supply.

        It is exactly what they would do.

    • I suspect China masks a huge amount of military infrastructure – the Spratly Islands, South China Sea Islands – now being expnded again, and their Great Steel Wall which includes subterranean rail and road freight transport for mobile missiles launchers is meant to be massive.

      https://www.dailymail.co.uk/news/article-6615715/China-building-indestructible-underground-Great-Wall-fend-foreign-attacks.html

      Their submarine base for example is the Yulin Submarine Naval base and is a steel reinforced mountain island which opens directly under the ocean so that their subs can be built and deployed and return without anyone every knowing their full number.

      • pfh007.comMEMBER

        I am sure they have a lot of military skunk works but I am also sure they would be prepared for Australia cutting off their iron ore supply.

        Who says the massive sales over the last few years have not been building massive stockpiles of iron and refined steel.

        If China seriously needs ore from Australia on a continuing basis they are really playing with fire assuming we (or Biden) will not tell them to get stuffed.

        If the US wanted to cripple China what better way than have their deputy sheriff kick them in the nuts with a steel embargo?

    • peter strachan

      Maybe they’re storing it in completed ghost towns and bridges to nowhere? Keeps employment up to build the stuff and if ever they are cut off from iron ore supplies they can recycle it by demolishing them. I don’t know. Is that possible?

  6. SoCalSurfCreeperMEMBER

    In the long run subsidies lead to surpluses and price controls lead to shortages. If China imposes price controls, sooner or later they’ll face shortage.

  7. Alex PiccininiMEMBER

    Australia is screwed in 2024 when Simandou comes online. The extra China pays today is a small price