3802
Views

Oil Plummets, But the Iron Ore Trade Carries On

alt
File image courtesy CSIRO

By The Strategist 05-06-2020 02:49:36

[By David Uren]

The continued strength of the iron ore price is surprising, given the collapse of oil, which traders have recently been willing to pay buyers for if they’ll agree to offload full tankers.

Oil and iron ore are the two most basic commodities of industrial economies and, through much of their history, their prices have moved in tandem along with the underlying health of global industrial production.

But iron ore has been holding comfortably above $80 a tonne throughout the Covid-19 crisis, delivering a continuing run of fabulous profits to Australia’s big miners, BHP, Rio Tinto and Fortescue, which can all dig it up at a cost of less than $15 a tonne. The current price is about 35 percent higher than the Australian government expected when it cast its mid-year budget outlook last December.

The short explanation for iron ore’s strength is China. China buys almost three-quarters of all seaborne iron ore and is the dominant influence on prices. China is seen to have emerged from the public health crisis and there’s an expectation the government will respond to lingering weakness in its economy with public spending on infrastructure that will boost steel demand.

By contrast, China accounts for only around 14 percent of the global oil market, which has abruptly contracted. The International Energy Agency estimates oil demand globally will be down six percent this year, equivalent to subtracting India’s entire consumption.

With the Covid-19 crisis still acute across the major Western economies, it is too soon to know what the global economy will look like on the other side of it.

It may be that once social-distancing restrictions are eased, everyone will go back to eating at restaurants and then, once travel is allowed, resume their long-delayed holidays and business trips. It will all pass like a bad dream. 

But a more pessimistic scenario of a long-lasting downturn in global demand cannot be discounted. Unemployment will remain high, banks will face large debt write-offs and will be reluctant to lend, and companies will defer investment decisions.

The backlash against globalization that has been building since the 2008 financial crisis may intensify, with the renewal of hostilities between the United States and China and pressure on companies to repatriate their supply lines. The World Trade Organization has forecast a fall in trade this year of anywhere from 13 percent to 32 percent. The post-Covid-19 world could be more like it was in the 1930s, when trade halved as a share of global GDP.

The resilience of the Chinese economy and its demand for commodities would be severely tested. The modernization and development of the Chinese economy over the past 30 years has been driven by globalization and the rapid growth of world trade. China has had some success in reducing its dependence on exports and fostering domestic consumption, but trade still underpins its manufacturing industry and it looks troubled.

In the first three months of the year, China’s exports to the US were down by 25 percent and its sales to the European Union were down 16 percent. Bigger falls are likely in the second quarter.

To some extent, the strength of the iron ore price relative to oil is a function of the leads and lags in the respective supply chains. Oil storage is limited and, if the producing nations keep pumping it at a faster rate than consumers are using it, the available space fills to the brim. The oil market is at that point.

By contrast, China’s manufacturers, construction companies, traders and producers all keep stocks of steel, and prices have been supported by buyers adding to inventories in anticipation of a revival in economic demand. The latest readings on Chinese industrial production for April show that, while businesses are slowly getting back to work, the loss of export markets is reducing overall output.

David Uren is a non-resident fellow with the United States Studies Centre at the University of Sydney.

This article appears courtesy of The Strategist and is reproduced here in abbreviated form. The original is available here

The opinions expressed herein are the author's and not necessarily those of The Maritime Executive.