China’s cut to coal and steel sectors is bad news for iron ore

Credit: iStock

Iron ore prices have staged a rally of sorts since the start of this year, including a 2.8% gain overnight to US$49.62 a tonne, but the good times may be ending.

At a news conference on Monday, Yin Weimin, the Chinese Minister for Human Resources and Social Security said that 1.8 million workers in the coal and steel sectors could lose their jobs. 1.3 million of those employees are in the coal industry. The sectors employ around 12 million workers, so it’s a drastic 15% cut in the work force.

The process is expected to take a number of years, as China works to overcome its bloated, inefficient industries and reduced the significant overcapacity and over-production of coal and steel.

More than half of China’s major steel producers reported losses last year. Member companies of the China Iron and Steel Association (CISA) suffered a combined loss of US$9.8 billion last year, after the steel industry contracted for the first time in nearly 35 years in 2015, according to the Financial Times.

Raw steel production fell 2.3% somewhat reducing the oversupply of steel, but nowhere near the levels required to match demand. Steel prices have dropped by more than 70% over the past two years.

Shanghai Baosteel Group Corp has reportedly forecast that China’s steel production may eventually shrink 20%, according to Bloomberg. Shen Wenrong, the Chairman of Shagang Group, China’s largest private steel mill also say he expects production to fall by 10% within the next decade from the current production levels of 830 million tonnes a year.

That flies in the face of predictions from BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) which had been forecasting China’s production to peak at around 950 million tonnes in the mid-2020s.

Coal supply has also been falling, with cheap gas offering a cleaner energy supply, while seaborne metallurgical coal supply growth sinking.

BHP recently estimated that more than 30% of the energy coal, metallurgical coal and iron ore sectors are operating at a loss at current prices, but much of that may, in fact, be Chinese operated so don’t necessarily have to be profitable. By that, I mean the companies are supported by the government, or sell their product to local steel mills.

The good news is that the proposed job cuts to the steel and coal industries should see coal and steel production fall, bringing supply and demand closer together. That should result in more stable commodities prices, but is likely to take some years.

Foolish takeaway

If steel production falls, demand for metallurgical coal and iron ore will also fall, and that seems highly likely to occur. Simple economics suggests that unless supply also moderates, coal and iron ore prices will keep sinking. That’s not great news for high-cost coal and iron ore producers.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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