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Why a drop in Chinese iron ore imports is worse for Fortescue Metals Group Limited (ASX:FMG) than its peers

A slump in iron ore exports to China and mounting inventories of the steel making ingredient at Chinese ports shouldn’t worry our two largest iron ore producers as it should Fortescue Metals Group Limited (ASX: FMG).

The share price of Fortescue has underperformed with the stock tumbling 19% over the past year when BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) have surged 32% and 21%. In contrast, the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is up 9%.

Fortescue’s losing streak could persist after Chinese iron ore imports fell 11.6% to 83.2 million tonnes in June from the previous month, according to Reuters.

Further, there’s 156.4 million tonnes of iron ore stockpiled at Chinese ports, which is just below the record high of 162 million tonnes in early June, data from SteelHome consultants showed.

One of the key drivers behind the falling demand for Australia’s largest export is pollution control. The Chinese government has been cracking down on the dirtiest steel makers to clean up the air in the major steel producing cities of Beijing, Tianjin and Hebei.

The environmental crackdown by the Chinese government is the primary reason why Fortescue is lagging so far behind its larger rivals. Fortescue produces lower quality ore and that means steel producers have to burn more of it in their blast furnaces to produce the same amount of steel compared to the higher quality commodity that is sold by BHP and Rio Tinto.

Some analysts were expecting the Chinese government to ease up on these restrictions around this time of the year but I don’t think that is likely to happen given the rhetoric from China’s ruling party.

If anything, the drop in imports supports the theory that the country’s leadership may not only be holding firm on their curbs but may increase restrictions on the steel industry.

The existing restrictions have created a big discount on the price of Fortescue’s ore compared to the ore sold by BHP and Rio Tinto, and this discount may not disappear for a while yet – especially if the ongoing trade war persists.

The tariffs imposed by US President Donald Trump on Chinese imports into the US will dampen demand for our ore and the excess supply of the commodity will provide little incentive for steel makers to purchase the more polluting ore.

What’s more, the latest production figures for Rio Tinto, BHP and their Brazilian counterpart Vale S.A. are likely to show a jump in output. Rio Tinto and BHP will release their quarterly reports this week while Vale is scheduled to announce its numbers on July 25.

As with most things in life, stick to quality when investing in our iron ore producers.

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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited and Rio Tinto Ltd. 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 Scott Phillips.