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china_steel
C h i n a b emerging d t e e l inaudtry an2 i t d impact
on t h e worla iron ore an2 d t e e l market
Stephen Labson
Peter Gooday
Andrew Manson
ABARE
ABARE RESEARCH REPORT 95.4
O Commonwealthof Australia 1995
This work is copyright. The Copyright Act 1968permits fair dealing for
study, research, news reporting, criticism or review. Selected passages,
tables or diagrams may be reproduced for such purposes provided
acknowledgment of the source is included. Major extracts or the entire
document may not be reproduced by any process without the written
permission of the Executive Director, ABARE.
ISSN 1037-8286
ISBN 0 642 22650 4
Labson, B.S., Gooday, P. and Manson, A. 1995, China's Emerging Steel
Industry and its Impact on the World Iron Ore and Steel Market, ABARE
Research Report 95.4, Canberra.
Australian Bureau of Agricultural and Resource Economics
GPO Box 1563 Canberra 2601
Telephone (06) 272 2000 Facsimile (06) 272 2001
ABARE is a professionally independent government economic research
organisation.
ABARE project 1162
Foreword
The industrial development of China over the past ten years has been
concomitantwith pronounced growth in China's iron ore and steel industry.
While much of this growth has been confined within domestic boundaries,
China's role in the world iron ore and steel market has increased markedly
since the early 1980s. This continuing integration with the world market,
coupled with China's growing iron ore and steel industry, is likely to have
a profound impact on world iron ore and steel trade. As a major exporter of
ironore,Australiais likelytobe particularly affectedby suchmarketforces.
The purpose in this study is to examine the potential impact of China's
emerging steel industry on the world iron ore and steel sector. This study
formspart of ABARE's continuingresearchintothe globalironoreand steel
markets, markets where Australia plays a vital role.
BERNARD WONDER
Executive Director, ABARE
March 1995
iii
Acknowledgments
The authors would like to acknowledge the role of Tom Waring in offering
the original inspiration for the modelling effort underlying this study, and
helpful comments offered by Terry Shealeson previous drafts.
Contents
Summary 1
1 Introduction 7
2 Development of the Chinese steel sector 9
Economic reform 10
The impact of reforms on the Chinese steel sector 11
The Chinese steel industry at present 12
China's participation in the world steel and raw materials
markets 18
The Chinese steel industry in 2000 20
3 Global effects of growth in the Chinese steel
industry
Baseline projections
The effects of high economic growth in China
The effects of low economic growth in China
4 Conclusions
I Policy directions
Appendix
Description of the world iron ore and steel trade model
I References
Box 1
A model of the world iron ore and steel trade
Map
Steelworksand iron ore producing regions in China 14
Figures
A Chinese crude steel production
B Chinese steel imports
C Chinese iron ore consumption
D GDP growth at constant prices
Tables
1 Chinese iron ore and steel production and imports 7
2 Steel production from major Chinese plants in 1993 13
3 Production of steel by product group 15
4 Iron content of marketable ore 17
5 Crude steel consumption, 1992 21
6 Baseline industrial production 24
7 Baseline projections of steel consumption and production 26
8 Baseline projections of iron ore consumption and production 28
9 Projected steel consumption and production under the
scenario of high growth in Chinese industrial production 30
10 Projected iron ore consumption and production under the
scenario of high growth in Chinese industrial production 31
11 Projected steel consumption and production under the
scenario of low growth in Chinese industrial production 32
12 Projected iron ore consumption and production under the
scenario of low growth in Chinese industrial production 33
13 Partial elasticity of steel demand 40
14 Price elasticity of iron ore supply (major producers) 45
15 In sample dynamic simulation performance, 1983-9 1 52
Summary
China is undergoing rapid industrial development China was the
due, at least in part, to the economic reforms world's thirdlargest
implemented since the late 1970s. Growth in the steelproducer in
Chinese iron ore and steel sector has been 1993, afivefold
concomitant to this development, placing China increasefrom 1970
among the world's largest producers and consumers
of steel and steelmaking raw materials. China has
progressed from being the world's seventh largest
steel producer (in volume terms) in 1970, to fifth in
1980and to third in 1993,behind the CIS and Japan.
The 89 million tonnes of steel produced in China in
1993is five times greater than the quantity of steel
produced in 1970 and almost two and a half times
that produced in 1980.
Even with this extraordinary growth in production,
China's demand for steel has outpaced domestic
production and China has become a significant
importer of steel. However, the volume of imports
has been extremely volatile, ranging between less
than 5 million tonnes and 30 million tonnes over the
past decade. By all accounts, production and
consumption of steel within China are expected to
I increase at a rapid pace to the end of this decade
' making China an increasingly important participant
in the world iron ore and steel market.
Chinahasvastdomesticreservesof steelmakingraw
materials, particularly iron ore and coking coal.
However, while China is likely to remain largely
self-sufficientin coking coal, it is expected to rely
more heavily on importediron ore as aconsequence
of the relatively poor quality and locationof its iron
ore deposits. Thus, continued growth in the
production of Chinesesteelcanbe expectedto result
in increased imports of iron ore. As a major supplier
Chinahas become a
significant importer
of steel and will
become an
increasingly
important
participant in the
world iron ore and
steel murket
Increasing demand
for iron ore in
Chinawillprovide a
largermarketfor
Australian iron ore
China's steel industry
of ironore,Australiaiswell placed torespondto this
demand.
A quantitative assessment
The model of world In orderto determinethepotential effecton the world
trade in iron ore market of growth in the Chinese iron ore and steel
and steel was used sector, a model of world trade in iron ore and steel
to examine the was constructed.Themodelis asetof linkedregional
impact of economic supply and demand relations. Capacity constraints,
growth in China adjustment costs, technological change and other
aspects of the sector are accounted for in the
modelling framework through their effect on these
supply and demand relationships. World prices,
production and consumption are then solved for
under market clearing conditions, that is, production
is equal to consumption. The model was employed
to examinethe impacton the world iron ore and steel
sector of economic growth in China by simulating
market outcomes based on projected growth in
Chinese industrialproduction to the year 2000.
China's expanding role in the world iron
ore and steel market
In addition to Annual steel consumption in China is projected to
increasing steel increase by 30 million tonnes over the period 1994
production China is to 2000. Thisincreasein demandaccountsfor 30per
expected to import cent of the projected total increase in annual world
increasing steel consumption over the same period. In response
quantities of steel to this significant increase in demand, China is
projected to increase annual steel production to 110
million tonnes in 2000, making China the world's
largest steelproducing country. Despite suchgrowth
in output of steel, China is projected to import
between 12and26 million tonnesof steel a year over
the rest of the decade.
The European To meet the projected increasein Chinese as well as
Union, North world steel demand, those regions with established
America and Japan steelmaking capacity, such as the European Union,
2 ABARE research report 95.4
North America and Japan are also projected to areprojected to
increase production. While projected steel increase steel
production for these mature steelmaking regions is production by more
well below previous peaks, growth in production is than loper cent by
significant, with each of these regions increasing the year 2000
annual steel production by more than 10per cent by
the year 2000.
China's increasingsteel output, comprised largely of China'sdemandfor
blast furnace based production, corresponds to an iron ore imports is
increase in annual iron ore consumption of 31 projected to rise
million tonnes over the period 1994 to 2000. Even from 37 million
with an increase in domesticproduction of iron ore, tonnes in 1994 to
China's import demand for iron ore is projected to 50 million tonnes
rise from 37 million tonnes in 1994, to 50 million 2y 2000
tonnes by 2000. This projected rise in iron ore
imports is consistent with Chinese plans for new
steel plants and increased capacity at existingplants
at locationsnear port facilities,and hence accessible
to imported ore.
Developments in iron ore supplying
countries
The major world exporters of iron ore are Australia, Australia, Brazil
Brazil and India. Australiais likely to be particularly and India will all
affected by growth in the Chinese steel market (as increase their
well as the general increase in demand worldwide). production and
In response to the projected increase in demand for exports of iron ore
iron ore,Australiaisprojected toincreaseproduction
by 17milliontonnesover the simulationperiod,with
16million tonnes of this increase sold on the export
market. Over this same period, Brazil's exports of
iron ore are projected to increase by 14 million
tonnes and India's exports by 10million tonnes.
, These projected increases in iron ore production Most of the increase
I from exporting countries can be expected to come inproduction willI
I from existing producers, and mostly from existing comefrom
mines. In Australia,a further 4 million tonnes a year existing mines
is planned to be mined from the Channar
China's steel industry 3
The effect of 'high'
and 'low' economic
growth rates in
China on the iron
ore and steel
market were
simulated
In the high growth
scenario Chinese
steel consumption
isprojected to rise
to 149 million
tonnes in theyear
2000. ..
...and to 119
million tonnes
under the low
growth scenario
(bothfrom a base
of 106 million
tonnes in 1994)
Australia-China joint venturemineby the year 2000,
with the increased production destined for the
growing Chinese market. Robe River Mining can
easily be expanded by 8 million tonnes. Hamersley
Iron's 12 million tonne a year capacity Marandoo
mine began production in 1994, as did BHP's 5
million tonne a year Yarrie mine.
The inJZuenceof economic growth in
China
While the projections presented above are based on
'best bet' assumptionsaboutfutureeconomicgrowth
rates, variations in economic growth could have a
marked effect on final outcomes. To illustrate the
impactof varyingrates of economic growthin China
on the iron ore and steelmarket, the model was used
to simulate 'high' and 'low' growth scenarios.
Under the high economic growth scenario, Chinese
industrialproduction is assumed to increase at a rate
of 15 per cent a year, which corresponds to the
averagerate of growth observed since the economic
reforms of 1985. In the high growth scenario,
Chinese steel consumption is projected to increase
from 106 million tonnes in 1994, to 149 million
tonnes in the year 2000.
Under the low growth scenario, Chinese industrial I
production is assumed to increase by only half as ~much as under the base case (around 5 per cent a
year). In this scenario, Chinese steel consumption is
projectedtoincreasefrom 106milliontonnesin 1994
to 119million tonnesin 2000.Therangeinprojected
Chinese steel consumption arising from varying
assumed economic growth rates highlights the
sensitivity of these projections to economic growth,
but also underscores the expectation for future
growth in the Chinese steel industry, even under
conservative assumptions for economic growth in
China.
Implicationsfor Australia
Australia holds the largest share of the Chinese iron Australia supplies
ore import market, supplying 17 million tonnes of over half of
the 33 million tonnes of Chinese iron ore imports in Chinese iron ore
1993. China's importance as a destination for imports- 15per
Australian iron ore exports has been increasing cent ofAustralian
strongly. In 1993China accounted for 15per cent of trade in iron ore
Australia's iron ore exports of 111million tonnes. in 1993
Australia is well placed to take advantage of the
projected increase in Chinese demand for iron ore.
Australia's relative proximity to the Chinese market
gives Australian iron ore producers a distinct cost
advantage in landing iron ore in China. With several
important additions to capacity expected to come on
linein the next few years, Australian iron ore exports
are projected to increase from 1I I million tonnes in
1993 to 137 million tonnes by 2000. Much of this
increase is likely to be used to satisfy the projected
17 million tonne rise in Chinese demand for im-
ported iron ore. Furthermore, the rapidly expanding
steelmaking industries in other developing Asian
economies, such as South Korea and Taiwan, as well
as a strengthening of steel production in Japan, will
offer Australia an expanding export market for iron
ore.
A rolefor cooperation
The degree to which growth in demand for steel and
steelmaking raw materials in China is sustained, and
the implications of this for Australian producers of
iron ore and steel, will be sensitive to the rate of
future economic growth in China, as well as the
development of a liberal policy environment that
allows for the free flow of trade, investment and
technology.Australia, asanefficientproducerof iron
ore and steel, has much to gain from a continued
effort to ensure a liberal, stable and well informed
policy environment within the region.
Australia's relative
proximity to the
Chinese market will
enable it to take
advantage of the
increase in China's
demandfor iron ore
South Korea,
Taiwanand Japan
will also offer
Australia an
expanding iron ore
market
The rate of
economic growth in
China and the
development of a
liberal, stable and
well informed policy
environment will
affect Australia-
China trade in iron
ore and steel
China'ssteel industry
The iron ore and
steel trade between
China and
Australia has
benefited from the
independent efforts
of Australian and
Chinese iron ore
and steel producers
Future
opportunities can
be assisted by
bilateral
government
organisations and
nzultilateral trade
agreements
China-Australia iron ore and steel trade has
increased through the independent efforts of
Australian and Chinese iron ore and steel producers,
as evidenced by the ongoing increase in Australian
iron ore exports to China and thejoint ventures being
formed by Australian and Chinese enterprises. There
is a recognition that further trade and investment
opportunities can be assisted by bilateral government
organisations such as the Australia-China Joint
Study Group intoIron Ore and Steel, and the Western
Australia-China Economic and Technical Research
Fund as exemplifiedby its recent studies intoiron ore
processing facilities in Western Australia. Together
with multilateral trade initiatives such as the GATT,
a Multilateral Stcel Agreement, or an East Asian
Steel agreement as proposed by Drysdale (1992),
such efforts will undoubtedly contribute to the
efficient development of the industry within the
Asian region as a whole, while also allowing for
increased Australian trade opportunities in iron ore,
as well as in value added iron and steel products.
6 ABARE research report 95.4
Introduction
China's steelindustry has been the fastest growing in the world over the past
two decades. It has progressed from being the world's seventh largest steel
producer (in volume terms) in 1970, to fifth in 1980 and to third in 1993,
behind the CIS and Japan. The 89 million tonnes of steel produced in China
in 1993 is five times the quantity produced in 1970 and almost two and a
half times that produced in 1980.
While much of this growth has been confined within domestic boundaries.
China's role in the world iron ore and steel market has increased markedly
sincethe early 1980s,with imports of steel accounting for up to 30 per cent
of total Chinese consumption. This continuing integration with the world
market, coupled with China's growing domestic iron ore and steel industry,
is likely to have a profound impact on world iron ore and steel trade.
As a major producer of iron ore, China has been able to satisfy a large
proportion of its demand for iron ore from domestic sources. However, the
increase in steel production observed over the past ten years has been
followed by a pronounced increase in China's imports of iron ore. Iron ore
imports increased from negligible amounts during the 1970s,to 33 million
tonnes by 1993 (table 1).
1 Chineseiron ore and steel production and imports
I
I
Iron ore Steel
I
Year Production Imports Productiona Importsb
1970 55.00 c 0 17.79
1975 96.94 1.44 23.90
1980 112.58 5.32 37.12
1985 137.84 10.11 46.79
1990 179.34 14.19 66.35
1992 195.95 25.20 80.04
1993 224.73 32.90 88.70
a Crude steel.b Semifinishedsteel.c 1971data. d Estimate.
Sources: International Iron and SteelInstitute (1993);UNCTAD (1994).
- - - -
CIzina'ssteel industry
It has been frequently suggested that strong growth in steel production and
consumption will continue at least to the year 2000 (see,for example, Chen,
Clements,Roberts andWeber 1991;Dorian, Clark,Jeon and Snowden 1990;
Drysdale 1992;Feng 1992).Although China has estimated reserves of iron
ore of over 46 billion tonnes, it appears unlikely that continued growth in
steel production will be based on domestically sourced ore. This is because
most of China's iron oreisrelatively low in iron content, leading to low blast
fuinace productivity and high energy consumption as well as high transport
and processing costs. Therefore, it seems that China will depend more
heavily on imported iron ore as its steel sector continues to grow.
In spite of the importance of China's emerging steelindustry, little is known
of how the above developments may affect the world iron ore and steel
industry. Few currently available models can quantitatively evaluate the
effects of a changing economic environment on world iron ore and steel
trade. Several iron ore and steel models explicitly consider the interaction
between supply anddemand(see,for example,Higgins 1969;Watanabe and
Kinoshita 1971; Tsao and Day 1971; Yamawaki 1984). However, these
models examined the market on aregional basis (primarily the United States
and Japan), without considering the world market as a whole. Hashimoto
(1981) constructed a world iron ore and steel model, but regional
specification was not considered. That is, Hashimoto's model solves for
world prices and quantities, but does not disaggregate by region. Priovolos
(1987), and Toweh and Newcomb (1991) constructed world iron ore trade
models which disaggregate by region; however, steel demand and prices are
not determined within these models.
The purpose in this study is to evaluate the impact of China's emerging steel
sector within an integrated world market for iron ore and steel. Specifically,
an econometric model of world iron ore and steel trade has been constructed
which simulates the direct effect of economic growth in China on the
Chinese iron ore and steel industry, as well as the indirect effects, as the rest
of the world adjusts to this new market environment.
A clearer understanding of the changing market for iron ore and steel
brought about by growth in China is particularly important to Australian
interests. Chinarepresents a significant market forAustralian exports of iron
ore and is likely to be a focal point of further development in the industry
at least to the end of the decade. Furthermore, there may be scope for
developing value added iron making facilities in Australia, given sufficient
growth in demand for steelmaking raw materials in the region.
8 ABARE research report 95.4
Development of the Chinese steel
sector
Since the end of civil war in 1949,the iron and steel sector has played an
importantrolein the developmentof the Chineseeconomy.Overthisperiod,
Chinese steel productionhas risen fromjust 160000 tonnes in 1949,to 89
million tonnes in 1993 (figure A). As a centrally planned economy, much
of the development of the Chinese steel sector has taken place under direct
governmentintervention.Considereda 'key industry' in terms of economic
planning, the Chineseiron and steel sector has been particularlyaffectedby
the centralisedsystemof economicdevelopment whichis largelyconducted
under 'Five Year Plans', the first spanning 1953-57.
Between 1958 and 1960, during the period known as 'The Great Leap
Forward', highrates of growthwereaimed at acrosstheeconomy.Industries
were assigned high output and growth targets with an aim to modernising
the economy and catching up with developed countries within 15-20 years
(Hsu 1989). The policies adopted in this period resulted in industries
producing low qualityproducts in order to meet high output targets. Within
the iron and steel industry, which was one of the industries targeted,
thousandsof smalliron and steel plants were opened throughoutChina and
crude steel production increased significantly. These plants produced
products of very low quality and most had closedby 1961(Findlay and Xin
1985).
-
A Chinesecrudesteel production
iiABARE
80 /
60
40
20
Mt
~ I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I
1953 1961 1969 1977 1985 1993
The Chinese economy apparently was unable to sustain the rate of growth
the steel industry attained during 'The Great Leap Forward'. Findlay and
Xin (1985) have attributedthis inability to the inefficient allocation of scarce
resources such as energy, raw materials and investment funds. As a result
crude steel output fell markedly in 1961and continued to fall in 1962.After
a period of recovery, disruptions caused by the Cultural Revolution resulted
in crude steel output falling significantly in 1967 and continuing to fall in
1968.
In the mid to late 1970s, with a shift in political power, the Chinese
government decided that the country should upgrade the level of technology
by importing advanced machinery from the West (Hsu 1989). The 'Four
Modernisations' program launched in 1978emphasised the use of modern
machinery. Under this program 120 large scale projects were proposed,
these included ten iron and steel mills, eight coal mines and five harbours
(Hsu 1989).
Under the 'Four Modernisations' program Chinese steel output was planned
to rise from 23.7 million tonnes in 1977, to 60 million tonnes by 1985. As
a result of domestic supply shortages, inefficient importing practices and
the emergence of a large trade deficit and inflationary problems the 'Four
Modernisations' program was abolished in late 1978 and the government
began to restrict technology imports (Hsu 1989). A major program of
readjustment and reform was then implemented which, among other things,
involved halting many large scale construction projects, including the
Baoshan steel mill. Other measures included a movement of investment
resources away from heavy industry toward agriculture and light industry
and a lowering of output targets for heavy industry.
Economic reform
The program of economic reform has involved an increased use of market
mechanisms to supplement central planning. Some decision making power
was decentralised to enterprises and local governments and incentives were
introduced to raise the productivity of workers and management in both the
agricultural and manufacturing industries. These measures were designed
to make commodity supplies more sensitive to demand and supply
conditions (Hsu 1989). Despite the failure of the 'Four Modernisations'
program, the government continued to pursue the goal of economic
modernisation. Rather than revert to a closed-door economy, foreign trade
continued to be promoted. In addition, in 1980, Special Economic Zones
10 ABARE research report 95.4
were set up in Shenzhen, Shantou and Zhuhai in Guangdongprovince and
Xiamen in Fujianprovince. TheSpecialEconomicZonesoperate under less
restrictive economic policies than the rest of the country, are given
preferential tax treatment, import Western technology, capital and
management skills,andencouragetheparticipationof foreignfirms.Market
factorsare supposed to play a greaterrole in decisionmaking in these zones
than in other parts of the country.
The Sixth Five Year Plan, 1981-85, reinforcedthe economicreforms made
in the Fifth Five Year Plan. The Sixth Five Year Plan was the first step in
the long term plan to quadruple output between 1980 and 2000. The plan
continued the economicreforms and sought to lay the foundation for high
andsustainedgrowth (JamesandYoung 1987).A greaterdegreeof autonomy
was granted to local regions and planning was decentralised further.
The Seventh Five Year Plan, 1986-90, involved policies designed to
continuetopromotethegrowthof theChineseeconomy andcalledforChina
to 'Give priority to reform and make sure that reform and development are
adapted to and promote each other' (Chinese Documents 1986). Another
major objective was to 'Open wider to the outside world and link the
development of the domestic economy more closely with expanded
economic and technological exchange with other countries' (Chinese
Documents 1986).Under the Seventh Five Year Plan, China was to invest
US$11 billion in technical renovation and capital construction in the iron
and steel industry and to seek additional foreign investment so that the
production targets of 60million tonnesof crude steelin 1990and 95 million
tonnes in 1995were met (Chin and Kuo 1990).
I The impact of reforms on the Chinese steel sector
The economicreforms which began in 1979have affectedthe Chinese steel
sector in a number of ways. Policies which have allowed for, and
encouraged,theimportationof Westerntechnologiesandrawmaterials have
helped to improve steel production processes in China. The import of
foreignsteel production technology has allowed Chinese steelproducers to
increase efficiency significantly through the upgrading of old Soviet
designed pIants and the constructionof new Japaneseand Germandesigned
plants. The change in attitude toward the import of raw materials has
provided the Chinese steel industry with access to high quality Australian
and Brazilian iron ores which can be expectedto increase the efficiency of
steel production.
Reformsto the pricing systemhavebeen importantto China's iron and steel
industry. The reforms have allowed major steelmaking enterprises
(accounting for 70 per cent of Chinese crude steel production) to sell any
excessproductionwithin arelatively opendomesticmarket, oncetheirquota
for the central government has been filled. The prices at which these sales
were concluded,however, were restricted to within 20 per cent of the price
received for sales to the central government (the state price). This price
restriction was removed in 1985 and prices on the domestic market were
allowed to fluctuatewith supply and demand.
In 1988ceilings on steelprices were introduced becausehigh prices of steel
led to complaints from users and the two tier system encouraged the
diversion of supplies from the state system to the market system (Feng
1990). The domestic market price of steel has remained relatively high,
however. Under the central planning system there is a limit to the amount
of foreign exchangethatis made availableforthe purchase of steelimports,
which effectively imposes a quota on steel imports into China. As a result
the domestic market price has generally been higher than the import price
(Feng 1990).
Reforms to the pricing of steelcan be expectedto improvethe way in which
steelis allocatedthroughoutthe Chinese economy.Chinese steelusers have
traditionally kept relatively large stocks of steel to trade in case the steel
they are allocated by the central government is not what they want. Steel
users can now purchase the specifictypes of steelthey requiredirectlyfrom
steelproducers on the domesticmarket. In addition, steelusers cannow sell
any unused allocation of steel.
The Chinese steel industry at present
The Chinese steel industry is under the direct control of the Ministry of
Metallurgical Industries which is responsible for the administration,
regulation and production of steel, iron and iron ore (Chin and Kuo 1990).
Steel production is dominated by large integrated steel works that require
ironore and coking coal as feedstock. Thefivelargeststeelplants produced
over 30million tonnes of thetotal 89million tonnes of crude steelproduced
in Chinain 1993.Anshan,China's largeststeelcompany,produced inexcess
of 8 million tonnes in 1993 (table 2), placing it in the world's top 20 steel
producers by volume.
12 ABARE researchreport 95.4
2 Steel productionfrom major Chinese plantsin 1993
Steel company Region Start-update Production
Anshan Liaoning 1916 8.51
Baoshan Shanghai 1985 6.98
Shougang Beijing 1920 7.02
Wuhan Hubei 1958 5.24
Baotou Inner Mongolia 1958 3.08
Sources: Metal Bulletin (1994);Tse (1992).
The five major steel enterprises listed in table 2 accounted for around 35per
cent of total Chinese steel production in 1993. There are many steel plants
producing much smaller volumes. For instance, there were fourteen steel
producing enterprises with output exceeding 1 million tonnes in 1989, ten
produced 0.5-1 million tonnes, and a further 118 each produced less than
0.5million tonnes of steel. Most of these smaller steelplants are also located
in eastern China (see map on page 14), although in 1989 some steel was
produced in 28 of the 31provinces and municipalities of China (Editorial
Board of the Yearbook of Iron and Steel Industry of China 1990).
Steel production is concentrated mostly in the more densely populated north
eastern and eastern provinces of China. The Beijing municipality and the
surrounding provinces of Liaoning, Hebei and Shandong in the north east
accounted for around a third of Chinesecrude steelproduction of 66million
tonnes in 1990.The eastern municipality of Shanghaiwas the second largest
steel producing region after Liaoning, producing almost 14per cent of total
crude steel output. Steelproduction does occur further inland. In particular,
largeintegrated steelplants suchasWuhan,Panzihua andBaotou arelocated
near the main waterways of the Yellow and Yangtze Rivers in the regions
of Hubei, Sichuan, and Inner Mongolia. Only a small share of China's steel
isproduced inthe southernregions of China,despitestrongdemand for steel
from the manufacturing sector, and very little steel is produced in the more
remote western regions.
Age distribution and technology used by Chinese steel
industry
The vintage and hence technology of China's steel plants varies
considerably. In 1992, only 30 per cent of the steel produced in China was
cast by the modern continuous casting method, compared with a world
average of 66 per cent. In the same year, over 17 per cent of steel was
produced by the outdated open hearth method in China, compared with a
total industrialised country average of less than one per cent (International
Iron and Steel Institute 1993).
Many large steel works such as Wuhan and Anshan were constructed in the
1950s using Russian technology, and have only recently begun the process
MONGOLIA
8 Shenzhen
9 Meishan
Sources: Metal Bulletin; MMI.
14 ABARE research report 95.4
of updating their technology. As the Chinese economy opened up to the
outside world, the steel industry gained access to more modern technology.
Newer steel plants have taken advantage of this, and imported modern
technology and equipment. The Baoshan steelworks on the Yangtze River
in Shanghai is China's most modern steel works and has been built using
imported technology and equipment from Japan and Germany.
In line with recent economic reforms, larger steel groups such as Wuhan,
Baoshan and Shougang arebeing encouraged to operate independently from
the central authorities as commercial enterprises (see for example Tex
Report 1993). The greater autonomy is allowing these steel producers to
reinvest much of their earnings in modernisation and in expansions to both
domestic production capacity and international holdings. Shougang for
example, has recently purchased a Peruvian iron ore mine, a controlling
interest in Hong Kong's second largest steel trading company,and aUS steel
mill which it plans to relocate to China.
The technological shortcomings of the Chinese steel industry are also
apparent in the quality of steel produced and in the product mix of that steel.
In 1990, only 40 per cent of China's rolled steel output would have met
international standards. The modernisation of steel works is likely to see
this proportion rise in the future. Under the Eighth Five Year Plan, this
proportion is to increase to 50 per cent by 1995 (United Nations Industrial
Development Organisation 1992).
China's output by product group is biased toward the production of long
products such as sections and wirethat are used in the construction industry,
and against the production of flat products such as sheet that are heavily
I
I 3 Productionof steel by product group
~
Productgroup China United States Japan Germany South Korea
Section 48.9 24.6 30.3 14.2 35.7
Wire 16.4 4.1 7.5 9.6 7.6
Plate 11.9 5.9 13.2 20.5 15.4
Sheet 10.3 53.1 44.2 47.2 41.2
Tube 8.8 0.0 4.7 8.5 0.0
Other 3.7 12.3 0.1 0.0 0.1
Source: Chin and Kuo (1990).
China's steel industry 15
consumed by the manufacturing industry (table 3). This product mix of
Chinese steelreflects not onlythe consumptionmix in Chinacompared with
other major steel producers, but also the comparative advantage of Chinese
steel producers in the production of long products which generally have
lower technology and capital requirements than the production of flat
products.
Inputs to steelmaking
China is the world's largest coal producer, with annual output in excess of
onebillion tonnes, andhas proven coal reserves of almost 900billion tonnes
or about 32 per cent of world reserves (China-Australia Joint Working
Group on Energy 1992). As about a quarter of Chinese coal reserves are
suitable as coking coal (United Nations Industrial Development
Organisation 1992), domestic coal resources appear sufficient to satisfy
future steelmaking requirements. However,the majority of coaldepositsare
located in the northern provinces of Shanxi, Henan, Hebei, the New
MongoliaAutonomous Region in the north west and Heilongjiang province
in the north east. This places a strain on the transport system as the
manufacturing facilities are in the east and southern part of the country.
China possesses large reserves of other raw materials required in the
steelmaking process such as manganese, tungsten, dolomite and limestone.
China is expected to at least remain self-sufficient in the supply of most of
these raw materials for its domestic steel industry. Although China's
reserves of manganese ore of around 14 million tonnes are large, the low
quality of the ore can be expected to require increased imports as the steel
industry increases output.
With a reserve base of around 9 billion tonnes, or 4 per cent of world
reserves, China has large resources of iron ore (Kirk 1993).Around 65 per
cent of these reserves are concentrated in northern China, and the remainder
in the south (United Nations Industrial Development Organisation 1992).
China is the world's largest producer of iron ore by volume, producing an
estimated 225 million tonnes in 1993(United Nations Conferenceon Trade
and Development 1994).The majority of iron ore production comes from
mines captive to steel enterprises within the same province. Anshan
produces iron ore from five mines in Liaoning, with annual capacity of
nearly 27 million tonnes to feed its steelworks in the same province. Other
major captive mines include Shougang mines in Beijing (18 million tonnes
16 ABARE research report 95.4
4 Iron contentof marketable ore
Australia
Brazil
China
India
United States
Former Soviet Union
Source:UNCTAD (1994).
capacity),Benxi in Liaoning (13.7 million tonnes), Maanshan in Anhui (8
million tonnes), Panzhihua operations in Sichuan (8.3 million tonnes),
Baotou in New Mongolia (7.8 million tonnes)and Wuhan in Hubei (5.1
million tonnes) (Tse 1992).A large number of smaller local iron ore mines
contribute around 35 per cent of total production. These mines are run as
smallcollectiveoperations or as a sidelineby farmers(Chin and Kuo 1990).
Although China is the world's largest producer of iron ore on a natural
weight basis, it is only the third largest producer on an iron content basis.
This is because the quality of Chinese iron ore is low by world standards
(table4). The iron content of Chinese ore is typically in the 30-35 per cent
range, and only 5 per cent of Chinese iron ore reserves contain more than
35 per cent iron (Chin and Kuo 1990).Only a few of the smaller mines, and
the Shilu mine on Hainan Island (4.6 million tonnes a year capacity) with
53 per cent iron content, produce ore with an iron content comparable to
that traded internationally. Relatively costly beneficiation is therefore
required to upgrade most Chinese domestic ore to a standard acceptable in
the steelmakingprocess.
I Production costs for Chinese iron ore are relatively high due to these
beneficiation requirements. Recently imposed taxes on Chinese iron ore
production furtherimpinge on the competitivenessof Chinese iron ore.The
cost of producing a high grade concentratein China roughly equivalent to
ore traded in world markets has been estimated to average US$25 a tonne
in 1994 (Tian 1994).In addition to this cost, a royalty averaging US$6 a
tonne and a 'value rising' tax of US$4.50 a tonne of concentrateproduced
has been imposed on Chinese iron ore producers. By comparing these costs
with the averagecif importpricepaid by Japanese steelproducers of US$25
a tonne in the first half of 1994,the competitivenessof imported iron ore in
China can be seen.
China's steel industry 17
Transportand infrastructure
Apart from the poor quality of iron ore, Chinese steel producers are further
constrained by inadequate internal transport systems for the delivery of
domestically produced iron ore and coal. It has been widely observed that
investment in the transport sectorin Chinahas been neglected in comparison
with other sectors (Feng, Findlay, Richardson and Wu 1993).Major iron ore
producers such as Australia and Brazil transport iron ore from mine to port
using dedicated rail systems. The rail system in China is overcrowded and
in a poor state so the task of transporting large volumes of iron ore on a
regular basis is both difficult and costly,even though steelplants are usually
located in the same province as iron ore and coal resources.
Considerable resources are now being devoted to upgrade the rail system.
Almost US$1 billion was spent on rail construction projects in 1990,and a
further US$18.8 billion is planned to be invested on the construction of a
more efficient rail system during the remainder of the decade (Tse 1992).
Port facilitiesrequired for the import of iron ore and steel products are also
inadequate. In particular, China has only one deep water port capable of
receiving iron ore in the large cape size vessels that carry ore in 150 000
tonnes or greater shipments. This places a strainon the operation of existing
ports. Iron ore is often reloaded into smaller ships or barges before delivery
to a steel works or rail terminal. For example, imported iron ore for Baoshan
is unloadedinitially atthe Beilun deep water port some 150kilometres south
and then barged to the steel works. Wuhan has higher transport costs for
imported ore, as iron ore has to be barged 1200kilometres up the Yangtze
River.
In preparation for expected increased imports of iron ore in the future,
China's port facilities are undergoing major expansions. These include
expansions to the deepwater port of Beilun, and an additional 100000tonne
capacity berth near Baoshan, as well as expansions to the smaller ports of
Qinhuandao in Beijing and Shijiusuo in Shandong.
China's participation in the world steel and raw
materials markets
Sincethe economic reforms of the late 1970s,China has been an important,
albeit volatile, importer of steel. As shown in figure B, steel imports have
ranged from less than 5 million tonnes a year to around 30 million tonnes,
18 ABARE research report 95.4
constituting from around 5 to roughly 30 per cent of total Chinese steel
consumption.Chinese steel importshave fluctuateddue to differing growth
rates in steel consumption and production, the lagged response of steel
producers to large demand increases and the availability of foreign
exchange. From 1982 through to 1985 China was importing increasingly
large quantitiesof steel as domestic steel production growth could not keep
pace with growth in demand for steel.The Chinesesteel industryresponded
to this increasein demandby increasingproduction capacity;however,steel
production did not increase by enough to allow for a fall in steel imports
until 1986.
Increased steel production has led to a significant increase in demand for
iron ore. As can be seen from figure C, a large proportion of Chinese iron
ore demand has been supplied from domestic sources. However, it should
be noted when examining figure C that no account has been taken of the fact
that Chinese iron ore has a considerably lower iron content than imported
ores. As a result figure C understates the importance of imported ore.
Nearly all of the integrated steel companies possess captive iron ore mines
within the same province. Only the Baoshan steel mill relies completely on
imported ore. However, the share of imports in total Chinese iron ore
consumptionhas been increasing sincethe early 1980s.The shareof imports
in total Chinese iron ore consumption increased from around 3 per cent (3.3
million tonnes) in 1981 to around 13 per cent (33 million tonnes) in 1993.
On an iron content basis, imports increased from around 6 per cent of total
consumption in 1981to around 21 per cent in 1993.
Not only have the economic reforms allowed for an increase in iron ore
imports but they have allowed Chinese organisations to develop interests in
iron oreprojects in foreign countries. These types of projects ensure that the
Chinese steel industry has access to supplies of high quality iron ore and
exposes Chinese engineers and managers to advanced foreign techniques.
An important example of this type ofjoint venture is the development of the
Western Australian Channar iron ore deposit by the Chinese government's
official trade agency, the China Metallurgical Import and Export Corp, and
the Australian iron ore producer Hamersley Iron. This mine currently
produces around 6million tonnes a year with all production going to China.
The Chinese steel industry in 2000
If the spectacular growth of Chinese steel consumption andproduction over
the past two decades continues, China will become an increasingly
important player in the world steel and steelmaking raw material markets.
Increases in Chinese production and imports of steel and steelmaking raw
materials can be expected to have implications for world prices and trade
flows of these comnlodities. There are several factors which suggest that
Chinese steel production and consumption are likely to grow.
GDP growth
The dramaticincreasein Chinese steel production has coincided with strong
growth in the Chinese economy. The rate of growth of Chinese gross
domestic product (GDP) has been high relative to other major economies
(figure D) and has resulted in a steady increase in the demand for steel.
20 ABARE research report 95.4
A large proportion of any increase in income in China can be expected to
be spent on the development of infrastructure which is a relatively steel
intensive activity, whereas industrialised economies already have well
developedinfrastructure andincreasesin income can be expected tobe spent
on less steel intensive items (for example, in the services sector). As can be
seen from table 5, Chinese steel consumption per person is still well below
that in industrialised countries and newly industrialised countries like South
Korea, Taiwan and Malaysia. As China's econolny develops, and more
investment is made in infrastructure it can be expected that crude steel
consumption per person will increase.
5 Crude steel consumption, 1992
China 71.3
Taiwan 1024.0
South Korea 532.3
Malaysia 238.8
Industrialised countries 374.0
World 143.2
Source: International lron and Steel Institute (1993).
Planned increases to Chinese production capacity
In light of expected growth in Chinese steel demand, there are numerous
plans for expansions to existing works and plans for several new large steel
- -
Chitza's steel industry
works have been proposed by the Chinese steel industry (see the map on
page 14). Although all of these planned expansions may not come to
fruition, they do give an indication of the commitment of the Chinese to
continue the expansion of their domestic steel industry. Official forecasts
indicate that China will be producing between 100 and 120million tonnes
of steel a year by the end of the decade.
Chinese crude steel and iron ore production forecasts
The production target set for the Chinese steel industry in the 'Eighth Five
Year Plan' was reported by the Tex Report (1993) as 100-120 million
tonnes. In addition to the government's plans for the iron and steel industry
set out in the five year plans, there are many publicly available forecasts of
Chinese steel production and consumption. These forecasts generally
predict that around 100 million tonnes of crude steel will be produced in
China in the year 2000. For example, Feng et al. (1993) predicted that
Chinese crude steel output will be of the order of 100million tonnes; Chen
et al. (1991) provided a forecast of 97.7 million tonnes for 2000; Gooday
and Manson (1993)projected Chinese crude steel production of around 100
million tonnesby 1998.TheWorldBank (1994)projection of Chinesecrude
steel production in 2000 is 111.5 million tonnes.
The World Bank (1994) projected that Chinese iron ore production, on a
metal content basis, would rise from the 1992level of 68.6 million tonnes
to 80.18 million tonnes by 2000, an average annual growth rate of 2.0 per
cent. If this average annual growth rate is applied to 1992Chinese iron ore
production of 210 million tonnes, measured on a natural weight basis, then
the 2000projection is around 245million tonnes. This is significantly higher
than the Chinese government's domestic iron ore supply forecast for the
year 2000 of 220-230 million tonnes (Wang 1993), and the projection of
Zhen (1990) of 210 million tonnes.
22 ABARE research report 95.4
Global effects of growth in the Chinese
steel industry
The focus in this chapter is to form projections of future production and
consumption of steel in China under alternative scenarios of growth in the
general economy, and then to quantify the impact of growth in the Chinese
steel industry on the world market for iron ore and steel. To do this, it is
necessary to account for the global response in production and consumption
within an integrated market of trade in iron ore and steel. A model of world
trade in iron ore and steel has been constructed (box 1)which is employed
toprovide aquantitative assessment of this changing market to the year 2000.
China's steel industry 23
The model described in box 1 was used to quantify the impact on the world
iron ore and steel sector of continued growth in the Chinese economy. First,
a baseline projection was computed based on ABARE's latest assumptions
about rates of growth in industrial production as shown in table 6. Other
variables which are not determined within the model, such as freight rates
and coking coal prices were held constant at observed 1993values.
In order to illustrate the impact on the iron ore and steelmarket of alternative
economic growth paths within the Chinese economy, the model was used to
simulate 'high' and 'low' growth scenarios. These alternative growth
scenarios are not assumptions about the upper and lower bounds of Chinese
industrial production growth, they are only used to illustrate the impact of
alternative growth scenarios. So that the impact of varying growth paths in
the Chinese economy on the iron ore and steel market can be directly
compared, the values of all other variables which are external to the model
were held constant across scenarios.
Under the 'high' growth scenario, Chinese industrial production is assumed
to continue to increase at the 1995 baseline assumption rate of 15 per cent
per year throughout the simulation period. A growth rate of 15 per cent
corresponds to the average rate of growth observed since the economic
reforms of 1985. Under the 'low' growth scenario, Chinese industrial
production is assumed to increaseby only half as much as under the baseline
assumption. While this lower rate of growth in the Chinese economy is not
expected, it must be remembered that China has previously embarked on
insular policies which have severely constrained economic growth. For
6 Baseline industrialproductiona
Other
China Asia Australia Brazil
1994 20.0 7.0 5.2 4.0
1995 15.0 6.9 4.4 5.0
1996 12.0 6.7 4.2 4.0
1997 12.0 6.5 3.2 4.0
1998 10.0 6.2 3.2 5.0
1999 10.0 6.2 3.0 5.0
2000 10.0 6.2 3.0 5.0
a GDP for Australia, Brazil, India and other Asia.
India Japan
North
America
24 ABARE research ~eport95.4
example, the average rate of growth in China's economy under the relatively
restrictivepolicy environment spanning the period 1967to 1978was roughly
5.2 per cent.
Baseline projections
Baseline projections of steel consumption and production are shown in table
7. Driven primarily by assumed growth in industrial production, annual
world steel consumption is projected to increase by 102 million tonnes by
the year 2000. Of this increase, China is projected to account for 30 million
tonnes, or 30per cent of the total increase in annual world steel consumption
to the year 2000. Over the simulation period, the level of growth in steel
demand in China is shown to be matched only by the other Asia region
(which is comprised of the East Asian countries,excluding China,Japan and
North Korea), where economic growth rates are also expected to be robust.
In response to the significant increase in steel demand, steel production in
China is projected to increase from 94million tonnes in 1994,to 110million
tonnes in 2000 with China surpassing Japan as the world's largest steel
producing country. This will require the construction of new steelmaking
capacity, most likely in the form of integrated steelmaking facilities such as
theproposed Baoshan no. 2plant, aswell ascontinued expansions to existing
facilities. Even with the projected increase in China's domestic steel
production, import demand is expected to range from 12 million tonnes to
26 million tonnes, representing about 20 per cent of total Chinese steel
consumption.
To meet the projected increase in world steel demand, those regions with
established steelmaking capacity, such as the European Union, North
I
America and Japan are also projected to increase production. While the
I projected steel production figures for these mature steelmaking regions do
I not representrecord levelsof production when compared with thelast several
decades, growth inproduction is significant, with theEuropean Union,North
America, and Japan each increasing steel production by more than 10 per
cent to the year 2000.
These production levels appear easily achievable when compared with
existing steelmaking capacity. The European Union currently has an
estimated capacity of 196million tonnes compared with production of only
132million tonnes in 1993.TheJapanese steel industry had an estimated 38
million tonnes of spare production capacity from the 100million tonnes of
China's steel industvy 25
steel produced in 1993. While the US steel industry is currently operating
athigher capacity utilisation rates (at around 85per cent),with the additional
capacity being brought on stream by steel producers such as Nucor, Geneva
Steel and BHP-North Star Steel, the projected increase in steel production
from this region is certainly achievable.
- -
7Baseline projections of steel consumption and production a
Mt Mt Mt Mt Mt Mt Mt
Australia
Steel consumption 6.4 6.5 6.7 6.7 6.8 6.9 7.0
Steel production 8.3 8.5 8.9 9.2 9.0 9.0 9.1
Brazil
Steelconsumption 12.9 13.4 14.0 14.9 16.7 18.2 19.9
Steel production 26.2 27.2 28.2 29.2 30.2 31.1 32.1
China
Steel consumption 106.2 111.1 115.5 120.5 125.2 130.3 136.0
Steel production 94.1 96.7 99.1 101.8 104.3 107.0 110.0
EuropeanUnion
Steelconsumption 113.7 117.1 119.4 120.8 120.9 120.7 120.5
Steel production 138.0 144.2 148.7 150.5 151.5 154.5 154.0
India
Steel consumption 18.0 19.2 20.5 21.8 23.1 24.5 25.9
Steel production 19.5 21.1 22.5 23.7 24.7 25.9 27.3
Japan
Steelconsumption 83.1 84.7 85.1 85.8 85.1 84.4 83.5
Steelproduction 99.6 105.4 107.5 109.5 110.5 110.5 109.5
North America
Steel consumption 121.4 127.8 131.0 131.9 129.8 127.3 124.7
Steelproduction 99.7 104.2 108.6 111.6 112.6 112.2 115.9
OtherAsia
Steel consumption 86.1 92.7 99.8 105.4 111.4 119.8 126.9
Steelproduction 55.0 57.2 60.2 64.0 67.5 71.4 74.1
OtherWest Europe
Steel consumption 20.0 21.1 21.8 22.3 22.7 22.9 23.1
Steel production 25.9 27.1 28.0 28.6 29.1 29.9 30.6
World total
Steelconsumption 736.4 761.9 782.4 799.6 811.9 825.0 837.9
a Eastern Europe consumption and production held constant at 1993levels.
26 ABARE research report 95.4
Steel production from the other Asia region is also projected to increase
significantly,by 35 per cent to 74 million tonnes by 2000. The Pohang Iron
and Steel Company of South Korea recently became the world's second
largest steelproducing company after Nippon Steelof Japan,with the recent
3 million tonnes expansion to its Kwangyang steel works. China Steel of
Taiwan is currentlyconstructing facilitiesto increase steel making capacity
by 40 per cent to 8 million tonnes. Numerous smaller electric arc furnace
steelplants are being constructed and planned for the growing steel markets
of south east Asia, as well as South Korea and Taiwan. For the projected 35
per cent increasein steel production from this region to be met, outputfrom
new electric arc furnace plants, and possibly from an additionalintegrated
producer (or increased output from an existing integrated producer in the
region) will be required.
China's increasingsteelproduction,comprisedlargelyof blastfurnacebased
steel output, corresponds to an increase in annual iron ore consumption of
31 million tonnes by the year 2000 (table 8). Even with an increase in
domestic production of iron ore, China's import demand for iron ore is
projected to rise from 37 million tonnes in 1994, to 50 million tonnes by
2000. This projected rise in imported iron ore is reinforced by the Chinese
plans for new steel plants and increased capacity at existing plants at
locations near to port facilities,and hence accessibleto imported ore.
Given the generallysustainedgrowthin economicactivityexpectedto occur
over the period, other major steel producing regions such as the European
Union, Japan and the other Asia group will also continue to be significant
importers of iron ore. Under the baseline projection, aggregate world
consumptionof iron oreis projectedto rise from956million tonnes in 1994,
to 1062milliontonnesin theyear 2000.Thereal price of ironoreisprojected
I to increasemarginally over this period.
Japan is the world's largest importer of iron ore, relying almost entirely on
imported ore for its blast furnace requirements. The relatively mature
Japanese steel industry can be expected to maintain its relationships with
ironoreproducers in Australia, Brazil and elsewhereoverthe medium term,
increasing its imports from these countriesto meet the projected 5 million
tonne increase in annual iron ore consumption by the year 2000.
As in Japan, steel producers of the other Asia region rely on imported iron
ore for blast furnacebased steel production because of the lack of domestic
iron ore resources. Reflecting this reliance,other Asian iron ore imports are
China's steel industry 27
projected to increase from 53 million tonnes in 1994, to 71 million tonnes
by the year 2000.
The major exporters of iron ore are Australia, Brazil and India. Australia is
particularly affected by growth in the Chinese steel market (as well as the
8 Baselineprojectionsof iron ore consumptionand productiona
Mt Mt Mt Mt Mt Mt Mt
Australia
lron ore consumption 11.3 11.4 12.0 12.4 12.1 11.9 12.0
Iron ore production 132.1 137.8 140.7 142.9 145.2 148.2 149.0
Brazil
Iron ore consumption 46.9 48.6 50.2 51.8 53.3 54.9 56.5
Iron ore production 163.9 169.9 173.1 179.0 181.9 185.3 187.0
China
lron ore consumption 252.1 258.2 262.4 267.5 272.0 277.1 283.5
Iron ore production 215.4 220.6 222.3 224.9 226.9 229.4 233.9
EuropeanUnion
Iron ore consumption 145.1 151.2 155.4 156.5 156.8 159.1 156.0
Iron ore production 6.9 6.2 5.6 5.0 4.5 4.1 3.7
India
Iron ore consumption 24.2 25.3 27.3 29.1 30.3 31.7 33.7
Iron ore production 59.5 64.0 68.2 71.6 74.5 77.6 78.8
Japan
Iron ore consumption 112.4 119.4 119.8 120.5 120.3 121.2 117.1
Iron ore production 0.3 0.3 0.3 0.3 0.3 0.3 0.3
North America
Ironoreconsumption 67.3 69.1 71.6 74.3 74.4 73.1 78.2
Iron ore production 87.4 89.1 90.2 91.0 90.5 91.4 96.1
Other Asia
Iron ore consumption 54.3 56.1 58.7 62.5 65.9 69.8 71.5
Iron ore production 0.8 0.8 0.8 0.8 0.8 0.8 0.8
Other West Europe
Iron ore consumption 27.3 28.2 28.6 28.8 28.9 29.4 29.8
Iron ore production 31.6 34.9 37.1 38.1 38.7 39.5 38.7
World total
Iron ore consumption 956.1 986.6 1004.8 1022.8 1034.4 1049.2 1061.8
a Eastern Europe consumption and production held constant at 1993levels.
28 ABARE ~nesearchreport 95.4
general increasein demand worldwide). Inresponseto the projected increase
in demand for iron ore, Australia is projected to increase production by 17
million tonnes over the simulation period, with 16 million tonnes of this
increase in production sold on the export market. Over this same period,
Brazil's exports of iron ore are projected to increase by 14 million tonnes
and India's exports to rise by 10 million tonnes.
These projected increases in iron ore production from exporting countries
can be expected to come from existing producers, and mostly from existing
mines. In Australia, a further 4 million tonnes a year is planned to be mined
from the Channar Australia-China joint venture mine by the year 2000, with
production destined for the growing Chinesemarket. Robe River Mining can
easily increase production by a further 8 million tonnes a year. Hamersley
Iron's 12 million tonnes a year capacity Marandoo mine began production
in 1994, as did BHP's 5 million tonnes a year Yarrie mine.
Plans are in existence to significantly increase production capacity in Brazil
and India, if demand warrants it. The Carajas mine in Brazil can now have
production capacity increased from 35 to 50 million tonnes a year, as the
expansion to port facilities was completed in 1993. Plans exist to expand
annualproduction capacity of the Bailadila operations in India by 13million
tonnes to 22 million tonnes by 1998.Hence, iron ore resources are available
to meet the projected strong increases in import demand for iron ore from
China and other Asia, as well as the growth in iron ore demand that is
projected for the steelmaking industries of Japan, the European Union and
North America.
The effects of high economic growth in China
Under the high economic growth scenario,industrial production in China isI
I set to rise at 15per cent a year, as opposed to the baseline average of roughly
I
I 1I per cent. Under this high growth scenario (which as noted above, is much
the same as that observed since the economic reforms of 1985) steel
consumption in China is projected to increase from 106 million tonnes in
1994 to 149 million tonnes by the year 2000 (table 9). Domestic steel
consumption was projected to rise to 136million tonnes by 2000 under the
baseline scenario. Under the high growth scenario, Chinese steel import
demand is projected to rise from an initial level of 12million tonnes in 1994
to 32 million tonnes by the year 2000, whereas under the baseline scenario,
the level of projected steel imports rise to 26 million tonnes in 2000.
In response to the increased demand for steel under the high economic
growth scenario, China is projected to increase annual production by 23
million tonnes over the simulationperiod. This increase is only marginally
larger than that shown under the baseline projection. To a large degree, the
increase in steel consumption in China can be expected to encourage
9 Projected steel consumptionand productionunder the scenarioof high
growth in Chineseindustrial production a
1994 1995 1996 1997 1998 1999 2000
Mt Mt Mt Mt Mt Mt Mt
Australia
Steel consumption 6.4 6.5 6.7 6.7 6.8 6.9 7.0
Steel production 8.3 8.5 8.9 9.2 9.1 9.1 9.3
Brazil
Steelconsumption 12.9 13.4 13.9 14.9 16.6 18.0 19.6
Steel production 26.2 27.2 28.2 29.2 30.2 31.1 32.1
China
Steel consumption 106.2 111.1 116.7 123.1 130.5 138.9 148.7
Steel production 94.1 96.7 99.7 103.1 107.1 111.6 116.8
European Union
Steel consumption 113.7 117.1 119.4 120.8 120.8 120.6 120.5
Steel production 138 144.2 148.9 151 152.6 156.3 156.6
India
Steel consumption 18.1 19.2 20.5 21.8 23.1 24.4 25.9
Steelproduction 19.5 21.1 22.5 23.8 24.8 26.1 27.6
Japan
Steel consumption 83.1 84.8 85.1 85.8 85.1 84.3 83.5
Steel production 99.6 105.4 107.7 109.9 111.3 111.8 111.3
North America
Steel consumption 121.4 127.8 131 131.9 129.8 127.3 124.6
Steel production 99.7 104.2 108.6 111.6 112.6 112.2 116.1
Other Asia
Steel consumption 86.1 92.7 99.8 105.4 111.3 119.7 126.8
Steel production 55.0 57.2 60.2 64.0 67.5 71.4 74.0
Other West Europe
Steel consumption 20.0 21.1 21.8 22.3 22.6 22.9 23.1
Steelproduction 25.9 27.1 28.0 28.7 29.2 30.0 30.8
World total
Steelconsumption 736.4 761.9 783.4 801.9 816.7 832.8 849.4
a Eastern Europe consumption and production held constant at 1993levels.
- -
ABARE research report 95.4
increased steel production by Japan and the European Union, both of which
currently have steelmaking capacity in place to easily meet the projected
level of demand. Under the high growth scenario, Japan and the European
Union are projected to increase annual steel exports by an additional 2 and
3 million tonnes respectively by 2000, when compared with the baseline
projection.
10 Projected iron ore consumptionand production under the scenarioof
high growth in Chineseindustrial production a
Mt Mt Mt Mt Mt Mt Mt
Australia
Ironoreconsumption 11.3 11.4 12.0 12.4 12.1 12.0 12.2
Iron ore production 132.1 137.8 140.8 143.1 145.8 149.1 150.2
Brazil
Iron ore consumption 46.9 48.6 50.2 51.8 53.4 54.9 56.5
Ironoreproduction 163.9 169.9 173.8 180.6 185.2 190.8 195.1
China
lron ore consumption 252.1 258.2 263.4 269.7 276.7 284.8 295
lron ore production 215.4 220.6 222.5 225.4 228.1 231.4 237.2
EuropeanUnion
Iron ore consumption 145.1 151.2 155.7 157.2 158.2 161.4 159.4
Iron ore production 6.9 6.2 5.6 5.0 4.5 4.1 3.7
India
Iron ore consumption 24.2 25.3 27.3 29.1 30.4 31.8 33.9
Ironoreproduction 59.5 64.0 68.3 71.8 75.1 78.6 80.5
Japan
Iron ore consumption 112.4 119.4 120.1 121.1 121.4 122.9 119.5
Iron ore production 0.3 0.3 0.3 0.3 0.3 0.3 0.3
North America
Iron ore consumption 67.3 69.1 71.3 73.9 73.6 71.2 76.8I
I Iron ore production 87.4 89.1 90.1 91.0 90.4 91.2 96.0
I
Other Asia
Iron ore consumption 54.3 56.1 58.7 62.4 65.8 69.5 71.1
Iron ore production 0.8 0.8 0.8 0.8 0.8 0.8 0.8
Other West Europe
Iron ore consumption 27.3 28.2 28.6 28.9 29.0 29.5 30.0
Ironoreproduction 31.6 34.9 37.2 38.4 39.2 40.2 39.8
World total
Iron ore consumption 956.1 986.6 1006 1026 1040 1059 1077
a Eastern Europeconsumptionand production held constant at 1993levels.
China'ssteel industry 31
As a result of the increase in steel consumption in China under the high
growth scenario, world iron ore demand is projected to increase by an
additional 15 million tonnes by 2000 (table lo), when compared with the
baseline projection of iron ore consumption (table 8). Chinese iron ore
consumption is projected to increase by an additional 12 million tonnes a
Projected steel consumptionand productionunder the scenario of
11 low growth in Chineseindustrial production
Australia
Steel consumption
Steel production
Brazil
Steel consumption
Steel production
China
Steel consumption
Steel production
European Union
Steel consumption
Steel production
India
Steel consumption
Steel production
Japan
Steel consumption
Steel production
North America
Steel consumption
Steel production
Other Asia
Steel consumption
Steel production
Other West Europe
Steel consumption
Steel production
World total
Steel consumption
a Eastern Europe consumption and production held constant at 1993levels.
32 ABARE researclz I-eport95.4
year, when compared with the baseline scenario. As a result, Chinese iron
ore imports are projected to increase by an additional 8 million tonnes. A
projected increase in iron ore exports of 8 million tonnes by Brazil and 1
million tonnes by Australia could be expected to meet a large part of the
12 Projected iron ore consumptionand production under the scenario of
low growth in Chineseindustrial production,1994-2000 a
Mt Mt Mt Mt Mt Mt Mt
Australia
Iron ore consumption 11.3 11.4 12.0 12.3 11.9 11.6 11.6
Iron ore production 132.1 137.6 140.2 142.1 144.3 147.0 147.6
Brazil
Iron ore consumption 46.9 48.6 50.2 51.8 53.3 54.9 56.5
Iron ore production 163.9 168.5 170.0 174.1 175.3 176.8 176.5
China
Ironoreconsumption 252.1 256.1 258.2 260.7 262.7 264.9 268.0
Iron ore production 215.4 220.2 221.3 223.1 224.2 225.6 228.9
European Union
Iron ore consumption 145.1 150.5 154.1 154.4 154.1 155.6 151.7
Iron ore production 6.9 6.2 5.6 5.0 4.5 4.1 3.7
India
Ironoreconsumption 24.2 25.4 27.3 29.0 30.1 31.4 33.4
Ironoreproduction 59.5 63.7 67.6 70.6 73.1 75.7 76.4
Japan
Iron ore consumption 112.4 118.9 118.9 119.1 118.4 118.8 114.1
Iron ore production 0.3 0.3 0.3 0.3 0.3 0.3 0.3
North America
Iron ore consumption 67.3 69.7 72.4 75.3 75.4 74.2 79.5
Ironoreproduction 87.4 89.3 90.3 91.2 90.6 91.4 96.1
Other Asia
I Iron ore consumption 54.3 56.2 58.8 62.7 66.2 70.1 72.0
I
I Iron ore production 0.8 0.8 0.8 0.8 0.8 0.8 0.8
Other West Europe
Iron ore consumption 27.3 28.1 28.5 28.7 28.8 29.2 29.6
Ironoreproduction 31.6 34.7 36.7 37.5 37.9 38.4 37.4
World total
Iron ore consumption 956.1 984.1 999.4 1014.0 1 022.1 1032.9 1041.1
a Eastern Europe consumption and production held constant at 1993levels.
China's steel industry 33
increased Chinese, European Union and Japanese import demand for iron
ore under the high growth scenario.
The effects of low economic growth in China
The results obtainedfrom the analysis of the low economic growth scenario
further demonstrate the effect of economic growth in China on the world
iron ore and steel market. Under the low growth scenario, with Chinese
industrial production assumed to grow by only half that of the baseline
assumptions, Chinese steel consumption is projected to increase from 106
million tonnes in 1994, to 119 million tonnes by 2000 (table 1I). This 12
per cent increase in steel consumption can be compared with the projected
increase of 28 per cent under the baseline scenario (with an average of
roughly 11 per cent annual growth in Chinese industrialproduction). The
regions most affected by a low growth outcome would be the European
Union, with a projected net decrease in steel exports of 3 million tonnes by
2000, as compared with the baseline, and Japan, with a net decrease in
exports of 2 million tonnes. Nevertheless, even under the low growth
scenario, world trade in steel remains vigorous, with the European Union
and Japan projected to export a net 30 and 24 million tonnes of steel a year,
respectively,by 2000.
The flow-on effect on the iron ore market can be seen by comparing the
projectedincreasein annualworldiron oreconsumptionof 85milliontonnes
over the simulation period under the low growth scenario (table 12), with
theincreaseunder thebaseline scenarioof 106million tonnes.Thecountries
shown to be the most affected in the model outcomes are Brazil and India.
Brazil's exports are 10million tonnes a year lower and India's exports are
2 million tonnes lower than under the baseline scenario in the year 2000.
34 ABARE research report 95.4
Conclusions
China is undergoingrapid industrial developmentdue, at least in part, to the
economicreforms implemented sincethe late 1970s.Growth in the Chinese
iron and steel sector has been concomitant to this development, making
China one of the world's major producers and consumers of steel and
steelmaking raw materials. While much of this growth has been confined
within domestic boundaries, China's role in the world iron ore and steel
market has increased markedly since the early 1980s. This continuing
integration with the world market, coupled with China's growing iron ore
and steel industry is likely to have a profound impact on world iron ore and
steel trade.
Simulation results suggest that under an assumed average annual rate of
growthin Chineseindustrialproductionof roughly 11per cent,Chinese steel
consumption is projected to reach 136million tonnes in 2000. To meet this
increase in steel consumption, Chinese steel production is projected to
increase to 110 million tonnes in 2000, surpassing Japan as the world's
largest steel producing country. This increasein production will require the
constructionof new integrated steelplants, someof which have alreadybeen
proposed by the Chinese steel industry.However,even with this increasein
production, baseline net Chinese steel imports are projected to range
between 12million tonnes and 26 million tonnes over the simulationperiod.
In response to the increased world demand for steel, those regions with
established steelmaking capacity such as the European Union, North
America andJapan areprojectedto increaseproduction.While theprojected
I
I steelproductionfiguresforthese mature steelmakingregions arewell below
I
I previous peaks, the European Union, North America and Japan are each
projected to increase annual steel production by more than 10per cent by
the year 2000. Even with this increasein production, the continued need for
restructuringof their steelindustriesis apparent,particularly in theEuropean
Union, which currently has significant excess steelmalung capacity.
Chinahas vast domesticreserves of steelmaking raw materials, particularly
iron ore and coking coal. However, while China is likely to remain self-
sufficientin coking coal, it will rely more heavily on imported iron ore due
to the quality and location of its iron ore resources. As such, continued
China's steel industry 35
growth in Chinese steel production will mean increased importsof iron ore.
It is projected that by the year 2000 China will import roughly 50 million
tonnes of iron ore a year.
Australia holds the largest share of the Chinese iron ore import market, and
is well placed to take advantageof the projectedincreasein Chinesedemand
for iron ore. Australia's relative proximity to the Chinese market gives
Australianironoreproducers adistinctfreightcost advantageinlandingiron
ore in China compared with their main competitors in the iron ore export
market, Brazil's producers. However, this competitive advantage cannot be
taken forgranted.FutureChineseinvestmentinportfacilitiesforlargercargo
carrierswill limit Australia's cost advantage over more distant suppliersto
the Chinese market. In the face of such competition, it is imperative that
Australia diligently maintains its standing as a reliable source of low cost,
high quality iron ore.
Policy directions
The realisation of sustained growth in the steel and steelmaking raw
materialssectorin Chinadependsona liberalpolicyenvironmentthat allows
for the free flow of trade, investment and technology. Australia, as an
efficient producer of iron ore and steel, has much to gain from a continued
liberal, stable and well informed policy environmentwithin the region.
China-Australia iron ore and steel trade has increased through the
independent efforts of Australian and Chinese iron ore and steel producers,
as well as through joint ventures formed by Australian and Chinese
enterprises.Bilateralgovernmentorganisations,suchastheAustralia-China
Joint Study Groupinto Iron Ore and Steel,and the WesternAustralia-China
Economic and Technical Research Fund may offer a means of further
promoting this mutually beneficial relationship. By fostering an
environmentof cooperationbasedonmutuallybeneficialoutcomes,bilateral
organisations can promote the efficient transfer of investment funds and
technology, and ensure a stable trading relationship. Together with
multilateral trade initiatives such as the GATT, a Multilateral Steel
Agreement, or an East Asian Steel agreement as proposed by Drysdale
(1992),sucheffortswillundoubtedlycontributeto the efficientdevelopment
of the industry within the Asian region as a whole, while also allowing for
increased Australian trade opportunitiesin iron ore, as well as valued added
iron and steel products.
36 ABARE research report 95.4
Appendix
Description of the world iron ore and
steel trade model
An econometric model of the world trade in iron ore and steel has been
constructed following the basic conceptual framework offered by Smithson
etal.(1979)in modellingworldtradein copper,aluminium,nickel, andzinc;
and is quite similar to the FAPRI system of modelling agriculturalmarkets
(Devadoss et al. 1989). In the model, world iron ore and steel trade is
disaggregated into eleven trading regions: Australia; Brazil; China; the
European Union; Eastern Europe (which includes the CIS, Bulgaria, the
Czech Republic, Hungary, Poland, Romania and the Slovak Republic);
India; Japan; North America; other Asia (which is East Asia, excluding
China, Japan and North Korea);other West Europe (which includesAustria,
Finland, Macedonia, Norway, Slovenia, Sweden, Switzerland,Turkey and
the former Yugoslavia); and a rest of world category.
The world iron ore and steel trade model is a dynamic,non-spatial,partial
equilibrium model which has been specified to quantitatively evaluate the
impact of growth in the East Asian iron and steel sector on the world market
overthe shortto medium term. Annual domestic supplyanddemand foriron
oreand steelisdeterminedwithin aframeworkof econometricallyestimated
supply and demand equations. Trade flowsbetween specific regions are not
identified;however, net import and export quantitiescan be computed from
the residual of domestic supply and demand estimated for each region.
In modelling the iron ore and steel sector, production and consumption
theory is used to postulate supply and demand relationships. This approach
is suited to the highly aggregatedata available on internationaliron ore and
steel production, consumption and trade. An alternative to this type of
modelling approach is to directly specify the production function within an
(preferablydynamicand stochastic)optimisationprocedureandderiveinput
demand and supply relations. This approach requires detailed input and
production data.
Econometrically estimated supply and demand equations allow for a
comparison of model predictions with the actual market outcome. This sort
of 'validation' procedure allows one to then make a statistically based
judgement on whether the model is a good approximationof the underlying
market.
China's steel industry 37
The model is a set of linked supply and demand relations. Capacity
constraints, adjustment costs, technological change and other aspects of the
sector are accounted for in the modelling framework as they affect this
supply and demand relationship. Worldprices, production and consumption
are solved for under market clearing conditions, that is, production equals
consumption.
The model contains three modules -iron ore, steel, and scrap, which are
described by 63 behavioural (regression) equations, and roughly the same
number of accounting and market identities. These three modules interact
simultaneously, and explicitly link prices, production and consumption of
the three materials. As such, the model predicts price and quantity
movements across regions and across commodities (except in the case of
steel scrap, for which only price is identified). The model is further capable
of producing a time path for these variables, as the industry adjusts to the
changing market environment. The various prices which producers and
consumers are faced with are adjusted for by price linkage equations. These
equations allow for differing prices due to varying transport costs, exchange
rate differentials and quality differentials.
The model has not been designed to capture many of the factors influencing
decisions about where and when to invest in iron ore and steel production
capacity, such as capital availability and government policy settings. Ideally
iron ore and steel production capacity would be modelled explicitly, but
because of data limitations this was not possible. However, if it is known
that a specific capacity expansion will take place at a specified date in the
future this can be exogenously incorporated into the model.
Many of the variables likely to affect capacity, and thus production, do not
enter the model directly. Of these variables, the price of capital (interest
rates) is the most obvious. Although interest rates do not enter the model
directly they do enter the model indirectly through the industrial production
indexes as these two variables display a strong negative correlation over a
wide range of countries.
For short to medium term projections and under scenarios where relative
prices are not expected to change dramatically the modelling approach used
here is not likely to produce results significantly different from a model
which endogenises production capacities.
38 ABARE research report 95.4
The steel module
Demand
The demand for steel is derived primarily from end use in construction
materials and consumer durables such as automobiles and whitegoods.
Researchers have found economic activity, as measured by subaggregates
suchasindustrial production, tobe theprimary factoraffecting steeldemand.
Even though steel consumption relative to economic activity may be greatly
influenced by technological advance and shocks to the prices of substitutes
and complements to steel use over the long run (Labson and Crompton
1993), the relationship between steel consumption and economic activity
has been stable since at least the mid-1970s. Furthermore, in a study of US
steel demand Considine (1991)found the cross-price elasticities for relevant
substitute materials to be less than 0.2. Thus, it is unlikely that the lack of
detail in material substitution will have a substantial affect on the results of
the simulationexercises unless there are significant changes inrelative prices
of available technology.
A commonly used reduced form representation of the derived demand for
steel (see, for example, Cox, Nagle and Lawson 1990) has been used in
which the quantity of steel demanded is determined by the price of steel (as
measured by the World Bank's aggregate steel price index), technological
change and industrial production. Steel price is deflated by a general index
of producer prices such that homogeneity of degree zero is imposed.
f {P:',Ic,,,Tech,}
where, for region i in year t,
D:?' = quantity of steel demanded (apparent consumption, crude
equivalent);
psteel
l,t
= steel price index, adjusted by domestic exchange rates and
producer price deflators;
IPi.t = real industrial production; and
Tech, = time as an index of technological change in the derived demand
for steel.
China'ssteel industry 39
13 Partial elasticity of steel demand
Region With respect to price
Australia
Brazil
China
Eastern Europe
European Union
India
Japan
North America
Other Asia
Other Western Europe
With respectto
industrialproductiona
2.33
3.65
0.38
nab
2.11
0.78
2.12
2.74
0.97
0.35
a GDP for Australia, other Asia and Brazil. b Industrial productionwas not entered
into the EasternEuropean steel demand regressionequation due to concern over the
accuracy of the available data.
Demandelasticities have been computed from the estimated coefficientson
price and industrial production. It should be noted that the demand
elasticities with respect to industrial production are not pure partial
elasticities as industrial production is strongly negatively correlated with
interest rates and interest rate movements have not been accounted for.
Steel demand was found to be inelastic with respect to price. Both the price
and income elasticities estimated (table 13) appear to be consistent with
those found by Cox et al. (1990)in their evaluationof aggregateworld steel
demand. China's income elasticity as estimated is quite low; however, the
estimate is in line with that reported by Feng (1992).
Supply
Virtually all of world steel is produced by one of two basic steelmaking
technologies, based on either blast furnace iron making, or the electric arc
furnace which primarily uses steel scrap as feedstock (see Labson, Gooday
and Manson 1994 for a description of steelmaking technologies). As will
be shownbelow,the identificationof blast furnace based productionof steel
is an important component in linking the steel and iron ore modules, with
iron ore demand specifiedas conditional on blast furnace based production
of steel. To simplify matters, other steelmakingtechnologies which bypass
the blast furnace are subsumedunder blast furnace production, since these
technologies use iron ore as the primary feedstock. Under this
40 ABARE research report 95.4
simplification,total steelproduction is divided among the two technologies,
with supply relations specified for each.
The quantity of blast furnace based steel supplied is specified as being a
function of the price of steel and input prices, includingiron ore, scrap and
coking coal (each deflated by a producer price index). A shift variable was
used to account for periods of significant restructuring within a regional
industry, as happened in North America during the 1980s, and Eastern
Europe in the early 1990s. The lagged dependant variable is entered to
capture partial adjustment following the work of Nerlove (1958). The
general specification of blast furnace based steel supplyis:
where, for region i in year t,
sBF1.t = blast furnacebased steel production;
p e e l
~ , t
= steel price index, adjusted by domestic exchange rates and
producer price deflators;
qf:pW = vector of input prices (iron ore, scrap, coking coal) adjusted
by domestic exchangerates and producer price deflators; and
Csteel
l,t
= shift variable accounting for structuralchange in production.
Steel produced via the electric arc furnace route is determined by the price
of steel, the price of scrap (each deflated by a producer price index) and a
time trend which accounts for the strong secular increase in electric arc
I
furnacesteelmaking(seeLabsonandGooday 1994).Theelectricarcfurnace
I steel supply relation is specified as;
= steel produced via the electric arc furnace;
P$" = steel price index, adjusted by domestic exchange rates and
producer price deflators;
China's steel industry 41
pscrap
l,t
= scrap steel price, adjusted by domestic exchange rates and
producer price deflators; and
t = time trend to capture adoption of EAF technology.
The iron ore module
Demand
Demand foriron oreis derivedfromtheproduction of pig iron-theprimary
feedstock for steel production via the blast furnace. As such, the iron ore
demand equations are based on the conditional factor demand of blast
furnace based steel production. Within the model, demand for iron ore is
determined by relative prices and blast furnace based production of steel. It
is presumed that steel scrap is the only significant substitute for iron ore in
blast furnace based production of steel, whereby the price of iron ore is
deflated by the price of scrap, rather than the more general producer price
index.
where, for region i in year t,
Dore~ , t
= apparent consumption of iron ore;
qy = price of iron ore,in domestic currency and deflated by domestic
producer price index;
f'yrap = scrap price, in domestic currency and deflated by domestic
producer price index;
sBFl , t
= steel produced via the blast furnace; and
t = time trend.
On further examination of the data, it became apparent that the coefficient
on blast furnace based steel production was affected by a trend in some
regions. This trend may be caused, for example, by the declining efficiency
of aging blast furnaces ordeclining iron orequality.To account for thistrend,
the coefficient on blast furnace based steel production was specified as a
time varying coefficient for those regions where it was found to be
ABARE research report 95.4
appropriate. Essentially, this is equivalent to a trending input-output
coefficient. The linear representation(in regression form) is:
(5)
where:
Due to data constraints, apparent consumption of iron ore was used in the
model instead of direct consumption.The formerincludesstock adjustment,
as well as domesticconsumption.The consumerprice of iron ore is in terms
of the fob price in those regions which are self-sufficientin iron ore. For
regions which import most of their iron ore, cif prices from the consumers'
primary sourcehave been used (forexamplethe Japanese consumerprice is
the Australian iron ore price, cif Japan, in constant yen values).In the case
of Eastern Europe and China, where prices are not easily obtained, market
prices in nearby regions are used. For example,in EasternEurope,cif prices
inWesternEuropehavebeen used. Scrappriceshavebeen chosenin asimilar
fashion.
Chineseironoredemandrepresentsaninterestingproblem, sinceChinauses
domestic ore which has roughly half the iron ore content of imported ore
(whereas marketed ore in the other regions is remarkably similar in iron
content).To accountfor the impact of imported iron ore on the input-output
coefficient for iron ore (by weight), a specification similar to that of
equations5 and 6has been used. In this case,the coefficient onblast furnace
based steel production is linearly decreasing in Chinese iron ore import
quantity as a percentage of total Chinese iron ore consumption, such that if
imported iron ore was to account for 100 per cent of Chinese iron ore
consumption,their input-outputcoefficient would be equalto that of Japan,
which generally imports iron ore from the same sources as China. The
intercept and slope coefficients were fitted through the observed 1992
input-output ratioliron ore import ratio for China; and the Japanese
input-output ratio (which is based on essentially 100per cent importediron
ore). Substitution between scrap and iron ore is not accounted for in this
specification of demand for iron ore.
Supply
The supply of iron ore is largely influenced by the level of infrastructure
required to mine and transport the ore. The large capital expenditure, with
implicit adjustment costs, means that dynamic considerations must be
China's steel industry 43
accounted for in the supply relation. A partial adjustment model is used to
capture the short to medium run dynamics of iron ore production.
To capture the effect of the addition of significant greenfield capacity, the
lagged adjustment model is augmented by shift variables (0,1 variables),
which capture the infrequent, but significant adjustment in supply brought
about by the addition of large greenfield mines. This turns out to be
particularly relevant to supply in Brazil and Australia. Conceptually, this
shift variable is consistent with the work of Wagenhals (1985); Bresnahan
and Suslow (1989);Beck,Jolly and Loncar (1991);and an applicationto the
iron ore market by Priovolos (1987) which incorporates the presence of
capacityconstrainedproductioninthe shortrun.Intuitively speaking,supply
is decomposed into large, long run changes in mine capacity related to the
additionof greenfieldmines and the additionof infrastructuresuch asroads,
rail, and port facilities; and into short to medium term adjustment based on
existing infrastructure.
The exogenous specification of the capacity shift variable means that the
iron ore production block is best interpreted as describing the short to
medium term, which could be characterisedas being up to ten years in the
iron ore sector. In the long run, capacity itself would be likely to adjust to
changingmarketfactors.Thebasicformof theproductionrelation is defined
as:
where, for region i in year t,
Sly? = quantity of steel supplied;
pore1,t
= priceof ironore,in domesticcurrencyanddeflatedby domestic
producer price index; and
C;' = shift variable for greenfieldadditions to capacity.
Ironoreproduction,represented inequation7,was specifiedwithproduction
being determined by past production, the price of iron ore, and the shift
variables representing additions to greenfield capacity. In the case of
Australian iron ore production, a time trend has been used to capture the
effect of increasingproductivity in production.For most exportingregions,
the price of iron ore is defined in terms of fob at a domesticport of trade, in
44 ABARE research report 95.4
14 Price elasticityof iron ore supply (major
producers)
Region Short run Medium run
(10years)
Australia 0.30
Brazil 0.26
China 0.13
Eastern Europe 0.04
India 0.10
North America 0.04
Other Western Europe 0.22
domestic currency deflated by a general domesticproducer price index. For
regions where fob prices are unavailable,cif prices have been used.
The lack of an appropriateprice of iron ore to producers in North America
proved to be troublesome.Since much of US iron ore production is captive
to nearby steelworksdue to geographicalconstraintsand transportcosts, cif
prices are not reflective of the supply and demand balance in the region
(Barrington 1992).In order to obtain a proxy for the producer price of iron
ore, North American blast furnace steel production has been added to the
supply equation (as well as cif prices) as a reduced form representation of
the producer price of iron ore relevant to captivemines.
Shortandmediumtermpartial elasticitiesof ironoreproductionwithrespect
to producer price for the major producing regions are reported in table 14.
The estimated values of the elasticities are very similar to those reported in
Priovolos (1987).In the short run, the world's two major iron ore exporters
(Australiaand Brazil)arethe more elastic suppliers,probably due to the fact
that they both have abundantiron ore resourcesnear port facilities,and have
the infrastructurein place necessary to handlelargevolumes.Other Western
Europeis also shownto be rather price responsive,but, giventheir relatively
low level of production, is not a decisive factor in the world market. In the
short term India and China are found to be quite unresponsive to price;
however, over the medium term, India and China are found to be a bit more
responsive to price than other regions and countries. This short term
unresponsiveness may reflect the relativelack of infrastructurein these two
countries and the associated delays in increasing iron ore production
capacity.Alternatively,North America,which asnoted above,hasminesthat
China's steel industry
are primarily captive to domestic steelmaking, shows a relatively inelastic
response of iron ore with respect to price. In general, iron ore supply can be
expected to be more responsive to price movements in the medium term than
inthe shortterm as production decisions are more restricted in the short term
because of factors such as work force and infrastructure constraints.
Price linkage
where
pore$US
z,t
= Domestic contract price of iron ore (US$);
P;;"" = 'World price7of iron ore (US$ fob Australia); and
zt = freight rate index.
As noted above, various iron ore prices have been used in order to capture
exchange rates, transport costs, and quality differentials. Price linkage
equations such as equation 8 tie the various supply and demand relations
together. These equations relate the individual prices to one representative
price. In the case of the iron ore market, the US dollar fob Japanese contract
price for Australian ore is used as a 'world price'. Since iron ore contract
prices are most often in US dollars, the price linkage equations are fairly
straight forward. The linear specification shown in equation 8 captures
averagequality differentials via the intercept; the basic price correspondence
in the coefficient on world price; and, with the addition of an index of ocean
freight rates, the effect of transport costs. These various domestic contract
prices (US$) are then transformed via a simple accounting identity into the
domestic currency (deflated by a domestic producer price index) of the
relevant region in order to form the prices relevant to regional supply and
demand ( cy).
The scrap module
Scrap steel price equations have been employed in a partially reduced form
representation. This partially reduced form is based on an implicit model of
supply and demand for steel scrap. To illustrate, consider the following
specification for supply and demand for scrap in a particular market.
46 ABARE research report 95.4
where, for region i in year t,
SfCraP
1,t
= quantity of scrap supplied,
X ~ ~ P P ~ Y
l.t
= a vector of factors affecting the quantity of scrap supplied,
D Y a P
l,t
= quantity of scrap demanded, and
x ~ ~ , " ~ ~ ~ ~= a vector of factors affecting the quantity of scrap demanded.
If the market is relatively insulated from other scrap markets the system can
be closed by equating Sl:zraPto Dl:? .A reduced form representation for
price, in terms of the variables influencing supply and demand for scrap can
be estimated and solved for. One could think of this as simply a price
forecasting equation. The advantage of this representation is that it solves
for equilibrium scrap prices (which directly and indirectly feed back into
iron ore demand) without having to use data on scrap quantities, of which
the accuracy is doubtful. The lack of identification of scrap quantities is not
particularly troublesome since it is not of central concern in this study. The
scrap price equations are of the general form;
where, for region i in year t,
sEAF = quantity of steel produced via the electric arc furnace; and1,f
I 4 , t = industrial production.
Scrap prices are assumed to be directly related to electric arc furnace
production of steel,which is the primary use of steel scrap,and scrap supply.
An important component of scrap comes in the formof trimmings generated
in the fabrication of goods such as automobiles and consumer durables.
China's steel industry 47
Since the scrap price series used here are related to this 'new' scrap,
industrial production has been used as a reduced form representation of
residual trimmings generated from the production of manufactured goods.
Scrap price equations have been estimated for three major regions in which
price data are readily available (the United States, Western Europe and
Japan). For the other steel producing regions, the available scrap price most
likely to be relevant to that region was used. The three basic scrap prices are
not directly linked under the model specification. This more flexible
approach was taken following preliminary analysis which suggested the lack
of a stable (linear) relationship among the various scrap prices. And while
trade exists in the scrap market, the more flexible representation based on a
degree of market insulation appears to be consistent with the observed data.
Model closure: a one region example
The model described above is closed through the use of market clearing
identities, see equations 12, 13 and 14below. To illustrate model closure, a
one region example of the model is described below, where (1*) is the one
region example of (1) and so on.
Steel
Demand for steel follows a standard form in which industrial production,
own price and time (as a proxy for materials substitution) influence demand
for steel (1"). Steel supply is divided into blast furnace (2") and EAF
production (3*), with a time trend added to the EAF production equation to
account for the strong secular trend in adoption of that technology. Prices
are all deflatedby the producer price index to imposehomogeneity. The sum
of EAF production and blast furnace production is identical to total steel
production, equation 12, and total steel production is identical to total
(apparent) steel consumption, equation 13.
d p"raP - pcoa Ssteel
2 t 2 t 2 t-l
-
ABARE research report 95.4
where, for time t,
stBF = quantity of blast furnace based steel supplied;
stEAF= quantity of EAF based steel supplied;
ststee1= quantity of steel supplied;
Yeeel= price of steel, deflatedby a producer price index;
cWa1= price of coal, deflated by a producer price index;
Dsteeel = quantity of steel demanded (apparent consumption);and
If', = real industrialproduction.
core = Price of iron ore, deflated by a producer price index;
cscrap= price of scrap, deflatedby a producer price index; and
Tech, = time as an index of technological change.
Iron ore
Ironoredemandistreatedintermsof conditionalfactordemand.Theactivity
level is blast furnaceproduction of steel.The ownprice of iron oreis relative
to the price of scrap steel, sinceit is presumed that the primary substitutefor
iron ore via the integrated steelmaking route is scrap. Iron ore supply is
determined within a partial adjustment model, which is further augmented
by a shiftvariable to capture significantincreasesin minesite capacity. Own
price is deflated by a general producer price index to impose homogeneity.
At market clearing prices the quantity supplied is equal to the quantity
demanded.
(7") Store= a,, +b5core+c5C? +d5S:y
- - -
China's steel industry
Where, in time t,
Store = quantity of iron ore supplied;
core = price of iron ore, deflated by a producer price index;
Ctore = ashiftvariable accounting for largejumps in mine sitecapacity;
Dere = quantity of iron ore supplied (apparent consumption);
S? = steel produced via the blast furnace; and
cScrap= the price of steel scrap, deflated by a producer price index.
Scrapprice
A scrapprice equation is specified, which isjointly determined with the level
of electric arc furnace production ( SY) as well as proxies which account
for exogenous supply factors (2,).This reduced form price equation is used
since the price data for scrap is available, but the quantity data are
incon~plete.Since the projects at hand are not specifically directed toward
the scrap market, this should be of little importance. However, it is accepted
that futureprojects may warrant a specification in which scrap quantities can
be solved for. Still, the point here is that such a specification will not have
much (if any) impact on the iron ore and steel projections, for which this
model has been built.
This one region example represents a system which solves for the time path
of equilibrium production, consumption and prices of iron ore and steel (as
well as scrapprice) for any giveninitial condition and projection of variables
which are exogenous to the model, which include real industrial production
and coking coal prices.
This oneregion model is expanded to eleven regions primarily by specifying
iron ore and steel supply and demand equations for each region, and
imposing the restriction that the quantity supplied worldwide equals the
quantity demanded worldwide. The trade model requires exchange rate and
50 ABARE research report 95.4
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china_steel

  • 2. C h i n a b emerging d t e e l inaudtry an2 i t d impact on t h e worla iron ore an2 d t e e l market Stephen Labson Peter Gooday Andrew Manson ABARE ABARE RESEARCH REPORT 95.4
  • 3. O Commonwealthof Australia 1995 This work is copyright. The Copyright Act 1968permits fair dealing for study, research, news reporting, criticism or review. Selected passages, tables or diagrams may be reproduced for such purposes provided acknowledgment of the source is included. Major extracts or the entire document may not be reproduced by any process without the written permission of the Executive Director, ABARE. ISSN 1037-8286 ISBN 0 642 22650 4 Labson, B.S., Gooday, P. and Manson, A. 1995, China's Emerging Steel Industry and its Impact on the World Iron Ore and Steel Market, ABARE Research Report 95.4, Canberra. Australian Bureau of Agricultural and Resource Economics GPO Box 1563 Canberra 2601 Telephone (06) 272 2000 Facsimile (06) 272 2001 ABARE is a professionally independent government economic research organisation. ABARE project 1162
  • 4. Foreword The industrial development of China over the past ten years has been concomitantwith pronounced growth in China's iron ore and steel industry. While much of this growth has been confined within domestic boundaries, China's role in the world iron ore and steel market has increased markedly since the early 1980s. This continuing integration with the world market, coupled with China's growing iron ore and steel industry, is likely to have a profound impact on world iron ore and steel trade. As a major exporter of ironore,Australiais likelytobe particularly affectedby suchmarketforces. The purpose in this study is to examine the potential impact of China's emerging steel industry on the world iron ore and steel sector. This study formspart of ABARE's continuingresearchintothe globalironoreand steel markets, markets where Australia plays a vital role. BERNARD WONDER Executive Director, ABARE March 1995 iii
  • 5. Acknowledgments The authors would like to acknowledge the role of Tom Waring in offering the original inspiration for the modelling effort underlying this study, and helpful comments offered by Terry Shealeson previous drafts.
  • 6. Contents Summary 1 1 Introduction 7 2 Development of the Chinese steel sector 9 Economic reform 10 The impact of reforms on the Chinese steel sector 11 The Chinese steel industry at present 12 China's participation in the world steel and raw materials markets 18 The Chinese steel industry in 2000 20 3 Global effects of growth in the Chinese steel industry Baseline projections The effects of high economic growth in China The effects of low economic growth in China 4 Conclusions I Policy directions Appendix Description of the world iron ore and steel trade model I References
  • 7. Box 1 A model of the world iron ore and steel trade Map Steelworksand iron ore producing regions in China 14 Figures A Chinese crude steel production B Chinese steel imports C Chinese iron ore consumption D GDP growth at constant prices Tables 1 Chinese iron ore and steel production and imports 7 2 Steel production from major Chinese plants in 1993 13 3 Production of steel by product group 15 4 Iron content of marketable ore 17 5 Crude steel consumption, 1992 21 6 Baseline industrial production 24 7 Baseline projections of steel consumption and production 26 8 Baseline projections of iron ore consumption and production 28 9 Projected steel consumption and production under the scenario of high growth in Chinese industrial production 30 10 Projected iron ore consumption and production under the scenario of high growth in Chinese industrial production 31 11 Projected steel consumption and production under the scenario of low growth in Chinese industrial production 32 12 Projected iron ore consumption and production under the scenario of low growth in Chinese industrial production 33 13 Partial elasticity of steel demand 40 14 Price elasticity of iron ore supply (major producers) 45 15 In sample dynamic simulation performance, 1983-9 1 52
  • 8. Summary China is undergoing rapid industrial development China was the due, at least in part, to the economic reforms world's thirdlargest implemented since the late 1970s. Growth in the steelproducer in Chinese iron ore and steel sector has been 1993, afivefold concomitant to this development, placing China increasefrom 1970 among the world's largest producers and consumers of steel and steelmaking raw materials. China has progressed from being the world's seventh largest steel producer (in volume terms) in 1970, to fifth in 1980and to third in 1993,behind the CIS and Japan. The 89 million tonnes of steel produced in China in 1993is five times greater than the quantity of steel produced in 1970 and almost two and a half times that produced in 1980. Even with this extraordinary growth in production, China's demand for steel has outpaced domestic production and China has become a significant importer of steel. However, the volume of imports has been extremely volatile, ranging between less than 5 million tonnes and 30 million tonnes over the past decade. By all accounts, production and consumption of steel within China are expected to I increase at a rapid pace to the end of this decade ' making China an increasingly important participant in the world iron ore and steel market. Chinahasvastdomesticreservesof steelmakingraw materials, particularly iron ore and coking coal. However, while China is likely to remain largely self-sufficientin coking coal, it is expected to rely more heavily on importediron ore as aconsequence of the relatively poor quality and locationof its iron ore deposits. Thus, continued growth in the production of Chinesesteelcanbe expectedto result in increased imports of iron ore. As a major supplier Chinahas become a significant importer of steel and will become an increasingly important participant in the world iron ore and steel murket Increasing demand for iron ore in Chinawillprovide a largermarketfor Australian iron ore China's steel industry
  • 9. of ironore,Australiaiswell placed torespondto this demand. A quantitative assessment The model of world In orderto determinethepotential effecton the world trade in iron ore market of growth in the Chinese iron ore and steel and steel was used sector, a model of world trade in iron ore and steel to examine the was constructed.Themodelis asetof linkedregional impact of economic supply and demand relations. Capacity constraints, growth in China adjustment costs, technological change and other aspects of the sector are accounted for in the modelling framework through their effect on these supply and demand relationships. World prices, production and consumption are then solved for under market clearing conditions, that is, production is equal to consumption. The model was employed to examinethe impacton the world iron ore and steel sector of economic growth in China by simulating market outcomes based on projected growth in Chinese industrialproduction to the year 2000. China's expanding role in the world iron ore and steel market In addition to Annual steel consumption in China is projected to increasing steel increase by 30 million tonnes over the period 1994 production China is to 2000. Thisincreasein demandaccountsfor 30per expected to import cent of the projected total increase in annual world increasing steel consumption over the same period. In response quantities of steel to this significant increase in demand, China is projected to increase annual steel production to 110 million tonnes in 2000, making China the world's largest steelproducing country. Despite suchgrowth in output of steel, China is projected to import between 12and26 million tonnesof steel a year over the rest of the decade. The European To meet the projected increasein Chinese as well as Union, North world steel demand, those regions with established America and Japan steelmaking capacity, such as the European Union, 2 ABARE research report 95.4
  • 10. North America and Japan are also projected to areprojected to increase production. While projected steel increase steel production for these mature steelmaking regions is production by more well below previous peaks, growth in production is than loper cent by significant, with each of these regions increasing the year 2000 annual steel production by more than 10per cent by the year 2000. China's increasingsteel output, comprised largely of China'sdemandfor blast furnace based production, corresponds to an iron ore imports is increase in annual iron ore consumption of 31 projected to rise million tonnes over the period 1994 to 2000. Even from 37 million with an increase in domesticproduction of iron ore, tonnes in 1994 to China's import demand for iron ore is projected to 50 million tonnes rise from 37 million tonnes in 1994, to 50 million 2y 2000 tonnes by 2000. This projected rise in iron ore imports is consistent with Chinese plans for new steel plants and increased capacity at existingplants at locationsnear port facilities,and hence accessible to imported ore. Developments in iron ore supplying countries The major world exporters of iron ore are Australia, Australia, Brazil Brazil and India. Australiais likely to be particularly and India will all affected by growth in the Chinese steel market (as increase their well as the general increase in demand worldwide). production and In response to the projected increase in demand for exports of iron ore iron ore,Australiaisprojected toincreaseproduction by 17milliontonnesover the simulationperiod,with 16million tonnes of this increase sold on the export market. Over this same period, Brazil's exports of iron ore are projected to increase by 14 million tonnes and India's exports by 10million tonnes. , These projected increases in iron ore production Most of the increase I from exporting countries can be expected to come inproduction willI I from existing producers, and mostly from existing comefrom mines. In Australia,a further 4 million tonnes a year existing mines is planned to be mined from the Channar China's steel industry 3
  • 11. The effect of 'high' and 'low' economic growth rates in China on the iron ore and steel market were simulated In the high growth scenario Chinese steel consumption isprojected to rise to 149 million tonnes in theyear 2000. .. ...and to 119 million tonnes under the low growth scenario (bothfrom a base of 106 million tonnes in 1994) Australia-China joint venturemineby the year 2000, with the increased production destined for the growing Chinese market. Robe River Mining can easily be expanded by 8 million tonnes. Hamersley Iron's 12 million tonne a year capacity Marandoo mine began production in 1994, as did BHP's 5 million tonne a year Yarrie mine. The inJZuenceof economic growth in China While the projections presented above are based on 'best bet' assumptionsaboutfutureeconomicgrowth rates, variations in economic growth could have a marked effect on final outcomes. To illustrate the impactof varyingrates of economic growthin China on the iron ore and steelmarket, the model was used to simulate 'high' and 'low' growth scenarios. Under the high economic growth scenario, Chinese industrialproduction is assumed to increase at a rate of 15 per cent a year, which corresponds to the averagerate of growth observed since the economic reforms of 1985. In the high growth scenario, Chinese steel consumption is projected to increase from 106 million tonnes in 1994, to 149 million tonnes in the year 2000. Under the low growth scenario, Chinese industrial I production is assumed to increase by only half as ~much as under the base case (around 5 per cent a year). In this scenario, Chinese steel consumption is projectedtoincreasefrom 106milliontonnesin 1994 to 119million tonnesin 2000.Therangeinprojected Chinese steel consumption arising from varying assumed economic growth rates highlights the sensitivity of these projections to economic growth, but also underscores the expectation for future growth in the Chinese steel industry, even under conservative assumptions for economic growth in China.
  • 12. Implicationsfor Australia Australia holds the largest share of the Chinese iron Australia supplies ore import market, supplying 17 million tonnes of over half of the 33 million tonnes of Chinese iron ore imports in Chinese iron ore 1993. China's importance as a destination for imports- 15per Australian iron ore exports has been increasing cent ofAustralian strongly. In 1993China accounted for 15per cent of trade in iron ore Australia's iron ore exports of 111million tonnes. in 1993 Australia is well placed to take advantage of the projected increase in Chinese demand for iron ore. Australia's relative proximity to the Chinese market gives Australian iron ore producers a distinct cost advantage in landing iron ore in China. With several important additions to capacity expected to come on linein the next few years, Australian iron ore exports are projected to increase from 1I I million tonnes in 1993 to 137 million tonnes by 2000. Much of this increase is likely to be used to satisfy the projected 17 million tonne rise in Chinese demand for im- ported iron ore. Furthermore, the rapidly expanding steelmaking industries in other developing Asian economies, such as South Korea and Taiwan, as well as a strengthening of steel production in Japan, will offer Australia an expanding export market for iron ore. A rolefor cooperation The degree to which growth in demand for steel and steelmaking raw materials in China is sustained, and the implications of this for Australian producers of iron ore and steel, will be sensitive to the rate of future economic growth in China, as well as the development of a liberal policy environment that allows for the free flow of trade, investment and technology.Australia, asanefficientproducerof iron ore and steel, has much to gain from a continued effort to ensure a liberal, stable and well informed policy environment within the region. Australia's relative proximity to the Chinese market will enable it to take advantage of the increase in China's demandfor iron ore South Korea, Taiwanand Japan will also offer Australia an expanding iron ore market The rate of economic growth in China and the development of a liberal, stable and well informed policy environment will affect Australia- China trade in iron ore and steel China'ssteel industry
  • 13. The iron ore and steel trade between China and Australia has benefited from the independent efforts of Australian and Chinese iron ore and steel producers Future opportunities can be assisted by bilateral government organisations and nzultilateral trade agreements China-Australia iron ore and steel trade has increased through the independent efforts of Australian and Chinese iron ore and steel producers, as evidenced by the ongoing increase in Australian iron ore exports to China and thejoint ventures being formed by Australian and Chinese enterprises. There is a recognition that further trade and investment opportunities can be assisted by bilateral government organisations such as the Australia-China Joint Study Group intoIron Ore and Steel, and the Western Australia-China Economic and Technical Research Fund as exemplifiedby its recent studies intoiron ore processing facilities in Western Australia. Together with multilateral trade initiatives such as the GATT, a Multilateral Stcel Agreement, or an East Asian Steel agreement as proposed by Drysdale (1992), such efforts will undoubtedly contribute to the efficient development of the industry within the Asian region as a whole, while also allowing for increased Australian trade opportunities in iron ore, as well as in value added iron and steel products. 6 ABARE research report 95.4
  • 14. Introduction China's steelindustry has been the fastest growing in the world over the past two decades. It has progressed from being the world's seventh largest steel producer (in volume terms) in 1970, to fifth in 1980 and to third in 1993, behind the CIS and Japan. The 89 million tonnes of steel produced in China in 1993 is five times the quantity produced in 1970 and almost two and a half times that produced in 1980. While much of this growth has been confined within domestic boundaries. China's role in the world iron ore and steel market has increased markedly sincethe early 1980s,with imports of steel accounting for up to 30 per cent of total Chinese consumption. This continuing integration with the world market, coupled with China's growing domestic iron ore and steel industry, is likely to have a profound impact on world iron ore and steel trade. As a major producer of iron ore, China has been able to satisfy a large proportion of its demand for iron ore from domestic sources. However, the increase in steel production observed over the past ten years has been followed by a pronounced increase in China's imports of iron ore. Iron ore imports increased from negligible amounts during the 1970s,to 33 million tonnes by 1993 (table 1). 1 Chineseiron ore and steel production and imports I I Iron ore Steel I Year Production Imports Productiona Importsb 1970 55.00 c 0 17.79 1975 96.94 1.44 23.90 1980 112.58 5.32 37.12 1985 137.84 10.11 46.79 1990 179.34 14.19 66.35 1992 195.95 25.20 80.04 1993 224.73 32.90 88.70 a Crude steel.b Semifinishedsteel.c 1971data. d Estimate. Sources: International Iron and SteelInstitute (1993);UNCTAD (1994). - - - - CIzina'ssteel industry
  • 15. It has been frequently suggested that strong growth in steel production and consumption will continue at least to the year 2000 (see,for example, Chen, Clements,Roberts andWeber 1991;Dorian, Clark,Jeon and Snowden 1990; Drysdale 1992;Feng 1992).Although China has estimated reserves of iron ore of over 46 billion tonnes, it appears unlikely that continued growth in steel production will be based on domestically sourced ore. This is because most of China's iron oreisrelatively low in iron content, leading to low blast fuinace productivity and high energy consumption as well as high transport and processing costs. Therefore, it seems that China will depend more heavily on imported iron ore as its steel sector continues to grow. In spite of the importance of China's emerging steelindustry, little is known of how the above developments may affect the world iron ore and steel industry. Few currently available models can quantitatively evaluate the effects of a changing economic environment on world iron ore and steel trade. Several iron ore and steel models explicitly consider the interaction between supply anddemand(see,for example,Higgins 1969;Watanabe and Kinoshita 1971; Tsao and Day 1971; Yamawaki 1984). However, these models examined the market on aregional basis (primarily the United States and Japan), without considering the world market as a whole. Hashimoto (1981) constructed a world iron ore and steel model, but regional specification was not considered. That is, Hashimoto's model solves for world prices and quantities, but does not disaggregate by region. Priovolos (1987), and Toweh and Newcomb (1991) constructed world iron ore trade models which disaggregate by region; however, steel demand and prices are not determined within these models. The purpose in this study is to evaluate the impact of China's emerging steel sector within an integrated world market for iron ore and steel. Specifically, an econometric model of world iron ore and steel trade has been constructed which simulates the direct effect of economic growth in China on the Chinese iron ore and steel industry, as well as the indirect effects, as the rest of the world adjusts to this new market environment. A clearer understanding of the changing market for iron ore and steel brought about by growth in China is particularly important to Australian interests. Chinarepresents a significant market forAustralian exports of iron ore and is likely to be a focal point of further development in the industry at least to the end of the decade. Furthermore, there may be scope for developing value added iron making facilities in Australia, given sufficient growth in demand for steelmaking raw materials in the region. 8 ABARE research report 95.4
  • 16. Development of the Chinese steel sector Since the end of civil war in 1949,the iron and steel sector has played an importantrolein the developmentof the Chineseeconomy.Overthisperiod, Chinese steel productionhas risen fromjust 160000 tonnes in 1949,to 89 million tonnes in 1993 (figure A). As a centrally planned economy, much of the development of the Chinese steel sector has taken place under direct governmentintervention.Considereda 'key industry' in terms of economic planning, the Chineseiron and steel sector has been particularlyaffectedby the centralisedsystemof economicdevelopment whichis largelyconducted under 'Five Year Plans', the first spanning 1953-57. Between 1958 and 1960, during the period known as 'The Great Leap Forward', highrates of growthwereaimed at acrosstheeconomy.Industries were assigned high output and growth targets with an aim to modernising the economy and catching up with developed countries within 15-20 years (Hsu 1989). The policies adopted in this period resulted in industries producing low qualityproducts in order to meet high output targets. Within the iron and steel industry, which was one of the industries targeted, thousandsof smalliron and steel plants were opened throughoutChina and crude steel production increased significantly. These plants produced products of very low quality and most had closedby 1961(Findlay and Xin 1985). - A Chinesecrudesteel production iiABARE 80 / 60 40 20 Mt ~ I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I 1953 1961 1969 1977 1985 1993
  • 17. The Chinese economy apparently was unable to sustain the rate of growth the steel industry attained during 'The Great Leap Forward'. Findlay and Xin (1985) have attributedthis inability to the inefficient allocation of scarce resources such as energy, raw materials and investment funds. As a result crude steel output fell markedly in 1961and continued to fall in 1962.After a period of recovery, disruptions caused by the Cultural Revolution resulted in crude steel output falling significantly in 1967 and continuing to fall in 1968. In the mid to late 1970s, with a shift in political power, the Chinese government decided that the country should upgrade the level of technology by importing advanced machinery from the West (Hsu 1989). The 'Four Modernisations' program launched in 1978emphasised the use of modern machinery. Under this program 120 large scale projects were proposed, these included ten iron and steel mills, eight coal mines and five harbours (Hsu 1989). Under the 'Four Modernisations' program Chinese steel output was planned to rise from 23.7 million tonnes in 1977, to 60 million tonnes by 1985. As a result of domestic supply shortages, inefficient importing practices and the emergence of a large trade deficit and inflationary problems the 'Four Modernisations' program was abolished in late 1978 and the government began to restrict technology imports (Hsu 1989). A major program of readjustment and reform was then implemented which, among other things, involved halting many large scale construction projects, including the Baoshan steel mill. Other measures included a movement of investment resources away from heavy industry toward agriculture and light industry and a lowering of output targets for heavy industry. Economic reform The program of economic reform has involved an increased use of market mechanisms to supplement central planning. Some decision making power was decentralised to enterprises and local governments and incentives were introduced to raise the productivity of workers and management in both the agricultural and manufacturing industries. These measures were designed to make commodity supplies more sensitive to demand and supply conditions (Hsu 1989). Despite the failure of the 'Four Modernisations' program, the government continued to pursue the goal of economic modernisation. Rather than revert to a closed-door economy, foreign trade continued to be promoted. In addition, in 1980, Special Economic Zones 10 ABARE research report 95.4
  • 18. were set up in Shenzhen, Shantou and Zhuhai in Guangdongprovince and Xiamen in Fujianprovince. TheSpecialEconomicZonesoperate under less restrictive economic policies than the rest of the country, are given preferential tax treatment, import Western technology, capital and management skills,andencouragetheparticipationof foreignfirms.Market factorsare supposed to play a greaterrole in decisionmaking in these zones than in other parts of the country. The Sixth Five Year Plan, 1981-85, reinforcedthe economicreforms made in the Fifth Five Year Plan. The Sixth Five Year Plan was the first step in the long term plan to quadruple output between 1980 and 2000. The plan continued the economicreforms and sought to lay the foundation for high andsustainedgrowth (JamesandYoung 1987).A greaterdegreeof autonomy was granted to local regions and planning was decentralised further. The Seventh Five Year Plan, 1986-90, involved policies designed to continuetopromotethegrowthof theChineseeconomy andcalledforChina to 'Give priority to reform and make sure that reform and development are adapted to and promote each other' (Chinese Documents 1986). Another major objective was to 'Open wider to the outside world and link the development of the domestic economy more closely with expanded economic and technological exchange with other countries' (Chinese Documents 1986).Under the Seventh Five Year Plan, China was to invest US$11 billion in technical renovation and capital construction in the iron and steel industry and to seek additional foreign investment so that the production targets of 60million tonnesof crude steelin 1990and 95 million tonnes in 1995were met (Chin and Kuo 1990). I The impact of reforms on the Chinese steel sector The economicreforms which began in 1979have affectedthe Chinese steel sector in a number of ways. Policies which have allowed for, and encouraged,theimportationof Westerntechnologiesandrawmaterials have helped to improve steel production processes in China. The import of foreignsteel production technology has allowed Chinese steelproducers to increase efficiency significantly through the upgrading of old Soviet designed pIants and the constructionof new Japaneseand Germandesigned plants. The change in attitude toward the import of raw materials has provided the Chinese steel industry with access to high quality Australian and Brazilian iron ores which can be expectedto increase the efficiency of steel production.
  • 19. Reformsto the pricing systemhavebeen importantto China's iron and steel industry. The reforms have allowed major steelmaking enterprises (accounting for 70 per cent of Chinese crude steel production) to sell any excessproductionwithin arelatively opendomesticmarket, oncetheirquota for the central government has been filled. The prices at which these sales were concluded,however, were restricted to within 20 per cent of the price received for sales to the central government (the state price). This price restriction was removed in 1985 and prices on the domestic market were allowed to fluctuatewith supply and demand. In 1988ceilings on steelprices were introduced becausehigh prices of steel led to complaints from users and the two tier system encouraged the diversion of supplies from the state system to the market system (Feng 1990). The domestic market price of steel has remained relatively high, however. Under the central planning system there is a limit to the amount of foreign exchangethatis made availableforthe purchase of steelimports, which effectively imposes a quota on steel imports into China. As a result the domestic market price has generally been higher than the import price (Feng 1990). Reforms to the pricing of steelcan be expectedto improvethe way in which steelis allocatedthroughoutthe Chinese economy.Chinese steelusers have traditionally kept relatively large stocks of steel to trade in case the steel they are allocated by the central government is not what they want. Steel users can now purchase the specifictypes of steelthey requiredirectlyfrom steelproducers on the domesticmarket. In addition, steelusers cannow sell any unused allocation of steel. The Chinese steel industry at present The Chinese steel industry is under the direct control of the Ministry of Metallurgical Industries which is responsible for the administration, regulation and production of steel, iron and iron ore (Chin and Kuo 1990). Steel production is dominated by large integrated steel works that require ironore and coking coal as feedstock. Thefivelargeststeelplants produced over 30million tonnes of thetotal 89million tonnes of crude steelproduced in Chinain 1993.Anshan,China's largeststeelcompany,produced inexcess of 8 million tonnes in 1993 (table 2), placing it in the world's top 20 steel producers by volume. 12 ABARE researchreport 95.4
  • 20. 2 Steel productionfrom major Chinese plantsin 1993 Steel company Region Start-update Production Anshan Liaoning 1916 8.51 Baoshan Shanghai 1985 6.98 Shougang Beijing 1920 7.02 Wuhan Hubei 1958 5.24 Baotou Inner Mongolia 1958 3.08 Sources: Metal Bulletin (1994);Tse (1992). The five major steel enterprises listed in table 2 accounted for around 35per cent of total Chinese steel production in 1993. There are many steel plants producing much smaller volumes. For instance, there were fourteen steel producing enterprises with output exceeding 1 million tonnes in 1989, ten produced 0.5-1 million tonnes, and a further 118 each produced less than 0.5million tonnes of steel. Most of these smaller steelplants are also located in eastern China (see map on page 14), although in 1989 some steel was produced in 28 of the 31provinces and municipalities of China (Editorial Board of the Yearbook of Iron and Steel Industry of China 1990). Steel production is concentrated mostly in the more densely populated north eastern and eastern provinces of China. The Beijing municipality and the surrounding provinces of Liaoning, Hebei and Shandong in the north east accounted for around a third of Chinesecrude steelproduction of 66million tonnes in 1990.The eastern municipality of Shanghaiwas the second largest steel producing region after Liaoning, producing almost 14per cent of total crude steel output. Steelproduction does occur further inland. In particular, largeintegrated steelplants suchasWuhan,Panzihua andBaotou arelocated near the main waterways of the Yellow and Yangtze Rivers in the regions of Hubei, Sichuan, and Inner Mongolia. Only a small share of China's steel isproduced inthe southernregions of China,despitestrongdemand for steel from the manufacturing sector, and very little steel is produced in the more remote western regions. Age distribution and technology used by Chinese steel industry The vintage and hence technology of China's steel plants varies considerably. In 1992, only 30 per cent of the steel produced in China was
  • 21. cast by the modern continuous casting method, compared with a world average of 66 per cent. In the same year, over 17 per cent of steel was produced by the outdated open hearth method in China, compared with a total industrialised country average of less than one per cent (International Iron and Steel Institute 1993). Many large steel works such as Wuhan and Anshan were constructed in the 1950s using Russian technology, and have only recently begun the process MONGOLIA 8 Shenzhen 9 Meishan Sources: Metal Bulletin; MMI. 14 ABARE research report 95.4
  • 22. of updating their technology. As the Chinese economy opened up to the outside world, the steel industry gained access to more modern technology. Newer steel plants have taken advantage of this, and imported modern technology and equipment. The Baoshan steelworks on the Yangtze River in Shanghai is China's most modern steel works and has been built using imported technology and equipment from Japan and Germany. In line with recent economic reforms, larger steel groups such as Wuhan, Baoshan and Shougang arebeing encouraged to operate independently from the central authorities as commercial enterprises (see for example Tex Report 1993). The greater autonomy is allowing these steel producers to reinvest much of their earnings in modernisation and in expansions to both domestic production capacity and international holdings. Shougang for example, has recently purchased a Peruvian iron ore mine, a controlling interest in Hong Kong's second largest steel trading company,and aUS steel mill which it plans to relocate to China. The technological shortcomings of the Chinese steel industry are also apparent in the quality of steel produced and in the product mix of that steel. In 1990, only 40 per cent of China's rolled steel output would have met international standards. The modernisation of steel works is likely to see this proportion rise in the future. Under the Eighth Five Year Plan, this proportion is to increase to 50 per cent by 1995 (United Nations Industrial Development Organisation 1992). China's output by product group is biased toward the production of long products such as sections and wirethat are used in the construction industry, and against the production of flat products such as sheet that are heavily I I 3 Productionof steel by product group ~ Productgroup China United States Japan Germany South Korea Section 48.9 24.6 30.3 14.2 35.7 Wire 16.4 4.1 7.5 9.6 7.6 Plate 11.9 5.9 13.2 20.5 15.4 Sheet 10.3 53.1 44.2 47.2 41.2 Tube 8.8 0.0 4.7 8.5 0.0 Other 3.7 12.3 0.1 0.0 0.1 Source: Chin and Kuo (1990). China's steel industry 15
  • 23. consumed by the manufacturing industry (table 3). This product mix of Chinese steelreflects not onlythe consumptionmix in Chinacompared with other major steel producers, but also the comparative advantage of Chinese steel producers in the production of long products which generally have lower technology and capital requirements than the production of flat products. Inputs to steelmaking China is the world's largest coal producer, with annual output in excess of onebillion tonnes, andhas proven coal reserves of almost 900billion tonnes or about 32 per cent of world reserves (China-Australia Joint Working Group on Energy 1992). As about a quarter of Chinese coal reserves are suitable as coking coal (United Nations Industrial Development Organisation 1992), domestic coal resources appear sufficient to satisfy future steelmaking requirements. However,the majority of coaldepositsare located in the northern provinces of Shanxi, Henan, Hebei, the New MongoliaAutonomous Region in the north west and Heilongjiang province in the north east. This places a strain on the transport system as the manufacturing facilities are in the east and southern part of the country. China possesses large reserves of other raw materials required in the steelmaking process such as manganese, tungsten, dolomite and limestone. China is expected to at least remain self-sufficient in the supply of most of these raw materials for its domestic steel industry. Although China's reserves of manganese ore of around 14 million tonnes are large, the low quality of the ore can be expected to require increased imports as the steel industry increases output. With a reserve base of around 9 billion tonnes, or 4 per cent of world reserves, China has large resources of iron ore (Kirk 1993).Around 65 per cent of these reserves are concentrated in northern China, and the remainder in the south (United Nations Industrial Development Organisation 1992). China is the world's largest producer of iron ore by volume, producing an estimated 225 million tonnes in 1993(United Nations Conferenceon Trade and Development 1994).The majority of iron ore production comes from mines captive to steel enterprises within the same province. Anshan produces iron ore from five mines in Liaoning, with annual capacity of nearly 27 million tonnes to feed its steelworks in the same province. Other major captive mines include Shougang mines in Beijing (18 million tonnes 16 ABARE research report 95.4
  • 24. 4 Iron contentof marketable ore Australia Brazil China India United States Former Soviet Union Source:UNCTAD (1994). capacity),Benxi in Liaoning (13.7 million tonnes), Maanshan in Anhui (8 million tonnes), Panzhihua operations in Sichuan (8.3 million tonnes), Baotou in New Mongolia (7.8 million tonnes)and Wuhan in Hubei (5.1 million tonnes) (Tse 1992).A large number of smaller local iron ore mines contribute around 35 per cent of total production. These mines are run as smallcollectiveoperations or as a sidelineby farmers(Chin and Kuo 1990). Although China is the world's largest producer of iron ore on a natural weight basis, it is only the third largest producer on an iron content basis. This is because the quality of Chinese iron ore is low by world standards (table4). The iron content of Chinese ore is typically in the 30-35 per cent range, and only 5 per cent of Chinese iron ore reserves contain more than 35 per cent iron (Chin and Kuo 1990).Only a few of the smaller mines, and the Shilu mine on Hainan Island (4.6 million tonnes a year capacity) with 53 per cent iron content, produce ore with an iron content comparable to that traded internationally. Relatively costly beneficiation is therefore required to upgrade most Chinese domestic ore to a standard acceptable in the steelmakingprocess. I Production costs for Chinese iron ore are relatively high due to these beneficiation requirements. Recently imposed taxes on Chinese iron ore production furtherimpinge on the competitivenessof Chinese iron ore.The cost of producing a high grade concentratein China roughly equivalent to ore traded in world markets has been estimated to average US$25 a tonne in 1994 (Tian 1994).In addition to this cost, a royalty averaging US$6 a tonne and a 'value rising' tax of US$4.50 a tonne of concentrateproduced has been imposed on Chinese iron ore producers. By comparing these costs with the averagecif importpricepaid by Japanese steelproducers of US$25 a tonne in the first half of 1994,the competitivenessof imported iron ore in China can be seen. China's steel industry 17
  • 25. Transportand infrastructure Apart from the poor quality of iron ore, Chinese steel producers are further constrained by inadequate internal transport systems for the delivery of domestically produced iron ore and coal. It has been widely observed that investment in the transport sectorin Chinahas been neglected in comparison with other sectors (Feng, Findlay, Richardson and Wu 1993).Major iron ore producers such as Australia and Brazil transport iron ore from mine to port using dedicated rail systems. The rail system in China is overcrowded and in a poor state so the task of transporting large volumes of iron ore on a regular basis is both difficult and costly,even though steelplants are usually located in the same province as iron ore and coal resources. Considerable resources are now being devoted to upgrade the rail system. Almost US$1 billion was spent on rail construction projects in 1990,and a further US$18.8 billion is planned to be invested on the construction of a more efficient rail system during the remainder of the decade (Tse 1992). Port facilitiesrequired for the import of iron ore and steel products are also inadequate. In particular, China has only one deep water port capable of receiving iron ore in the large cape size vessels that carry ore in 150 000 tonnes or greater shipments. This places a strainon the operation of existing ports. Iron ore is often reloaded into smaller ships or barges before delivery to a steel works or rail terminal. For example, imported iron ore for Baoshan is unloadedinitially atthe Beilun deep water port some 150kilometres south and then barged to the steel works. Wuhan has higher transport costs for imported ore, as iron ore has to be barged 1200kilometres up the Yangtze River. In preparation for expected increased imports of iron ore in the future, China's port facilities are undergoing major expansions. These include expansions to the deepwater port of Beilun, and an additional 100000tonne capacity berth near Baoshan, as well as expansions to the smaller ports of Qinhuandao in Beijing and Shijiusuo in Shandong. China's participation in the world steel and raw materials markets Sincethe economic reforms of the late 1970s,China has been an important, albeit volatile, importer of steel. As shown in figure B, steel imports have ranged from less than 5 million tonnes a year to around 30 million tonnes, 18 ABARE research report 95.4
  • 26. constituting from around 5 to roughly 30 per cent of total Chinese steel consumption.Chinese steel importshave fluctuateddue to differing growth rates in steel consumption and production, the lagged response of steel producers to large demand increases and the availability of foreign exchange. From 1982 through to 1985 China was importing increasingly large quantitiesof steel as domestic steel production growth could not keep pace with growth in demand for steel.The Chinesesteel industryresponded to this increasein demandby increasingproduction capacity;however,steel production did not increase by enough to allow for a fall in steel imports until 1986. Increased steel production has led to a significant increase in demand for iron ore. As can be seen from figure C, a large proportion of Chinese iron
  • 27. ore demand has been supplied from domestic sources. However, it should be noted when examining figure C that no account has been taken of the fact that Chinese iron ore has a considerably lower iron content than imported ores. As a result figure C understates the importance of imported ore. Nearly all of the integrated steel companies possess captive iron ore mines within the same province. Only the Baoshan steel mill relies completely on imported ore. However, the share of imports in total Chinese iron ore consumptionhas been increasing sincethe early 1980s.The shareof imports in total Chinese iron ore consumption increased from around 3 per cent (3.3 million tonnes) in 1981 to around 13 per cent (33 million tonnes) in 1993. On an iron content basis, imports increased from around 6 per cent of total consumption in 1981to around 21 per cent in 1993. Not only have the economic reforms allowed for an increase in iron ore imports but they have allowed Chinese organisations to develop interests in iron oreprojects in foreign countries. These types of projects ensure that the Chinese steel industry has access to supplies of high quality iron ore and exposes Chinese engineers and managers to advanced foreign techniques. An important example of this type ofjoint venture is the development of the Western Australian Channar iron ore deposit by the Chinese government's official trade agency, the China Metallurgical Import and Export Corp, and the Australian iron ore producer Hamersley Iron. This mine currently produces around 6million tonnes a year with all production going to China. The Chinese steel industry in 2000 If the spectacular growth of Chinese steel consumption andproduction over the past two decades continues, China will become an increasingly important player in the world steel and steelmaking raw material markets. Increases in Chinese production and imports of steel and steelmaking raw materials can be expected to have implications for world prices and trade flows of these comnlodities. There are several factors which suggest that Chinese steel production and consumption are likely to grow. GDP growth The dramaticincreasein Chinese steel production has coincided with strong growth in the Chinese economy. The rate of growth of Chinese gross domestic product (GDP) has been high relative to other major economies (figure D) and has resulted in a steady increase in the demand for steel. 20 ABARE research report 95.4
  • 28. A large proportion of any increase in income in China can be expected to be spent on the development of infrastructure which is a relatively steel intensive activity, whereas industrialised economies already have well developedinfrastructure andincreasesin income can be expected tobe spent on less steel intensive items (for example, in the services sector). As can be seen from table 5, Chinese steel consumption per person is still well below that in industrialised countries and newly industrialised countries like South Korea, Taiwan and Malaysia. As China's econolny develops, and more investment is made in infrastructure it can be expected that crude steel consumption per person will increase. 5 Crude steel consumption, 1992 China 71.3 Taiwan 1024.0 South Korea 532.3 Malaysia 238.8 Industrialised countries 374.0 World 143.2 Source: International lron and Steel Institute (1993). Planned increases to Chinese production capacity In light of expected growth in Chinese steel demand, there are numerous plans for expansions to existing works and plans for several new large steel - - Chitza's steel industry
  • 29. works have been proposed by the Chinese steel industry (see the map on page 14). Although all of these planned expansions may not come to fruition, they do give an indication of the commitment of the Chinese to continue the expansion of their domestic steel industry. Official forecasts indicate that China will be producing between 100 and 120million tonnes of steel a year by the end of the decade. Chinese crude steel and iron ore production forecasts The production target set for the Chinese steel industry in the 'Eighth Five Year Plan' was reported by the Tex Report (1993) as 100-120 million tonnes. In addition to the government's plans for the iron and steel industry set out in the five year plans, there are many publicly available forecasts of Chinese steel production and consumption. These forecasts generally predict that around 100 million tonnes of crude steel will be produced in China in the year 2000. For example, Feng et al. (1993) predicted that Chinese crude steel output will be of the order of 100million tonnes; Chen et al. (1991) provided a forecast of 97.7 million tonnes for 2000; Gooday and Manson (1993)projected Chinese crude steel production of around 100 million tonnesby 1998.TheWorldBank (1994)projection of Chinesecrude steel production in 2000 is 111.5 million tonnes. The World Bank (1994) projected that Chinese iron ore production, on a metal content basis, would rise from the 1992level of 68.6 million tonnes to 80.18 million tonnes by 2000, an average annual growth rate of 2.0 per cent. If this average annual growth rate is applied to 1992Chinese iron ore production of 210 million tonnes, measured on a natural weight basis, then the 2000projection is around 245million tonnes. This is significantly higher than the Chinese government's domestic iron ore supply forecast for the year 2000 of 220-230 million tonnes (Wang 1993), and the projection of Zhen (1990) of 210 million tonnes. 22 ABARE research report 95.4
  • 30. Global effects of growth in the Chinese steel industry The focus in this chapter is to form projections of future production and consumption of steel in China under alternative scenarios of growth in the general economy, and then to quantify the impact of growth in the Chinese steel industry on the world market for iron ore and steel. To do this, it is necessary to account for the global response in production and consumption within an integrated market of trade in iron ore and steel. A model of world trade in iron ore and steel has been constructed (box 1)which is employed toprovide aquantitative assessment of this changing market to the year 2000. China's steel industry 23
  • 31. The model described in box 1 was used to quantify the impact on the world iron ore and steel sector of continued growth in the Chinese economy. First, a baseline projection was computed based on ABARE's latest assumptions about rates of growth in industrial production as shown in table 6. Other variables which are not determined within the model, such as freight rates and coking coal prices were held constant at observed 1993values. In order to illustrate the impact on the iron ore and steelmarket of alternative economic growth paths within the Chinese economy, the model was used to simulate 'high' and 'low' growth scenarios. These alternative growth scenarios are not assumptions about the upper and lower bounds of Chinese industrial production growth, they are only used to illustrate the impact of alternative growth scenarios. So that the impact of varying growth paths in the Chinese economy on the iron ore and steel market can be directly compared, the values of all other variables which are external to the model were held constant across scenarios. Under the 'high' growth scenario, Chinese industrial production is assumed to continue to increase at the 1995 baseline assumption rate of 15 per cent per year throughout the simulation period. A growth rate of 15 per cent corresponds to the average rate of growth observed since the economic reforms of 1985. Under the 'low' growth scenario, Chinese industrial production is assumed to increaseby only half as much as under the baseline assumption. While this lower rate of growth in the Chinese economy is not expected, it must be remembered that China has previously embarked on insular policies which have severely constrained economic growth. For 6 Baseline industrialproductiona Other China Asia Australia Brazil 1994 20.0 7.0 5.2 4.0 1995 15.0 6.9 4.4 5.0 1996 12.0 6.7 4.2 4.0 1997 12.0 6.5 3.2 4.0 1998 10.0 6.2 3.2 5.0 1999 10.0 6.2 3.0 5.0 2000 10.0 6.2 3.0 5.0 a GDP for Australia, Brazil, India and other Asia. India Japan North America 24 ABARE research ~eport95.4
  • 32. example, the average rate of growth in China's economy under the relatively restrictivepolicy environment spanning the period 1967to 1978was roughly 5.2 per cent. Baseline projections Baseline projections of steel consumption and production are shown in table 7. Driven primarily by assumed growth in industrial production, annual world steel consumption is projected to increase by 102 million tonnes by the year 2000. Of this increase, China is projected to account for 30 million tonnes, or 30per cent of the total increase in annual world steel consumption to the year 2000. Over the simulation period, the level of growth in steel demand in China is shown to be matched only by the other Asia region (which is comprised of the East Asian countries,excluding China,Japan and North Korea), where economic growth rates are also expected to be robust. In response to the significant increase in steel demand, steel production in China is projected to increase from 94million tonnes in 1994,to 110million tonnes in 2000 with China surpassing Japan as the world's largest steel producing country. This will require the construction of new steelmaking capacity, most likely in the form of integrated steelmaking facilities such as theproposed Baoshan no. 2plant, aswell ascontinued expansions to existing facilities. Even with the projected increase in China's domestic steel production, import demand is expected to range from 12 million tonnes to 26 million tonnes, representing about 20 per cent of total Chinese steel consumption. To meet the projected increase in world steel demand, those regions with established steelmaking capacity, such as the European Union, North I America and Japan are also projected to increase production. While the I projected steel production figures for these mature steelmaking regions do I not representrecord levelsof production when compared with thelast several decades, growth inproduction is significant, with theEuropean Union,North America, and Japan each increasing steel production by more than 10 per cent to the year 2000. These production levels appear easily achievable when compared with existing steelmaking capacity. The European Union currently has an estimated capacity of 196million tonnes compared with production of only 132million tonnes in 1993.TheJapanese steel industry had an estimated 38 million tonnes of spare production capacity from the 100million tonnes of China's steel industvy 25
  • 33. steel produced in 1993. While the US steel industry is currently operating athigher capacity utilisation rates (at around 85per cent),with the additional capacity being brought on stream by steel producers such as Nucor, Geneva Steel and BHP-North Star Steel, the projected increase in steel production from this region is certainly achievable. - - 7Baseline projections of steel consumption and production a Mt Mt Mt Mt Mt Mt Mt Australia Steel consumption 6.4 6.5 6.7 6.7 6.8 6.9 7.0 Steel production 8.3 8.5 8.9 9.2 9.0 9.0 9.1 Brazil Steelconsumption 12.9 13.4 14.0 14.9 16.7 18.2 19.9 Steel production 26.2 27.2 28.2 29.2 30.2 31.1 32.1 China Steel consumption 106.2 111.1 115.5 120.5 125.2 130.3 136.0 Steel production 94.1 96.7 99.1 101.8 104.3 107.0 110.0 EuropeanUnion Steelconsumption 113.7 117.1 119.4 120.8 120.9 120.7 120.5 Steel production 138.0 144.2 148.7 150.5 151.5 154.5 154.0 India Steel consumption 18.0 19.2 20.5 21.8 23.1 24.5 25.9 Steel production 19.5 21.1 22.5 23.7 24.7 25.9 27.3 Japan Steelconsumption 83.1 84.7 85.1 85.8 85.1 84.4 83.5 Steelproduction 99.6 105.4 107.5 109.5 110.5 110.5 109.5 North America Steel consumption 121.4 127.8 131.0 131.9 129.8 127.3 124.7 Steelproduction 99.7 104.2 108.6 111.6 112.6 112.2 115.9 OtherAsia Steel consumption 86.1 92.7 99.8 105.4 111.4 119.8 126.9 Steelproduction 55.0 57.2 60.2 64.0 67.5 71.4 74.1 OtherWest Europe Steel consumption 20.0 21.1 21.8 22.3 22.7 22.9 23.1 Steel production 25.9 27.1 28.0 28.6 29.1 29.9 30.6 World total Steelconsumption 736.4 761.9 782.4 799.6 811.9 825.0 837.9 a Eastern Europe consumption and production held constant at 1993levels. 26 ABARE research report 95.4
  • 34. Steel production from the other Asia region is also projected to increase significantly,by 35 per cent to 74 million tonnes by 2000. The Pohang Iron and Steel Company of South Korea recently became the world's second largest steelproducing company after Nippon Steelof Japan,with the recent 3 million tonnes expansion to its Kwangyang steel works. China Steel of Taiwan is currentlyconstructing facilitiesto increase steel making capacity by 40 per cent to 8 million tonnes. Numerous smaller electric arc furnace steelplants are being constructed and planned for the growing steel markets of south east Asia, as well as South Korea and Taiwan. For the projected 35 per cent increasein steel production from this region to be met, outputfrom new electric arc furnace plants, and possibly from an additionalintegrated producer (or increased output from an existing integrated producer in the region) will be required. China's increasingsteelproduction,comprisedlargelyof blastfurnacebased steel output, corresponds to an increase in annual iron ore consumption of 31 million tonnes by the year 2000 (table 8). Even with an increase in domestic production of iron ore, China's import demand for iron ore is projected to rise from 37 million tonnes in 1994, to 50 million tonnes by 2000. This projected rise in imported iron ore is reinforced by the Chinese plans for new steel plants and increased capacity at existing plants at locations near to port facilities,and hence accessibleto imported ore. Given the generallysustainedgrowthin economicactivityexpectedto occur over the period, other major steel producing regions such as the European Union, Japan and the other Asia group will also continue to be significant importers of iron ore. Under the baseline projection, aggregate world consumptionof iron oreis projectedto rise from956million tonnes in 1994, to 1062milliontonnesin theyear 2000.Thereal price of ironoreisprojected I to increasemarginally over this period. Japan is the world's largest importer of iron ore, relying almost entirely on imported ore for its blast furnace requirements. The relatively mature Japanese steel industry can be expected to maintain its relationships with ironoreproducers in Australia, Brazil and elsewhereoverthe medium term, increasing its imports from these countriesto meet the projected 5 million tonne increase in annual iron ore consumption by the year 2000. As in Japan, steel producers of the other Asia region rely on imported iron ore for blast furnacebased steel production because of the lack of domestic iron ore resources. Reflecting this reliance,other Asian iron ore imports are China's steel industry 27
  • 35. projected to increase from 53 million tonnes in 1994, to 71 million tonnes by the year 2000. The major exporters of iron ore are Australia, Brazil and India. Australia is particularly affected by growth in the Chinese steel market (as well as the 8 Baselineprojectionsof iron ore consumptionand productiona Mt Mt Mt Mt Mt Mt Mt Australia lron ore consumption 11.3 11.4 12.0 12.4 12.1 11.9 12.0 Iron ore production 132.1 137.8 140.7 142.9 145.2 148.2 149.0 Brazil Iron ore consumption 46.9 48.6 50.2 51.8 53.3 54.9 56.5 Iron ore production 163.9 169.9 173.1 179.0 181.9 185.3 187.0 China lron ore consumption 252.1 258.2 262.4 267.5 272.0 277.1 283.5 Iron ore production 215.4 220.6 222.3 224.9 226.9 229.4 233.9 EuropeanUnion Iron ore consumption 145.1 151.2 155.4 156.5 156.8 159.1 156.0 Iron ore production 6.9 6.2 5.6 5.0 4.5 4.1 3.7 India Iron ore consumption 24.2 25.3 27.3 29.1 30.3 31.7 33.7 Iron ore production 59.5 64.0 68.2 71.6 74.5 77.6 78.8 Japan Iron ore consumption 112.4 119.4 119.8 120.5 120.3 121.2 117.1 Iron ore production 0.3 0.3 0.3 0.3 0.3 0.3 0.3 North America Ironoreconsumption 67.3 69.1 71.6 74.3 74.4 73.1 78.2 Iron ore production 87.4 89.1 90.2 91.0 90.5 91.4 96.1 Other Asia Iron ore consumption 54.3 56.1 58.7 62.5 65.9 69.8 71.5 Iron ore production 0.8 0.8 0.8 0.8 0.8 0.8 0.8 Other West Europe Iron ore consumption 27.3 28.2 28.6 28.8 28.9 29.4 29.8 Iron ore production 31.6 34.9 37.1 38.1 38.7 39.5 38.7 World total Iron ore consumption 956.1 986.6 1004.8 1022.8 1034.4 1049.2 1061.8 a Eastern Europe consumption and production held constant at 1993levels. 28 ABARE ~nesearchreport 95.4
  • 36. general increasein demand worldwide). Inresponseto the projected increase in demand for iron ore, Australia is projected to increase production by 17 million tonnes over the simulation period, with 16 million tonnes of this increase in production sold on the export market. Over this same period, Brazil's exports of iron ore are projected to increase by 14 million tonnes and India's exports to rise by 10 million tonnes. These projected increases in iron ore production from exporting countries can be expected to come from existing producers, and mostly from existing mines. In Australia, a further 4 million tonnes a year is planned to be mined from the Channar Australia-China joint venture mine by the year 2000, with production destined for the growing Chinesemarket. Robe River Mining can easily increase production by a further 8 million tonnes a year. Hamersley Iron's 12 million tonnes a year capacity Marandoo mine began production in 1994, as did BHP's 5 million tonnes a year Yarrie mine. Plans are in existence to significantly increase production capacity in Brazil and India, if demand warrants it. The Carajas mine in Brazil can now have production capacity increased from 35 to 50 million tonnes a year, as the expansion to port facilities was completed in 1993. Plans exist to expand annualproduction capacity of the Bailadila operations in India by 13million tonnes to 22 million tonnes by 1998.Hence, iron ore resources are available to meet the projected strong increases in import demand for iron ore from China and other Asia, as well as the growth in iron ore demand that is projected for the steelmaking industries of Japan, the European Union and North America. The effects of high economic growth in China Under the high economic growth scenario,industrial production in China isI I set to rise at 15per cent a year, as opposed to the baseline average of roughly I I 1I per cent. Under this high growth scenario (which as noted above, is much the same as that observed since the economic reforms of 1985) steel consumption in China is projected to increase from 106 million tonnes in 1994 to 149 million tonnes by the year 2000 (table 9). Domestic steel consumption was projected to rise to 136million tonnes by 2000 under the baseline scenario. Under the high growth scenario, Chinese steel import demand is projected to rise from an initial level of 12million tonnes in 1994 to 32 million tonnes by the year 2000, whereas under the baseline scenario, the level of projected steel imports rise to 26 million tonnes in 2000.
  • 37. In response to the increased demand for steel under the high economic growth scenario, China is projected to increase annual production by 23 million tonnes over the simulationperiod. This increase is only marginally larger than that shown under the baseline projection. To a large degree, the increase in steel consumption in China can be expected to encourage 9 Projected steel consumptionand productionunder the scenarioof high growth in Chineseindustrial production a 1994 1995 1996 1997 1998 1999 2000 Mt Mt Mt Mt Mt Mt Mt Australia Steel consumption 6.4 6.5 6.7 6.7 6.8 6.9 7.0 Steel production 8.3 8.5 8.9 9.2 9.1 9.1 9.3 Brazil Steelconsumption 12.9 13.4 13.9 14.9 16.6 18.0 19.6 Steel production 26.2 27.2 28.2 29.2 30.2 31.1 32.1 China Steel consumption 106.2 111.1 116.7 123.1 130.5 138.9 148.7 Steel production 94.1 96.7 99.7 103.1 107.1 111.6 116.8 European Union Steel consumption 113.7 117.1 119.4 120.8 120.8 120.6 120.5 Steel production 138 144.2 148.9 151 152.6 156.3 156.6 India Steel consumption 18.1 19.2 20.5 21.8 23.1 24.4 25.9 Steelproduction 19.5 21.1 22.5 23.8 24.8 26.1 27.6 Japan Steel consumption 83.1 84.8 85.1 85.8 85.1 84.3 83.5 Steel production 99.6 105.4 107.7 109.9 111.3 111.8 111.3 North America Steel consumption 121.4 127.8 131 131.9 129.8 127.3 124.6 Steel production 99.7 104.2 108.6 111.6 112.6 112.2 116.1 Other Asia Steel consumption 86.1 92.7 99.8 105.4 111.3 119.7 126.8 Steel production 55.0 57.2 60.2 64.0 67.5 71.4 74.0 Other West Europe Steel consumption 20.0 21.1 21.8 22.3 22.6 22.9 23.1 Steelproduction 25.9 27.1 28.0 28.7 29.2 30.0 30.8 World total Steelconsumption 736.4 761.9 783.4 801.9 816.7 832.8 849.4 a Eastern Europe consumption and production held constant at 1993levels. - - ABARE research report 95.4
  • 38. increased steel production by Japan and the European Union, both of which currently have steelmaking capacity in place to easily meet the projected level of demand. Under the high growth scenario, Japan and the European Union are projected to increase annual steel exports by an additional 2 and 3 million tonnes respectively by 2000, when compared with the baseline projection. 10 Projected iron ore consumptionand production under the scenarioof high growth in Chineseindustrial production a Mt Mt Mt Mt Mt Mt Mt Australia Ironoreconsumption 11.3 11.4 12.0 12.4 12.1 12.0 12.2 Iron ore production 132.1 137.8 140.8 143.1 145.8 149.1 150.2 Brazil Iron ore consumption 46.9 48.6 50.2 51.8 53.4 54.9 56.5 Ironoreproduction 163.9 169.9 173.8 180.6 185.2 190.8 195.1 China lron ore consumption 252.1 258.2 263.4 269.7 276.7 284.8 295 lron ore production 215.4 220.6 222.5 225.4 228.1 231.4 237.2 EuropeanUnion Iron ore consumption 145.1 151.2 155.7 157.2 158.2 161.4 159.4 Iron ore production 6.9 6.2 5.6 5.0 4.5 4.1 3.7 India Iron ore consumption 24.2 25.3 27.3 29.1 30.4 31.8 33.9 Ironoreproduction 59.5 64.0 68.3 71.8 75.1 78.6 80.5 Japan Iron ore consumption 112.4 119.4 120.1 121.1 121.4 122.9 119.5 Iron ore production 0.3 0.3 0.3 0.3 0.3 0.3 0.3 North America Iron ore consumption 67.3 69.1 71.3 73.9 73.6 71.2 76.8I I Iron ore production 87.4 89.1 90.1 91.0 90.4 91.2 96.0 I Other Asia Iron ore consumption 54.3 56.1 58.7 62.4 65.8 69.5 71.1 Iron ore production 0.8 0.8 0.8 0.8 0.8 0.8 0.8 Other West Europe Iron ore consumption 27.3 28.2 28.6 28.9 29.0 29.5 30.0 Ironoreproduction 31.6 34.9 37.2 38.4 39.2 40.2 39.8 World total Iron ore consumption 956.1 986.6 1006 1026 1040 1059 1077 a Eastern Europeconsumptionand production held constant at 1993levels. China'ssteel industry 31
  • 39. As a result of the increase in steel consumption in China under the high growth scenario, world iron ore demand is projected to increase by an additional 15 million tonnes by 2000 (table lo), when compared with the baseline projection of iron ore consumption (table 8). Chinese iron ore consumption is projected to increase by an additional 12 million tonnes a Projected steel consumptionand productionunder the scenario of 11 low growth in Chineseindustrial production Australia Steel consumption Steel production Brazil Steel consumption Steel production China Steel consumption Steel production European Union Steel consumption Steel production India Steel consumption Steel production Japan Steel consumption Steel production North America Steel consumption Steel production Other Asia Steel consumption Steel production Other West Europe Steel consumption Steel production World total Steel consumption a Eastern Europe consumption and production held constant at 1993levels. 32 ABARE researclz I-eport95.4
  • 40. year, when compared with the baseline scenario. As a result, Chinese iron ore imports are projected to increase by an additional 8 million tonnes. A projected increase in iron ore exports of 8 million tonnes by Brazil and 1 million tonnes by Australia could be expected to meet a large part of the 12 Projected iron ore consumptionand production under the scenario of low growth in Chineseindustrial production,1994-2000 a Mt Mt Mt Mt Mt Mt Mt Australia Iron ore consumption 11.3 11.4 12.0 12.3 11.9 11.6 11.6 Iron ore production 132.1 137.6 140.2 142.1 144.3 147.0 147.6 Brazil Iron ore consumption 46.9 48.6 50.2 51.8 53.3 54.9 56.5 Iron ore production 163.9 168.5 170.0 174.1 175.3 176.8 176.5 China Ironoreconsumption 252.1 256.1 258.2 260.7 262.7 264.9 268.0 Iron ore production 215.4 220.2 221.3 223.1 224.2 225.6 228.9 European Union Iron ore consumption 145.1 150.5 154.1 154.4 154.1 155.6 151.7 Iron ore production 6.9 6.2 5.6 5.0 4.5 4.1 3.7 India Ironoreconsumption 24.2 25.4 27.3 29.0 30.1 31.4 33.4 Ironoreproduction 59.5 63.7 67.6 70.6 73.1 75.7 76.4 Japan Iron ore consumption 112.4 118.9 118.9 119.1 118.4 118.8 114.1 Iron ore production 0.3 0.3 0.3 0.3 0.3 0.3 0.3 North America Iron ore consumption 67.3 69.7 72.4 75.3 75.4 74.2 79.5 Ironoreproduction 87.4 89.3 90.3 91.2 90.6 91.4 96.1 Other Asia I Iron ore consumption 54.3 56.2 58.8 62.7 66.2 70.1 72.0 I I Iron ore production 0.8 0.8 0.8 0.8 0.8 0.8 0.8 Other West Europe Iron ore consumption 27.3 28.1 28.5 28.7 28.8 29.2 29.6 Ironoreproduction 31.6 34.7 36.7 37.5 37.9 38.4 37.4 World total Iron ore consumption 956.1 984.1 999.4 1014.0 1 022.1 1032.9 1041.1 a Eastern Europe consumption and production held constant at 1993levels. China's steel industry 33
  • 41. increased Chinese, European Union and Japanese import demand for iron ore under the high growth scenario. The effects of low economic growth in China The results obtainedfrom the analysis of the low economic growth scenario further demonstrate the effect of economic growth in China on the world iron ore and steel market. Under the low growth scenario, with Chinese industrial production assumed to grow by only half that of the baseline assumptions, Chinese steel consumption is projected to increase from 106 million tonnes in 1994, to 119 million tonnes by 2000 (table 1I). This 12 per cent increase in steel consumption can be compared with the projected increase of 28 per cent under the baseline scenario (with an average of roughly 11 per cent annual growth in Chinese industrialproduction). The regions most affected by a low growth outcome would be the European Union, with a projected net decrease in steel exports of 3 million tonnes by 2000, as compared with the baseline, and Japan, with a net decrease in exports of 2 million tonnes. Nevertheless, even under the low growth scenario, world trade in steel remains vigorous, with the European Union and Japan projected to export a net 30 and 24 million tonnes of steel a year, respectively,by 2000. The flow-on effect on the iron ore market can be seen by comparing the projectedincreasein annualworldiron oreconsumptionof 85milliontonnes over the simulation period under the low growth scenario (table 12), with theincreaseunder thebaseline scenarioof 106million tonnes.Thecountries shown to be the most affected in the model outcomes are Brazil and India. Brazil's exports are 10million tonnes a year lower and India's exports are 2 million tonnes lower than under the baseline scenario in the year 2000. 34 ABARE research report 95.4
  • 42. Conclusions China is undergoingrapid industrial developmentdue, at least in part, to the economicreforms implemented sincethe late 1970s.Growth in the Chinese iron and steel sector has been concomitant to this development, making China one of the world's major producers and consumers of steel and steelmaking raw materials. While much of this growth has been confined within domestic boundaries, China's role in the world iron ore and steel market has increased markedly since the early 1980s. This continuing integration with the world market, coupled with China's growing iron ore and steel industry is likely to have a profound impact on world iron ore and steel trade. Simulation results suggest that under an assumed average annual rate of growthin Chineseindustrialproductionof roughly 11per cent,Chinese steel consumption is projected to reach 136million tonnes in 2000. To meet this increase in steel consumption, Chinese steel production is projected to increase to 110 million tonnes in 2000, surpassing Japan as the world's largest steel producing country. This increasein production will require the constructionof new integrated steelplants, someof which have alreadybeen proposed by the Chinese steel industry.However,even with this increasein production, baseline net Chinese steel imports are projected to range between 12million tonnes and 26 million tonnes over the simulationperiod. In response to the increased world demand for steel, those regions with established steelmaking capacity such as the European Union, North America andJapan areprojectedto increaseproduction.While theprojected I I steelproductionfiguresforthese mature steelmakingregions arewell below I I previous peaks, the European Union, North America and Japan are each projected to increase annual steel production by more than 10per cent by the year 2000. Even with this increasein production, the continued need for restructuringof their steelindustriesis apparent,particularly in theEuropean Union, which currently has significant excess steelmalung capacity. Chinahas vast domesticreserves of steelmaking raw materials, particularly iron ore and coking coal. However, while China is likely to remain self- sufficientin coking coal, it will rely more heavily on imported iron ore due to the quality and location of its iron ore resources. As such, continued China's steel industry 35
  • 43. growth in Chinese steel production will mean increased importsof iron ore. It is projected that by the year 2000 China will import roughly 50 million tonnes of iron ore a year. Australia holds the largest share of the Chinese iron ore import market, and is well placed to take advantageof the projectedincreasein Chinesedemand for iron ore. Australia's relative proximity to the Chinese market gives Australianironoreproducers adistinctfreightcost advantageinlandingiron ore in China compared with their main competitors in the iron ore export market, Brazil's producers. However, this competitive advantage cannot be taken forgranted.FutureChineseinvestmentinportfacilitiesforlargercargo carrierswill limit Australia's cost advantage over more distant suppliersto the Chinese market. In the face of such competition, it is imperative that Australia diligently maintains its standing as a reliable source of low cost, high quality iron ore. Policy directions The realisation of sustained growth in the steel and steelmaking raw materialssectorin Chinadependsona liberalpolicyenvironmentthat allows for the free flow of trade, investment and technology. Australia, as an efficient producer of iron ore and steel, has much to gain from a continued liberal, stable and well informed policy environmentwithin the region. China-Australia iron ore and steel trade has increased through the independent efforts of Australian and Chinese iron ore and steel producers, as well as through joint ventures formed by Australian and Chinese enterprises.Bilateralgovernmentorganisations,suchastheAustralia-China Joint Study Groupinto Iron Ore and Steel,and the WesternAustralia-China Economic and Technical Research Fund may offer a means of further promoting this mutually beneficial relationship. By fostering an environmentof cooperationbasedonmutuallybeneficialoutcomes,bilateral organisations can promote the efficient transfer of investment funds and technology, and ensure a stable trading relationship. Together with multilateral trade initiatives such as the GATT, a Multilateral Steel Agreement, or an East Asian Steel agreement as proposed by Drysdale (1992),sucheffortswillundoubtedlycontributeto the efficientdevelopment of the industry within the Asian region as a whole, while also allowing for increased Australian trade opportunitiesin iron ore, as well as valued added iron and steel products. 36 ABARE research report 95.4
  • 44. Appendix Description of the world iron ore and steel trade model An econometric model of the world trade in iron ore and steel has been constructed following the basic conceptual framework offered by Smithson etal.(1979)in modellingworldtradein copper,aluminium,nickel, andzinc; and is quite similar to the FAPRI system of modelling agriculturalmarkets (Devadoss et al. 1989). In the model, world iron ore and steel trade is disaggregated into eleven trading regions: Australia; Brazil; China; the European Union; Eastern Europe (which includes the CIS, Bulgaria, the Czech Republic, Hungary, Poland, Romania and the Slovak Republic); India; Japan; North America; other Asia (which is East Asia, excluding China, Japan and North Korea);other West Europe (which includesAustria, Finland, Macedonia, Norway, Slovenia, Sweden, Switzerland,Turkey and the former Yugoslavia); and a rest of world category. The world iron ore and steel trade model is a dynamic,non-spatial,partial equilibrium model which has been specified to quantitatively evaluate the impact of growth in the East Asian iron and steel sector on the world market overthe shortto medium term. Annual domestic supplyanddemand foriron oreand steelisdeterminedwithin aframeworkof econometricallyestimated supply and demand equations. Trade flowsbetween specific regions are not identified;however, net import and export quantitiescan be computed from the residual of domestic supply and demand estimated for each region. In modelling the iron ore and steel sector, production and consumption theory is used to postulate supply and demand relationships. This approach is suited to the highly aggregatedata available on internationaliron ore and steel production, consumption and trade. An alternative to this type of modelling approach is to directly specify the production function within an (preferablydynamicand stochastic)optimisationprocedureandderiveinput demand and supply relations. This approach requires detailed input and production data. Econometrically estimated supply and demand equations allow for a comparison of model predictions with the actual market outcome. This sort of 'validation' procedure allows one to then make a statistically based judgement on whether the model is a good approximationof the underlying market. China's steel industry 37
  • 45. The model is a set of linked supply and demand relations. Capacity constraints, adjustment costs, technological change and other aspects of the sector are accounted for in the modelling framework as they affect this supply and demand relationship. Worldprices, production and consumption are solved for under market clearing conditions, that is, production equals consumption. The model contains three modules -iron ore, steel, and scrap, which are described by 63 behavioural (regression) equations, and roughly the same number of accounting and market identities. These three modules interact simultaneously, and explicitly link prices, production and consumption of the three materials. As such, the model predicts price and quantity movements across regions and across commodities (except in the case of steel scrap, for which only price is identified). The model is further capable of producing a time path for these variables, as the industry adjusts to the changing market environment. The various prices which producers and consumers are faced with are adjusted for by price linkage equations. These equations allow for differing prices due to varying transport costs, exchange rate differentials and quality differentials. The model has not been designed to capture many of the factors influencing decisions about where and when to invest in iron ore and steel production capacity, such as capital availability and government policy settings. Ideally iron ore and steel production capacity would be modelled explicitly, but because of data limitations this was not possible. However, if it is known that a specific capacity expansion will take place at a specified date in the future this can be exogenously incorporated into the model. Many of the variables likely to affect capacity, and thus production, do not enter the model directly. Of these variables, the price of capital (interest rates) is the most obvious. Although interest rates do not enter the model directly they do enter the model indirectly through the industrial production indexes as these two variables display a strong negative correlation over a wide range of countries. For short to medium term projections and under scenarios where relative prices are not expected to change dramatically the modelling approach used here is not likely to produce results significantly different from a model which endogenises production capacities. 38 ABARE research report 95.4
  • 46. The steel module Demand The demand for steel is derived primarily from end use in construction materials and consumer durables such as automobiles and whitegoods. Researchers have found economic activity, as measured by subaggregates suchasindustrial production, tobe theprimary factoraffecting steeldemand. Even though steel consumption relative to economic activity may be greatly influenced by technological advance and shocks to the prices of substitutes and complements to steel use over the long run (Labson and Crompton 1993), the relationship between steel consumption and economic activity has been stable since at least the mid-1970s. Furthermore, in a study of US steel demand Considine (1991)found the cross-price elasticities for relevant substitute materials to be less than 0.2. Thus, it is unlikely that the lack of detail in material substitution will have a substantial affect on the results of the simulationexercises unless there are significant changes inrelative prices of available technology. A commonly used reduced form representation of the derived demand for steel (see, for example, Cox, Nagle and Lawson 1990) has been used in which the quantity of steel demanded is determined by the price of steel (as measured by the World Bank's aggregate steel price index), technological change and industrial production. Steel price is deflated by a general index of producer prices such that homogeneity of degree zero is imposed. f {P:',Ic,,,Tech,} where, for region i in year t, D:?' = quantity of steel demanded (apparent consumption, crude equivalent); psteel l,t = steel price index, adjusted by domestic exchange rates and producer price deflators; IPi.t = real industrial production; and Tech, = time as an index of technological change in the derived demand for steel. China'ssteel industry 39
  • 47. 13 Partial elasticity of steel demand Region With respect to price Australia Brazil China Eastern Europe European Union India Japan North America Other Asia Other Western Europe With respectto industrialproductiona 2.33 3.65 0.38 nab 2.11 0.78 2.12 2.74 0.97 0.35 a GDP for Australia, other Asia and Brazil. b Industrial productionwas not entered into the EasternEuropean steel demand regressionequation due to concern over the accuracy of the available data. Demandelasticities have been computed from the estimated coefficientson price and industrial production. It should be noted that the demand elasticities with respect to industrial production are not pure partial elasticities as industrial production is strongly negatively correlated with interest rates and interest rate movements have not been accounted for. Steel demand was found to be inelastic with respect to price. Both the price and income elasticities estimated (table 13) appear to be consistent with those found by Cox et al. (1990)in their evaluationof aggregateworld steel demand. China's income elasticity as estimated is quite low; however, the estimate is in line with that reported by Feng (1992). Supply Virtually all of world steel is produced by one of two basic steelmaking technologies, based on either blast furnace iron making, or the electric arc furnace which primarily uses steel scrap as feedstock (see Labson, Gooday and Manson 1994 for a description of steelmaking technologies). As will be shownbelow,the identificationof blast furnace based productionof steel is an important component in linking the steel and iron ore modules, with iron ore demand specifiedas conditional on blast furnace based production of steel. To simplify matters, other steelmakingtechnologies which bypass the blast furnace are subsumedunder blast furnace production, since these technologies use iron ore as the primary feedstock. Under this 40 ABARE research report 95.4
  • 48. simplification,total steelproduction is divided among the two technologies, with supply relations specified for each. The quantity of blast furnace based steel supplied is specified as being a function of the price of steel and input prices, includingiron ore, scrap and coking coal (each deflated by a producer price index). A shift variable was used to account for periods of significant restructuring within a regional industry, as happened in North America during the 1980s, and Eastern Europe in the early 1990s. The lagged dependant variable is entered to capture partial adjustment following the work of Nerlove (1958). The general specification of blast furnace based steel supplyis: where, for region i in year t, sBF1.t = blast furnacebased steel production; p e e l ~ , t = steel price index, adjusted by domestic exchange rates and producer price deflators; qf:pW = vector of input prices (iron ore, scrap, coking coal) adjusted by domestic exchangerates and producer price deflators; and Csteel l,t = shift variable accounting for structuralchange in production. Steel produced via the electric arc furnace route is determined by the price of steel, the price of scrap (each deflated by a producer price index) and a time trend which accounts for the strong secular increase in electric arc I furnacesteelmaking(seeLabsonandGooday 1994).Theelectricarcfurnace I steel supply relation is specified as; = steel produced via the electric arc furnace; P$" = steel price index, adjusted by domestic exchange rates and producer price deflators; China's steel industry 41
  • 49. pscrap l,t = scrap steel price, adjusted by domestic exchange rates and producer price deflators; and t = time trend to capture adoption of EAF technology. The iron ore module Demand Demand foriron oreis derivedfromtheproduction of pig iron-theprimary feedstock for steel production via the blast furnace. As such, the iron ore demand equations are based on the conditional factor demand of blast furnace based steel production. Within the model, demand for iron ore is determined by relative prices and blast furnace based production of steel. It is presumed that steel scrap is the only significant substitute for iron ore in blast furnace based production of steel, whereby the price of iron ore is deflated by the price of scrap, rather than the more general producer price index. where, for region i in year t, Dore~ , t = apparent consumption of iron ore; qy = price of iron ore,in domestic currency and deflated by domestic producer price index; f'yrap = scrap price, in domestic currency and deflated by domestic producer price index; sBFl , t = steel produced via the blast furnace; and t = time trend. On further examination of the data, it became apparent that the coefficient on blast furnace based steel production was affected by a trend in some regions. This trend may be caused, for example, by the declining efficiency of aging blast furnaces ordeclining iron orequality.To account for thistrend, the coefficient on blast furnace based steel production was specified as a time varying coefficient for those regions where it was found to be ABARE research report 95.4
  • 50. appropriate. Essentially, this is equivalent to a trending input-output coefficient. The linear representation(in regression form) is: (5) where: Due to data constraints, apparent consumption of iron ore was used in the model instead of direct consumption.The formerincludesstock adjustment, as well as domesticconsumption.The consumerprice of iron ore is in terms of the fob price in those regions which are self-sufficientin iron ore. For regions which import most of their iron ore, cif prices from the consumers' primary sourcehave been used (forexamplethe Japanese consumerprice is the Australian iron ore price, cif Japan, in constant yen values).In the case of Eastern Europe and China, where prices are not easily obtained, market prices in nearby regions are used. For example,in EasternEurope,cif prices inWesternEuropehavebeen used. Scrappriceshavebeen chosenin asimilar fashion. Chineseironoredemandrepresentsaninterestingproblem, sinceChinauses domestic ore which has roughly half the iron ore content of imported ore (whereas marketed ore in the other regions is remarkably similar in iron content).To accountfor the impact of imported iron ore on the input-output coefficient for iron ore (by weight), a specification similar to that of equations5 and 6has been used. In this case,the coefficient onblast furnace based steel production is linearly decreasing in Chinese iron ore import quantity as a percentage of total Chinese iron ore consumption, such that if imported iron ore was to account for 100 per cent of Chinese iron ore consumption,their input-outputcoefficient would be equalto that of Japan, which generally imports iron ore from the same sources as China. The intercept and slope coefficients were fitted through the observed 1992 input-output ratioliron ore import ratio for China; and the Japanese input-output ratio (which is based on essentially 100per cent importediron ore). Substitution between scrap and iron ore is not accounted for in this specification of demand for iron ore. Supply The supply of iron ore is largely influenced by the level of infrastructure required to mine and transport the ore. The large capital expenditure, with implicit adjustment costs, means that dynamic considerations must be China's steel industry 43
  • 51. accounted for in the supply relation. A partial adjustment model is used to capture the short to medium run dynamics of iron ore production. To capture the effect of the addition of significant greenfield capacity, the lagged adjustment model is augmented by shift variables (0,1 variables), which capture the infrequent, but significant adjustment in supply brought about by the addition of large greenfield mines. This turns out to be particularly relevant to supply in Brazil and Australia. Conceptually, this shift variable is consistent with the work of Wagenhals (1985); Bresnahan and Suslow (1989);Beck,Jolly and Loncar (1991);and an applicationto the iron ore market by Priovolos (1987) which incorporates the presence of capacityconstrainedproductioninthe shortrun.Intuitively speaking,supply is decomposed into large, long run changes in mine capacity related to the additionof greenfieldmines and the additionof infrastructuresuch asroads, rail, and port facilities; and into short to medium term adjustment based on existing infrastructure. The exogenous specification of the capacity shift variable means that the iron ore production block is best interpreted as describing the short to medium term, which could be characterisedas being up to ten years in the iron ore sector. In the long run, capacity itself would be likely to adjust to changingmarketfactors.Thebasicformof theproductionrelation is defined as: where, for region i in year t, Sly? = quantity of steel supplied; pore1,t = priceof ironore,in domesticcurrencyanddeflatedby domestic producer price index; and C;' = shift variable for greenfieldadditions to capacity. Ironoreproduction,represented inequation7,was specifiedwithproduction being determined by past production, the price of iron ore, and the shift variables representing additions to greenfield capacity. In the case of Australian iron ore production, a time trend has been used to capture the effect of increasingproductivity in production.For most exportingregions, the price of iron ore is defined in terms of fob at a domesticport of trade, in 44 ABARE research report 95.4
  • 52. 14 Price elasticityof iron ore supply (major producers) Region Short run Medium run (10years) Australia 0.30 Brazil 0.26 China 0.13 Eastern Europe 0.04 India 0.10 North America 0.04 Other Western Europe 0.22 domestic currency deflated by a general domesticproducer price index. For regions where fob prices are unavailable,cif prices have been used. The lack of an appropriateprice of iron ore to producers in North America proved to be troublesome.Since much of US iron ore production is captive to nearby steelworksdue to geographicalconstraintsand transportcosts, cif prices are not reflective of the supply and demand balance in the region (Barrington 1992).In order to obtain a proxy for the producer price of iron ore, North American blast furnace steel production has been added to the supply equation (as well as cif prices) as a reduced form representation of the producer price of iron ore relevant to captivemines. Shortandmediumtermpartial elasticitiesof ironoreproductionwithrespect to producer price for the major producing regions are reported in table 14. The estimated values of the elasticities are very similar to those reported in Priovolos (1987).In the short run, the world's two major iron ore exporters (Australiaand Brazil)arethe more elastic suppliers,probably due to the fact that they both have abundantiron ore resourcesnear port facilities,and have the infrastructurein place necessary to handlelargevolumes.Other Western Europeis also shownto be rather price responsive,but, giventheir relatively low level of production, is not a decisive factor in the world market. In the short term India and China are found to be quite unresponsive to price; however, over the medium term, India and China are found to be a bit more responsive to price than other regions and countries. This short term unresponsiveness may reflect the relativelack of infrastructurein these two countries and the associated delays in increasing iron ore production capacity.Alternatively,North America,which asnoted above,hasminesthat China's steel industry
  • 53. are primarily captive to domestic steelmaking, shows a relatively inelastic response of iron ore with respect to price. In general, iron ore supply can be expected to be more responsive to price movements in the medium term than inthe shortterm as production decisions are more restricted in the short term because of factors such as work force and infrastructure constraints. Price linkage where pore$US z,t = Domestic contract price of iron ore (US$); P;;"" = 'World price7of iron ore (US$ fob Australia); and zt = freight rate index. As noted above, various iron ore prices have been used in order to capture exchange rates, transport costs, and quality differentials. Price linkage equations such as equation 8 tie the various supply and demand relations together. These equations relate the individual prices to one representative price. In the case of the iron ore market, the US dollar fob Japanese contract price for Australian ore is used as a 'world price'. Since iron ore contract prices are most often in US dollars, the price linkage equations are fairly straight forward. The linear specification shown in equation 8 captures averagequality differentials via the intercept; the basic price correspondence in the coefficient on world price; and, with the addition of an index of ocean freight rates, the effect of transport costs. These various domestic contract prices (US$) are then transformed via a simple accounting identity into the domestic currency (deflated by a domestic producer price index) of the relevant region in order to form the prices relevant to regional supply and demand ( cy). The scrap module Scrap steel price equations have been employed in a partially reduced form representation. This partially reduced form is based on an implicit model of supply and demand for steel scrap. To illustrate, consider the following specification for supply and demand for scrap in a particular market. 46 ABARE research report 95.4
  • 54. where, for region i in year t, SfCraP 1,t = quantity of scrap supplied, X ~ ~ P P ~ Y l.t = a vector of factors affecting the quantity of scrap supplied, D Y a P l,t = quantity of scrap demanded, and x ~ ~ , " ~ ~ ~ ~= a vector of factors affecting the quantity of scrap demanded. If the market is relatively insulated from other scrap markets the system can be closed by equating Sl:zraPto Dl:? .A reduced form representation for price, in terms of the variables influencing supply and demand for scrap can be estimated and solved for. One could think of this as simply a price forecasting equation. The advantage of this representation is that it solves for equilibrium scrap prices (which directly and indirectly feed back into iron ore demand) without having to use data on scrap quantities, of which the accuracy is doubtful. The lack of identification of scrap quantities is not particularly troublesome since it is not of central concern in this study. The scrap price equations are of the general form; where, for region i in year t, sEAF = quantity of steel produced via the electric arc furnace; and1,f I 4 , t = industrial production. Scrap prices are assumed to be directly related to electric arc furnace production of steel,which is the primary use of steel scrap,and scrap supply. An important component of scrap comes in the formof trimmings generated in the fabrication of goods such as automobiles and consumer durables. China's steel industry 47
  • 55. Since the scrap price series used here are related to this 'new' scrap, industrial production has been used as a reduced form representation of residual trimmings generated from the production of manufactured goods. Scrap price equations have been estimated for three major regions in which price data are readily available (the United States, Western Europe and Japan). For the other steel producing regions, the available scrap price most likely to be relevant to that region was used. The three basic scrap prices are not directly linked under the model specification. This more flexible approach was taken following preliminary analysis which suggested the lack of a stable (linear) relationship among the various scrap prices. And while trade exists in the scrap market, the more flexible representation based on a degree of market insulation appears to be consistent with the observed data. Model closure: a one region example The model described above is closed through the use of market clearing identities, see equations 12, 13 and 14below. To illustrate model closure, a one region example of the model is described below, where (1*) is the one region example of (1) and so on. Steel Demand for steel follows a standard form in which industrial production, own price and time (as a proxy for materials substitution) influence demand for steel (1"). Steel supply is divided into blast furnace (2") and EAF production (3*), with a time trend added to the EAF production equation to account for the strong secular trend in adoption of that technology. Prices are all deflatedby the producer price index to imposehomogeneity. The sum of EAF production and blast furnace production is identical to total steel production, equation 12, and total steel production is identical to total (apparent) steel consumption, equation 13. d p"raP - pcoa Ssteel 2 t 2 t 2 t-l - ABARE research report 95.4
  • 56. where, for time t, stBF = quantity of blast furnace based steel supplied; stEAF= quantity of EAF based steel supplied; ststee1= quantity of steel supplied; Yeeel= price of steel, deflatedby a producer price index; cWa1= price of coal, deflated by a producer price index; Dsteeel = quantity of steel demanded (apparent consumption);and If', = real industrialproduction. core = Price of iron ore, deflated by a producer price index; cscrap= price of scrap, deflatedby a producer price index; and Tech, = time as an index of technological change. Iron ore Ironoredemandistreatedintermsof conditionalfactordemand.Theactivity level is blast furnaceproduction of steel.The ownprice of iron oreis relative to the price of scrap steel, sinceit is presumed that the primary substitutefor iron ore via the integrated steelmaking route is scrap. Iron ore supply is determined within a partial adjustment model, which is further augmented by a shiftvariable to capture significantincreasesin minesite capacity. Own price is deflated by a general producer price index to impose homogeneity. At market clearing prices the quantity supplied is equal to the quantity demanded. (7") Store= a,, +b5core+c5C? +d5S:y - - - China's steel industry
  • 57. Where, in time t, Store = quantity of iron ore supplied; core = price of iron ore, deflated by a producer price index; Ctore = ashiftvariable accounting for largejumps in mine sitecapacity; Dere = quantity of iron ore supplied (apparent consumption); S? = steel produced via the blast furnace; and cScrap= the price of steel scrap, deflated by a producer price index. Scrapprice A scrapprice equation is specified, which isjointly determined with the level of electric arc furnace production ( SY) as well as proxies which account for exogenous supply factors (2,).This reduced form price equation is used since the price data for scrap is available, but the quantity data are incon~plete.Since the projects at hand are not specifically directed toward the scrap market, this should be of little importance. However, it is accepted that futureprojects may warrant a specification in which scrap quantities can be solved for. Still, the point here is that such a specification will not have much (if any) impact on the iron ore and steel projections, for which this model has been built. This one region example represents a system which solves for the time path of equilibrium production, consumption and prices of iron ore and steel (as well as scrapprice) for any giveninitial condition and projection of variables which are exogenous to the model, which include real industrial production and coking coal prices. This oneregion model is expanded to eleven regions primarily by specifying iron ore and steel supply and demand equations for each region, and imposing the restriction that the quantity supplied worldwide equals the quantity demanded worldwide. The trade model requires exchange rate and 50 ABARE research report 95.4