To call it ironic doesn’t quite capture the moment. Just as Beijing is punishing Australia with trade sanctions, sales of the one commodity the Chinese can’t target, iron ore, are delivering billions in windfall gains to miners, their shareholders and the government in Canberra.
Iron ore exports have broken records for volumes and prices in recent months, largely because of the strong rebound in the Chinese economy and the lack of alternative suppliers for the country’s steel makers.
The Treasury based its budget forecasts on a price of $US55 a tonne, for this financial year and the next. In recent weeks, prices have topped $US230 a tonne. This has turbocharged mining profits, which flow straight to the budget bottom line through company taxes and to the states in royalties.
“Every $US10 a tonne above $US55 is worth over $2 billion a year in federal taxes,” says Chris Richardson, of Deloitte Access Economics.
The iron ore boom has also had a less noticed political impact, bolstering confidence in the government and among commentators that Australia can ride out Chinese trade sanctions without substantial damage.
Individual winemakers and lobster producers may have had their export businesses wiped out, so the argument goes, but iron ore and other commodities are more than making up the difference.
The iron ore trade, in that respect, is stiffening the resolve of the Morrison government in dealing with Beijing, because the cost of resisting trade coercion is minimal on the broader economy.
For a China determined to punish Australia, this is intolerable. What, then, are Beijing’s options to wind back the benefits from the iron ore trade?
Beijing’s longer-term options are obvious: to find more supplies, a task the government is working on with a feverishness absent during the days of smooth Sino-Australian relations.
Like Japan in the decades from the 1960s, China, once it became a resource importer, has sought to bring other countries and producers into commodity markets, to keep supply up and prices down.
But Beijing’s battle with Australia has made the supply of iron ore not just an issue of price. With talk of war in the air, it is one of national security.
If Australia were to cut supplies off now, for example, the construction sector in China, the core of the economy, would struggle to stay afloat.
China is pushing Brazil, Australia’s main iron ore competitor, to get back online after accidents and COVID-19-related shutdowns. A much-touted mine in west Africa, considered to be years away, is being accelerated.
The 110-kilometre Simandou mountain range in Guinea is one of the best medium- to long-term solutions to reduce dependency on Australia and is widely regarded to be the highest-quality iron ore still untapped in the world.
Despite the huge risks in the project, which requires the construction of a 650-kilometre double-track railway with dozens of bridges and purpose-built tunnels and then a huge wharf, Beijing is backing its development.
In its draft five-year plan published in early 2021, the Ministry of Industry and Information Technology elevated resource security to one of the six top strategic priorities, alongside long-standing objectives such as innovation and productivity.
The draft policy is explicit in stating the need to diversify both production and supply chains of key industrial ingredients such as iron ore, manganese and chromium.
The ministry set goals for greater self-sufficiency in iron ore supplies, increased use of scrap steel and the construction of one to two competitive, Chinese-owned iron ore mines overseas.
The government doesn’t just have Guinea in mind. In official government documents so far unreported in Australia, the ministry’s draft, which acts as the government’s definitive policy planning document, also calls for building ties with iron ore miners in Russia, Myanmar, Kazakhstan and Mongolia.
A Chinese mine in Western Australia, which is not named in the document but which is presumably the Citic-owned Sino-Iron project, is also singled out as a preferred source of the resource.
The ministry envisages a China Inc-style approach to build alternative suppliers, with steel makers, resources companies, banks and transport companies all encouraged to form consortia to explore projects abroad.
The National Development and Reform Commission, the chief economic co-ordination ministry, re-emphasised the policies this week, saying it would step up local production and encourage steel makers to get their iron ore from elsewhere.
Longer-term options, though, are just that, and an acknowledgement that China is years away from being able to wean itself off substantial reliance on Australia for iron ore.
In the short-term, Beijing has already begun in recent weeks jawboning rising commodities prices down, by threatening steel market participants with punishment for speculation.
Before prices began to fall last week, domestic iron ore futures were up 34 per cent this year, according to Gavekal, an economic research consultancy, steel and coal were up 40 per cent, and copper up 34 per cent.
Such increases not only potentially feed into inflation and property prices, they also interfere with a host of policies being rolled out to cap China’s carbon emissions by 2030.
Chinese Premier Li Keqiang convened a meeting of the cabinet this week to look at ways to get commodity prices down. Among other measures, the government increased export tariffs for steel products, and cut import tariffs on scrap metal to zero.
China has a suite of other options to hurt Australia and cut into the profits of the big mining companies, BHP, Rio and Fortescue. All of them, however, carry big risks.
Beijing could, for example, go back to the future in the way that prices are set by reinstating the system the Japanese used when they were the dominant buyer of Australian iron ore.
Under this system, Beijing would appoint a single company, in all likelihood the giant Baowu Steel Group, to negotiate on behalf of the industry, in theory using China’s buying power to drive prices down.
Such a system would be difficult to manage because the Chinese steel industry is so vast and hyper-competitive, with dispersed and complex buying interests. (China makes about 1.2 billion tonnes of steel a year; Japan in its heyday made about 100 million tonnes.)
It also might not work. In the final years of the old contract system, in 2010 and 2011, prices nearly doubled as Chinese buyers scrambled to obtain supplies as demand rose and supply tightened, much as is happening today.
A second option is to claw back some profits flowing to Australia through an antitrust action launched by the State Administration for Market Regulation (SAMR). The charge would be some form of concerted pricing, in which different companies are alleged to mimic the pricing practices of their competitors.
Politically, it matters little in China that prices are set not by the companies but in the market. “It’s not hard for them to find an excuse, even if BHP and Rio are lilywhite,” says Allan Fels, the former head of the Australian Competition and Consumer Commission, who also advised the Chinese on their anti-monopoly laws.
The SAMR, set up in 2018 as a super regulator with anti-monopoly powers, has been flexing its muscles of late, mainly against China’s big tech companies. In April, Alibaba was fined a record $US2.8 billion for anti-competitive behaviour.
But an antitrust action contains risks, too. Australia’s big miners don’t have any substantial assets in China itself, which gives them some bargaining power. Beijing might also not want to draw the attention of the Chinese people to the iron ore trade, and the huge profits it is generating down under, when the official narrative is all about punishing Australia.
Finally, the authorities in China could fine Australian producers for bringing into the market ores that don’t match to a tee what their contracts prescribe. With Australian mines running full bore, it wouldn’t be hard to find a shipment with problems, however superficial.
None of these options would reduce China’s reliance on Australian iron ore in the short term, but they could punish the miners financially and cut into their profits.
It is also worth noting that China’s complaints – about high prices, market manipulation and Australian perfidy – have been the same for about 15 years. “The Chinese don’t trust markets, especially ones they don’t control themselves,” says one mining executive with extensive China experience.
Likewise, Australia’s geographic and geological advantages won’t go away. “You can’t tow west Africa or Brazil any closer to China,” says the executive.
Still, that Beijing is even contemplating punitive action underlines how seriously the bilateral relationship has deteriorated, and how distant the two countries are from the origin story of co-operation on iron ore.
In 1985, Bob Hawke and the then head of the Communist Party, Hu Yaobang, travelled together to iron-rich Mount Channar in Western Australia to launch the trade.
“I am standing on a mountain of iron,” said the ebullient Hu once on site, according to Richard Rigby, who was acting as their interpreter. In the car from the airport in Perth after his arrival, Hu sat with Hawke and insisted on holding his hand.
These days, the way the two sides talk about the trade is very different. In 2019, speaking privately, one of Australia’s most prominent mining executives used colourful language to illustrate how both countries needed each other.
“China and Australia are in a kind of multi-scrotum clutch on iron ore,” he said. “They are not going to hurt us. We are not going to hurt them.”
For the time being, that remains true. But once the pendulum swings back in Beijing’s favour, China will want to make sure the windfall profits could disappear as quickly as possible.
Richard McGregor and Peter Cai are fellows at the Lowy Institute.