Why China is important to the dry bulk shipping industry (Part 5 of 9)
Why is domestic output important?
Another factor that could affect iron ore imports is domestic output. When demand for iron ore is rising faster than domestic output, China will have to rely more on imported goods. As a result, this can have a positive or negative impact on shipping rates. When imports’ share of iron ore supply increases, it could be positive for shipping rates. But when domestic production is increasing more than imported supply, it could be negative.
On July, 2013, China’s domestic iron ore output as a share of total supply, measured by adding iron ore imports and domestic output together, amounted to 62.23%. This was a drop from the 67.48% in July, showing imports drove a larger share of July’s supply. July’s drop appears to be driven by higher imports, as traders took advantage of low imported iron ore prices. Over the past six years, we’ve seen an overall growth in the share of domestic output, increasing from ~61% to ~64%. During the overall increase throughout the six years, however, there were periods when iron ore gained shares and then some periods when it lost shares.
Background on historical trends
Throughout late 2008 to early 2009, domestic producers’ shares fell from 70% to 50%. This was because Chinese iron ore producers are one of the most expensive producers in the world. As economic growth slowed and foreign suppliers such as BHP Biliton, Rio Tinto, and Vale didn’t cut output right away, domestic producers had to scale back their production to some extent, which allowed foreign mining giants to gain market share.
Domestic suppliers were saved with the government’s massive injections thereafter, and economic growth soared higher while investment flowed into iron ore mines. As long as demand for iron ore was growing faster than foreign suppliers were increasing supplies, domestic producers had business, and their share rose back to 70%.
Since 2011, however, the trend reversed. Instead of hitting record highs each year, each peak was lower than the previous year’s. Domestic suppliers began to lose market share when the Chinese government restricted lending and raised interest rates to combat high inflation in mid-2011. Because foreign suppliers incur a lower cost of extracting iron ore, they were able to take advantage of China’s weaker growth by increasing output, which pushed some domestic suppliers out.
Takeaway from future impact
In its five-year plan, the government intends to shut down dangerous small mines that are environmentally unfriendly and economically expensive. A part of these mines financed the shadow banking system. So the share of foreign imports should grow over time. Nonetheless, a sudden layoff of millions of Chinese workers employed in the iron ore mining industry could create social unrest, so the government has no option but to support demand.
So if domestic suppliers are gaining share, it’s likely because of strong economic growth in China. If domestic suppliers are losing share, it’s because foreign suppliers are exporting more iron ore. Both are positive for companies like DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Navios Maritime Partners LP (NMM), Navios Maritime Holdings Inc. (NM), and Safe Bulkers Inc. (SB)
Browse this series on Market Realist: