china_steel

Ch inab emerging d t e e l inaudtry an2 i t d impact

on t h e worla i ron ore an2 d t e e l market

Stephen Labson

Peter Gooday

Andrew Manson

ABARE ABARE RESEARCH REPORT 95.4

O Commonwealth of Australia 1995

This work is copyright. The Copyright Act 1968 permits 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 1 162

Foreword

The industrial development of China over the past ten years has been concomitant with 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 iron ore, Australia is likely to be particularly affected by such market forces.

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 forms part of ABARE's continuing research into the global iron ore and 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 Sheales on 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 Steelworks and 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 steel producer in Chinese iron ore and steel sector has been 1993, a fivefold 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 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 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.

China has vast domestic reserves of steelmaking raw materials, particularly iron ore and coking coal. However, while China is likely to remain largely self-sufficient in coking coal, it is expected to rely more heavily on imported iron ore as a consequence of the relatively poor quality and location of its iron ore deposits. Thus, continued growth in the production of Chinese steel can be expected to result in increased imports of iron ore. As a major supplier

China has 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

China will provide a larger market for

Australian iron ore

China's steel industry

of iron ore, Australia is well placed to respond to this demand.

A quantitative assessment The model of world In order to determine the potential effect on 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. The model is a set of linked regional 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 examine the impact on the world iron ore and steel sector of economic growth in China by simulating market outcomes based on projected growth in Chinese industrial production 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. This increase in demand accounts for 30 per 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 steel producing country. Despite such growth in output of steel, China is projected to import between 12 and 26 million tonnes of steel a year over the rest of the decade.

The European To meet the projected increase in 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 are projected 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 10 per cent by the year 2000.

China's increasing steel output, comprised largely of China's demand for 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 domestic production 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 existing plants at locations near 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. Australia is 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, Australia is projected to increase production by 17 million tonnes over the simulation period, with 16 million 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 10 million tonnes. , These projected increases in iron ore production Most of the increase

I from exporting countries can be expected to come inproduction will I I from existing producers, and mostly from existing come from

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 is projected to rise to 149 million tonnes in the year 2000. . .

. . . and to 119 million tonnes under the low growth scenario (both from a base of 106 million tonnes in 1994)

Australia-China joint venture mine by 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 inJZuence of economic growth in China While the projections presented above are based on 'best bet' assumptions about future economic growth rates, variations in economic growth could have a marked effect on final outcomes. To illustrate the impact of varying rates of economic growth in China on the iron ore and steel market, the model was used to simulate 'high' and 'low' growth scenarios.

Under the high economic growth scenario, Chinese industrial production is assumed to increase at a rate of 15 per cent a year, which corresponds to the average rate 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 projected to increase from 106 million tonnes in 1994 to 1 19 million tonnes in 2000. The range in projected 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.

Implications for 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 1993 China accounted for 15 per cent of trade in iron ore Australia's iron ore exports of 11 1 million 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 line in the next few years, Australian iron ore exports are projected to increase from 1 I 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 imported 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 role for 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, as an efficient producer of 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

demand for iron ore

South Korea, Taiwan and 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


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 the joint 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 into Iron Ore and Steel, and the Western Australia-China Economic and Technical Research Fund as exemplified by its recent studies into iron 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.


Introduction

China's steel industry 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 since the 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 Chinese iron ore and steel production and imports

I

I Iron ore Steel

I Year Production Imports Production a Imports b

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 Semifinished steel. c 1971 data. d Estimate. Sources: International Iron and Steel Institute (1993); UNCTAD (1994).

- - - -

CIzina's steel 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 and Weber 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 ore is relatively 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 steel industry, 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 and demand (see, for example, Higgins 1969; Watanabe and Kinoshita 1971; Tsao and Day 1971; Yamawaki 1984). However, these models examined the market on a regional 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. China represents a significant market for Australian 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.


Development of the Chinese steel sector

Since the end of civil war in 1949, the iron and steel sector has played an important role in the development of the Chinese economy. Over this period, Chinese steel production has risen from just 160 000 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 government intervention. Considered a 'key industry' in terms of economic planning, the Chinese iron and steel sector has been particularly affected by the centralised system of economic development which is largely conducted under 'Five Year Plans', the first spanning 1953-57.

Between 1958 and 1960, during the period known as 'The Great Leap Forward', high rates of growth were aimed at across the economy. 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 quality products in order to meet high output targets. Within the iron and steel industry, which was one of the industries targeted, thousands of small iron and steel plants were opened throughout China and crude steel production increased significantly. These plants produced products of very low quality and most had closed by 1961 (Findlay and Xin 1985).

- A Chinese crude steel production ii ABARE

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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 attributed this 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 1961 and 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 1978 emphasised 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


were set up in Shenzhen, Shantou and Zhuhai in Guangdong province and Xiamen in Fujian province. The Special Economic Zones operate under less restrictive economic policies than the rest of the country, are given preferential tax treatment, import Western technology, capital and management skills, and encourage the participation of foreign firms. Market factors are supposed to play a greater role in decision making in these zones than in other parts of the country.

The Sixth Five Year Plan, 1981-85, reinforced the economic reforms 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 economic reforms and sought to lay the foundation for high and sustained growth (James and Young 1987). A greater degree of autonomy was granted to local regions and planning was decentralised further.

The Seventh Five Year Plan, 1986-90, involved policies designed to continue to promote the growth of the Chinese economy and called for China 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 60 million tonnes of crude steel in 1990 and 95 million tonnes in 1995 were met (Chin and Kuo 1990).

I The impact of reforms on the Chinese steel sector The economic reforms which began in 1979 have affected the Chinese steel sector in a number of ways. Policies which have allowed for, and encouraged, the importation of Western technologies and raw materials have helped to improve steel production processes in China. The import of foreign steel production technology has allowed Chinese steel producers to increase efficiency significantly through the upgrading of old Soviet designed pIants and the construction of new Japanese and German designed 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 expected to increase the efficiency of steel production.

Reforms to the pricing system have been important to 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 excess production within a relatively open domestic market, once their quota 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 fluctuate with supply and demand.

In 1988 ceilings on steel prices were introduced because high 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 exchange that is made available for the purchase of steel imports, 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 steel can be expected to improve the way in which steel is allocated throughout the Chinese economy. Chinese steel users 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 specific types of steel they require directly from steel producers on the domestic market. In addition, steel users can now 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 iron ore and coking coal as feedstock. The five largest steel plants produced over 30 million tonnes of the total 89 million tonnes of crude steel produced in China in 1993. Anshan, China's largest steel company, produced in excess of 8 million tonnes in 1993 (table 2), placing it in the world's top 20 steel producers by volume.


2 Steel production from major Chinese plants in 1993

Steel company Region Start-up date 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 35 per 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 0.5 million tonnes of steel. Most of these smaller steel plants are also located in eastern China (see map on page 14), although in 1989 some steel was produced in 28 of the 3 1 provinces 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 Chinese crude steel production of 66 million tonnes in 1990. The eastern municipality of Shanghai was the second largest steel producing region after Liaoning, producing almost 14 per cent of total crude steel output. Steel production does occur further inland. In particular, large integrated steel plants such as Wuhan, Panzihua and Baotou are located 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 is produced in the southern regions of China, despite strong demand 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.


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 are being 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 a US 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 wire that are used in the construction industry, and against the production of flat products such as sheet that are heavily

I

I 3 Production of steel by product group

~ Product group 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).


consumed by the manufacturing industry (table 3). This product mix of Chinese steel reflects not only the consumption mix in China compared 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 one billion tonnes, and has proven coal reserves of almost 900 billion 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 coal deposits are located in the northern provinces of Shanxi, Henan, Hebei, the New Mongolia Autonomous 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 Conference on 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


4 Iron content of 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 small collective operations or as a sideline by 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 (table 4). 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 steelmaking process.

I Production costs for Chinese iron ore are relatively high due to these beneficiation requirements. Recently imposed taxes on Chinese iron ore production further impinge on the competitiveness of Chinese iron ore. The cost of producing a high grade concentrate in 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 concentrate produced has been imposed on Chinese iron ore producers. By comparing these costs with the average cif import price paid by Japanese steel producers of US$25 a tonne in the first half of 1994, the competitiveness of imported iron ore in China can be seen.


Transport and 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 sector in China has 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 steel plants 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 facilities required 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 strain on 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 at the Beilun deep water port some 150 kilometres south and then barged to the steel works. Wuhan has higher transport costs for imported ore, as iron ore has to be barged 1200 kilometres 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 deep water port of Beilun, and an additional 100 000 tonne 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 Since the 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,


constituting from around 5 to roughly 30 per cent of total Chinese steel consumption. Chinese steel imports have fluctuated due 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 quantities of steel as domestic steel production growth could not keep pace with growth in demand for steel. The Chinese steel industry responded to this increase in demand by increasing production 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 consumption has been increasing since the early 1980s. The share of 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 1981 to 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 ore projects 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 of joint 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 6 million tonnes a year with all production going to China.

The Chinese steel industry in 2000 If the spectacular growth of Chinese steel consumption and production 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 dramatic increase in 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.


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 developed infrastructure and increases in income can be expected to be 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 1 024.0 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 120 million 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 100 million 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 tonnes by 1998. The World Bank (1994) projection of Chinese crude steel production in 2000 is 11 1.5 million tonnes.

The World Bank (1994) projected that Chinese iron ore production, on a metal content basis, would rise from the 1992 level 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 1992 Chinese iron ore production of 210 million tonnes, measured on a natural weight basis, then the 2000 projection is around 245 million 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.


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 to provide a quantitative assessment of this changing market to the year 2000.


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 1993 values.

In order to illustrate the impact on the iron ore and steel market 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 increase by 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 industrial production a

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 ~eport 95.4

example, the average rate of growth in China's economy under the relatively restrictive policy environment spanning the period 1967 to 1978 was 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 30 per 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 94 million tonnes in 1994, to 1 10 million 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 the proposed Baoshan no. 2 plant, as well as continued 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 represent record levels of production when compared with the last several

decades, growth in production is significant, with the European 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 196 million tonnes compared with production of only 132 million tonnes in 1993. The Japanese steel industry had an estimated 38 million tonnes of spare production capacity from the 100 million tonnes of

China's steel industvy 25

steel produced in 1993. While the US steel industry is currently operating at higher capacity utilisation rates (at around 85 per 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.

- - 7 Baseline 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

European Union 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 Steel production 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 Steel production 99.7 104.2 108.6 111.6 112.6 112.2 115.9

Other Asia Steel consumption 86.1 92.7 99.8 105.4 111.4 119.8 126.9 Steel production 55.0 57.2 60.2 64.0 67.5 71.4 74.1

Other West 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 1993 levels.


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 steel producing company after Nippon Steel of Japan, with the recent 3 million tonnes expansion to its Kwangyang steel works. China Steel of Taiwan is currently constructing facilities to increase steel making capacity by 40 per cent to 8 million tonnes. Numerous smaller electric arc furnace steel plants 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 increase in steel production from this region to be met, output from new electric arc furnace plants, and possibly from an additional integrated producer (or increased output from an existing integrated producer in the region) will be required.

China's increasing steel production, comprised largely of blast furnace based 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 accessible to imported ore.

Given the generally sustained growth in economic activity expected to 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 consumption of iron ore is projected to rise from 956 million tonnes in 1994, to 1062 million tonnes in the year 2000. The real price of iron ore is projected

I to increase marginally 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 iron ore producers in Australia, Brazil and elsewhere over the medium term, increasing its imports from these countries to 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 furnace based steel production because of the lack of domestic iron ore resources. Reflecting this reliance, other Asian iron ore imports are

China's steel industry 2 7

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 Baseline projections of iron ore consumption and production a

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

European Union 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 1 004.8 1 022.8 1 034.4 1 049.2 1 061.8


28 ABARE ~nesearch report 95.4

general increase in demand worldwide). In response to 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 Chinese market. 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 annual production capacity of the Bailadila operations in India by 13 million 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 is

I

I set to rise at 15 per cent a year, as opposed to the baseline average of roughly I I 1 I 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 136 million 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 12 million 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 simulation period. 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 consumption and production under the scenario of high growth in Chinese industrial 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 Steel production 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 11 1.3 119.7 126.8 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 Steel production 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 1993 levels. - -

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 consumption and production under the scenario of high growth in Chinese industrial 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


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


North America Iron ore consumption 67.3 69.1 71.3 73.9 73.6 71.2 76.8

I 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



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 consumption and production under the scenario of 1 1 low growth in Chinese industrial 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


32 ABARE researclz I-eport 95.4

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 consumption and production under the scenario of low growth in Chinese industrial 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


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


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 1 014.0 1 022.1 1 032.9 1 041.1



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 obtained from 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 1 I). 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 industrial production). 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 projected increase in annual world iron ore consumption of 85 million tonnes over the simulation period under the low growth scenario (table 12), with the increase under the baseline scenario of 106 million tonnes. The countries shown to be the most affected in the model outcomes are Brazil and India. Brazil's exports are 10 million tonnes a year lower and India's exports are 2 million tonnes lower than under the baseline scenario in the year 2000.


Conclusions

China is undergoing rapid industrial development due, at least in part, to the economic reforms implemented since the 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 growth in Chinese industrial production of roughly 1 1 per cent, Chinese steel consumption is projected to reach 136 million 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 increase in production will require the construction of new integrated steel plants, some of which have already been proposed by the Chinese steel industry. However, even with this increase in production, baseline net Chinese steel imports are projected to range between 12 million tonnes and 26 million tonnes over the simulation period.

In response to the increased world demand for steel, those regions with established steelmaking capacity such as the European Union, North America and Japan are projected to increase production. While the projected

I

I steel production figures for these mature steelmaking regions are well below I I previous peaks, the European Union, North America and Japan are each

projected to increase annual steel production by more than 10 per cent by the year 2000. Even with this increase in production, the continued need for restructuring of their steel industries is apparent, particularly in the European Union, which currently has significant excess steelmalung capacity.

China has vast domestic reserves of steelmaking raw materials, particularly iron ore and coking coal. However, while China is likely to remain self- sufficient in 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


growth in Chinese steel production will mean increased imports of 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 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 freight cost advantage in landing iron ore in China compared with their main competitors in the iron ore export market, Brazil's producers. However, this competitive advantage cannot be taken for granted. Future Chinese investment in port facilities for larger cargo carriers will limit Australia's cost advantage over more distant suppliers to 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 materials sector in China depends on a liberal policy environment that 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 environment within 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. Bilateral government organisations, such as the Australia-China Joint Study Group into Iron Ore and Steel, and the Western Australia-China Economic and Technical Research Fund may offer a means of further promoting this mutually beneficial relationship. By fostering an environment of cooperation based on mutually beneficial outcomes, 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 (1 992), 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 valued added iron and steel products.


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 et al. (1 979) in modelling world trade in copper, aluminium, nickel, and zinc; and is quite similar to the FAPRI system of modelling agricultural markets (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 includes Austria, 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 over the short to medium term. Annual domestic supply and demand for iron ore and steel is determined within a framework of econometrically estimated supply and demand equations. Trade flows between specific regions are not identified; however, net import and export quantities can 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 aggregate data available on international iron ore and steel production, consumption and trade. An alternative to this type of modelling approach is to directly specify the production function within an (preferably dynamic and stochastic) optimisation procedure and derive input 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 approximation of the underlying market.


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. World prices, 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.


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 such as industrial production, to be the primary factor affecting steel demand. 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 simulation exercises unless there are significant changes in relative 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:', I c , , , 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 's steel 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 respect to industrial production a

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 production was not entered into the Eastern European steel demand regression equation due to concern over the accuracy of the available data.

Demand elasticities have been computed from the estimated coefficients on 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 evaluation of aggregate world 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 shown below, the identification of blast furnace based production of steel is an important component in linking the steel and iron ore modules, with iron ore demand specified as conditional on blast furnace based production of steel. To simplify matters, other steelmaking technologies which bypass the blast furnace are subsumed under blast furnace production, since these technologies use iron ore as the primary feedstock. Under this


simplification, total steel production 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, including iron 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 supply is:


sBF 1.t = blast furnace based 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 exchange rates and producer price deflators; and

Csteel l , t

= shift variable accounting for structural change 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 furnace steelmaking (see Labson and Gooday 1994). The electric arc furnace 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;


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 for iron ore is derived from the production of pig iron - the primary 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.


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;

sBF l , 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 or declining iron ore quality. To account for this trend, the coefficient on blast furnace based steel production was specified as a time varying coefficient for those regions where it was found to be


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 former includes stock adjustment, as well as domestic consumption. The consumer price of iron ore is in terms of the fob price in those regions which are self-sufficient in iron ore. For regions which import most of their iron ore, cif prices from the consumers' primary source have been used (for example the Japanese consumer price 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 Eastern Europe, cif prices in Western Europe have been used. Scrap prices have been chosen in a similar fashion.

Chinese iron ore demand represents an interesting problem, since China uses 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 account for the impact of imported iron ore on the input-output coefficient for iron ore (by weight), a specification similar to that of equations 5 and 6 has been used. In this case, the coefficient on blast 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-output coefficient would be equal to 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 100 per cent imported iron 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


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 application to the iron ore market by Priovolos (1987) which incorporates the presence of capacity constrained production in the short run. Intuitively speaking, supply is decomposed into large, long run changes in mine capacity related to the addition of greenfield mines and the addition of infrastructure such as roads, 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 characterised as being up to ten years in the iron ore sector. In the long run, capacity itself would be likely to adjust to changing market factors. The basic form of the production relation is defined as:


Sly? = quantity of steel supplied;

pore 1,t

= price of iron ore, in domestic currency and deflated by domestic producer price index; and

C;' = shift variable for greenfield additions to capacity.

Iron ore production, represented in equation 7, was specified with production 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 increasing productivity in production. For most exporting regions, the price of iron ore is defined in terms of fob at a domestic port of trade, in


14 Price elasticity of iron ore supply (major producers)

Region Short run Medium run (10 years)

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 domestic producer price index. For regions where fob prices are unavailable, cif prices have been used.

The lack of an appropriate price of iron ore to producers in North America proved to be troublesome. Since much of US iron ore production is captive to nearby steelworks due to geographical constraints and transport costs, 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 captive mines.

Short and medium term partial elasticities of iron ore production with respect 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 (Australia and Brazil) are the more elastic suppliers, probably due to the fact that they both have abundant iron ore resources near port facilities, and have the infrastructure in place necessary to handle large volumes. Other Western Europe is also shown to be rather price responsive, but, given their 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 relative lack of infrastructure in these two countries and the associated delays in increasing iron ore production capacity. Alternatively, North America, which as noted above, has mines that


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 in the short term 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 price7 of 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 average quality 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.



S f C r a P 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:zraP to 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;


sEAF = quantity of steel produced via the electric arc furnace; and 1,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 form of trimmings generated in the fabrication of goods such as automobiles and consumer durables.


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 14 below. 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 deflated by the producer price index to impose homogeneity. 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

-


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, deflated by a producer price index;

cWa1 = price of coal, deflated by a producer price index;

Dsteeel = quantity of steel demanded (apparent consumption); and

If', = real industrial production.

core = Price of iron ore, deflated by a producer price index;

cscrap = price of scrap, deflated by a producer price index; and

Tech, = time as an index of technological change.

Iron ore Iron ore demand is treated in terms of conditional factor demand. The activity level is blast furnace production of steel. The own price of iron ore is relative to the price of scrap steel, since it is presumed that the primary substitute for 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 shift variable to capture significant increases in 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

- - -


Where, in time t,

Store = quantity of iron ore supplied;

core = price of iron ore, deflated by a producer price index;

Ctore = a shift variable accounting for large jumps in mine site capacity;

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.

Scrap price A scrap price equation is specified, which is jointly 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 future projects 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 scrap price) for any given initial condition and projection of variables which are exogenous to the model, which include real industrial production and coking coal prices.

This one region 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


freight rate assumptions, and implicitly solves for net imports and exports on a regional basis. Price linkage equations are used to define a simple linear equivalence between regional prices which account for quality differentials in iron ore and the effect of freight rates on price arbitrage.

Estimation The structural equations underlying the iron ore and steel world trade model were estimated, for the most part, in linear form with standard econometric techniques (OLS with correction for serial correlation where appropriate). For the most part, direct estimation of the structural equations was performed even though jointly dependent variables appear in most of the equations. It is well known that this may lead to biased estimates of the underlying parameters. However, the relatively small sample used for this study limits the usefulness of asymptotically correct procedures. In those cases where simultaneity bias appeared to be significant, as judged by comparison of the estimated value of the parameters to theoretical restrictions, instrumental variable techniques were used.

Variables which had estimated coefficients of the apriori incorrect sign were excluded. The sample period for estimation of the coefficients generally covered 1972-92. However, shorter sample periods were used when structural change seemed apparent. For the most part, data were collected from various issues of the International Iron and Steel Institute's Steel Statistical Yearbook and the International Monetary Fund International Financial Statistics.

Validation The mean absolute percentage error (MAPE) for the model was computed by first running a dynamic simulation given the observed values of the exogenous variables and model predictions of the lagged endogenous variables. These predicted values were then compared with the true values for the period 1983-91, which is the longest period for which observations on all variables were available (table 15).

For the most part, the MAPE for the endogenously determined variables was well under 10 per cent. Several variables which have large MAPE are not likely to be of much concern for the intended purpose of the model. For example, Japanese and other Asia's MAPE in iron ore supply is 18.3 per cent and 10.2 per cent respectively. However, the combined iron ore

- -


production in these two regions is typically about 1 million tonnes a year, which is roughly 0.1 per cent of world iron ore supply. As such, a 10-20 per cent error in Japanese iron ore supply will have a negligible effect on projected market outcomes.

Systematically large errors were also found in the iron ore apparent consumption variables of the large exporters of iron ore, including Australia, Brazil and India. This is due to the fact that consumption is measured as

15 In sample dynamic simulation performance, 1983-91

Mean absolute Variable percentage error Mean absolute

Variable percentage error %

Steel production Australia Brazil China European Union Eastern Europe India Japan North America Other Asia Other Western Europe Rest of world World

Steel apparent consumption Australia Brazil China European Union Eastern Europe India Japan North America Other Asia Other Western Europe Rest of world

Steel prices Steel price index Scrap price (US) Scrap price (Japan) Scrap price (EU)

Iron ore supply Australia Brazil China European Union Eastern Europe India Japan North America Other Asia Other Western Europe Rest of world World

Iron ore apparent consumption Australia Brazil China European Union Eastern Europe India Japan North America Other Asia Other Western Europe Rest of world

Iron ore price fob Australia

- - - - -


apparent consumption, which includes stock adjustment. While stock adjustment is not particularly significant when compared with domestic production or exports (typically less than 5 per cent of annual production) it can overwhelm direct consumption in a large iron ore producing but small steelmaking country such as Australia. However, even in Australia, which has a MAPE in iron ore apparent consumption of 479.7 per cent, this error is unlikely to seriously effect the model's projections. This is because on average, stock adjustments tend to cancel each other out, such that projected Australian iron ore consumption is a quite reasonable approximation of direct iron ore consumption, and any remaining error is probably quite small in comparison to variables of interest such as Australian production and export of iron ore. For example, baseline projections of Australian iron ore consumption vary from 11.3 million tonnes to 12 million tonnes over the simulation period 1994-2000, which is quite in line with projected steel production figures. The remaining error is likely to be very small when compared with Australian export projections of over 100 million tonnes. This problem would be ameliorated by using direct consumption figures, combined with a stock adjustment equation, but the data necessary for such a specification are not available.

-

China 's steel industry

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