As China-Australia Ties Worsen, Iron Ore Remains Bulletproof

(Bloomberg) -- As China-Australia relations descend into a morass of sanctions and mutual recriminations, Beijing is delivering a huge cash windfall to Canberra and Australia’s economy through its insatiable demand for iron ore.

China has few alternatives as it seeks to stimulate its economy post Covid-19 through infrastructure investment, with Australia accounting for more than half of iron ore shipments globally. If Beijing were to try to purchase solely from non-Australian producers, at best it could get 56% of the volumes it typically imports, according to analysis by Goldman Sachs Group Inc.

“China is likely to remain reliant on Australian iron ore for the foreseeable future,” said Andrew Boak, Goldman’s chief economist for Australia. This reflects “the inelasticity of global supply and that China’s annual import requirement far exceeds the seaborne supply” of other nations.

Beijing has hit Australian wine and barley with steep tariffs and restricted other commodities such as beef and seafood in recent months, ratcheting up pressure on the world’s most China-dependent developed economy. Ties have deteriorated since 2018 after Canberra barred Huawei Technologies Co. from building a 5G network and plummeted earlier this year when Australia called for an independent probe into the origins of the pandemic in Wuhan.

The total value of exports impacted by China’s restrictions to date is just 0.3% of Australian gross domestic product. Yet, Goldman estimates that if Beijing took the nuclear option of banning Australian iron ore imports, that would cut GDP growth by about 2 percentage points over 12 months, widen the current account by A$40 billion ($29.7 billion), equivalent to 2% of GDP, and blow out Australia’s budget deficit by A$12 billion, or 0.6% of GDP.

China has been trying to give itself greater flexibility by buying ore carriers that improve the economics of long-distance shipping from Brazil and purchasing Guinea mines. Yet, ongoing production problems after an accident at a Vale SA mine mean Brazil is unlikely to be back at full output before the end of 2022 and the output potential of the latter has been heavily questioned.

Iron ore surged to a seven-year high last week and is trading above A$140 a ton on strong steel demand from China’s steel mills. Elevated prices have brought a number of smaller Australian mines back to life; meanwhile, billions are being invested in new mines from BHP Billiton Ltd., Rio Tinto Group and Fortescue Metals Group Ltd. that are due to come online in the next few months.

With action against iron ore unlikely, Beijing’s ability to bring Australia to heel through economic coercion is being undermined, at least for now.

©2020 Bloomberg L.P.