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Australian iron ore miners shine despite China's fury

Confluence of favorable supply and demand factors unlikely to last

SYDNEY -- These are difficult times for many Australian industries that have profited from the country's trade links with China due to the recent souring of ties between the two nations.

But for iron ore producers like Rio Tinto and BHP, these are glory days. Prices for future deliveries have reached record levels and shares in the mining companies are hitting new highs. The Australian government is now eyeing a potential tax windfall that would help offset its biggest annual budget deficit ever.

If market conditions could hardly be better for the miners, they could certainly take a turn for the worse.

"Conditions are so good they can't continue," said Morningstar analyst Mathew Hodge, pointing out that both BHP and Rio Tinto are earning well over 100% annual returns on their capital invested in iron ore at the moment.

Supply and demand factors now working in the miners' favor could quickly change, with ore shipments from other sources disrupted by the COVID-19 pandemic rebounding and Chinese steelmakers, the miners' best customers, coming under stronger pressure to reduce output.

"There are specific peculiarities in the market at the moment," said James McGlew, executive director at brokerage Argonaut in Perth. "It is volatile, and that has led to speculators moving in on the commodity (iron) as well."

Iron ore futures touched a record high of $233.10 a ton last week according to S&P Global Platts. Although they have settled back, prices remain significantly higher than the average $160 a ton seen earlier this year and are running about double year-ago levels.

The surge has raised concerns about market speculation with Chinese officials, who at the beginning of the month cut tariffs on some iron and steel inputs as a cooling measure.

After the trading frenzy last week, commodity exchanges in Dalian and Shanghai moved to raise margin requirements and trading fees for iron contracts, among other measures. The moves initially knocked ore prices back down as low as $187 a ton yet the China Iron and Steel Association, representing local producers, called for the authorities to go further in curbing speculative activity.

By Tuesday, iron ore futures were back up to about $215 a ton.

Mine and port disruptions due to COVID-19, especially in Brazil, Australia's main rival on the international ore market, have been a key driver of the price surge. Analysts see a continuing deficit of 18 million to 20 million tons in the seaborne iron market persisting until at least September.

This has come at the same time that Chinese steelmakers are calling out for ore to sustain record high output levels amid orders to support infrastructure development and manufacturing.

Production of crude steel reached 97.85 million tons last month, up 15% from a year before, even as Beijing has tried to reduce output to curb complaints from other countries about discounted exports and the sector's damaging environmental profile.

Steel producers, like other industries, are now under pressure to come up with a roadmap to support Chinese President Xi Jinping's pledge of achieving zero net carbon emissions by 2060.

The souring of political ties between China and Australia, tied to issues including restrictions on Huawei Technologies, blocked investment deals and investigations into the origins of the COVID pandemic, has cast a spotlight on the iron trade.

Over the past year, China has taken measures to block or curb imports of cotton, barley, beef, lobsters, timber and wine from Australia, but not iron. According to trade data, Australia supplies 60% of China's ore imports while China takes 70% of Australia's exports.

"Even before iron ore prices started to move, it was an unwinnable trade war for China because China needs Australian iron ore and that is far more important to it than wine or lobsters or all the other things we read about," said Tom Smith, head of the department of applied finance at Macquarie University in Sydney.

In early May, Beijing suspended activity under the China-Australia Strategic Economic Dialogue in its latest retaliatory measure. Ore prices rose $39 a ton over the following three trading days amid speculation shipments might be affected.

"Near term, we do not expect the bilateral tension to have a major impact on the iron ore trade as there is no immediate source of iron ore units to replace Australia," UBS analyst Myles Allsop said in a report this month. "Medium term, we expect China to invest less in Australian natural resource projects and to accelerate its objective to reduce dependence on non-captive imported iron ore."

On Tuesday, China's National Development and Reform Commission said it would investigate iron ore trading activity while encouraging domestic exploration and the development of new import channels.

In the meantime, Canberra is expecting a AU$30 billion ($23.38 billion) tax windfall out of record ore exports of $104 billion forecast for the year ending June 30.

"During a very challenging 2020, the Australian minerals industry drove prosperity in Australia, making substantial contributions to investment, exports, wages, jobs and government revenue," said Tanya Constable, chief executive of the Minerals Council of Australia last week.

Rio Tinto last year reported its best annual earnings since 2011, with profits up 20% to AU$12.45 billion. BHP saw its earnings rise by an equal measure in the six months to Dec. 31 to reach AU$6.04 billion, its highest half-year figure in seven years.

Smaller rival Fortescue Metals logged an even bigger gain, with half-year profits rising 66% to AU$4.08 billion. Analysts are bullish the momentum will continue when figures for the period to June 30 are reported in August.

Most believe prices have to turn, however.

Citigroup analysts expect benchmark prices will average $174 a ton over the whole year. At HSBC, analysts put this year's average at $162 a ton and next year's at $135.

A consensus of analysts surveyed by Bloomberg puts prices at $124 a ton by next March. But official Australian government forecasts, which tend to be conservative, see ore returning to a long-term average of just $55 a ton by then.

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