BHP: Premium Iron Ore Miners Set to Gain From China Reforms

China is handing producers of higher-quality iron ore and coking coal an advantage over competitors with reforms to its steel industry.

That’s according to BHP (ASX:BHP,NYSE:BHP,LSE:BLT), the world’s largest miner and a major iron ore producer.

In an interview with Bloomberg, BHP chief commercial officer Arnoud Balhuizen said that steel mills in China are likely to retain about two-thirds of the improvements in margins seen since a push by the Chinese government began in late 2015 to reduce excess capacity and meet more stringent environmental standards.

“This drove – and is driving – a continuous demand for higher-quality raw materials,” which has resulted in wider spreads between premium and lower-grade iron ore and coking coal, Balhuizen said. “We think these price differentials will be sustained — for at least two-thirds of what we have seen last year.”

In 2018, the government upped requirements for steelmakers, dictating that for a minimum 1.25 tonnes of steel capacity closed in environmentally sensitive areas, 1 tonne could be built.

According to Balhuizen, China’s reforms to its steel industry are shifting from removing capacity to upgrading operations, meaning the sector will favor large, coastal mills using cleaner, premium steelmaking materials.

Although competitors with BHP could disagree – Australian miner Fortescue Metals (ASX:FMG), which exports a lower-grade iron ore than rivals BHP and Rio Tinto (ASX:RIO, NYSE:RIO, LSE:RIO), said last month that its customers would be looking for cheaper iron ore.

Recent Chinese limitations on production are diverse, including forcing steelmakers that build new facilities to shut down old facilities first.

The reasons for imposing restrictions on steel production are partly environmental, with steel markers in environmentally sensitive parts of the country targeted – like those near Beijing and in Hebei and Tianjin provinces.

Another reason is that China produces too much steel – as the largest consumer of iron ore and coal, it produced a record volume of steel at 832 million tonnes in 2017. Despite that, it only clocks in as the third-largest iron ore producer – well behind the largest producer Australia – BHP’s base of operations.

According to a Bloomberg Intelligence index of basic oxygen furnace steel manufacturers, steel mill profitability peaked in December and slumped through March before rebounding.

Profitability of steel companies in Asia will remain stable in 2018, underpinned by demand and capacity cuts, Moody’s Investors Service said in a February note.

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Securities Disclosure: I, Scott Tibballs, hold no direct investment interest in any company mentioned in this article.