BERLIN SCHOOL OF ECONOMICS AND LAW

Institute of Management Berlin (IMB)

Analysis of the Chinese steel industry

under the perspective of government intervention

Name of Student:

Wang Shuo

Matr. No.: 385301

Masters Thesis

Submitted in partial fulfilment for the degree of

"Master of Arts"

Supervisor: Associate Prof. Dr. Jiannan Guo

Prof. Dr. Hansjrg Herr

Date: June 28, 2014

Statutory Declaration

I herewith formally declare that I myself have written the submitted Master Thesis

independently. I did not use any outside support except for the quoted literature and other

sources mentioned at the end of this paper.

I clearly marked and separately listed all the literature and all other sources which I employed

producing this academic work, either literally or in content.

I am aware that the violation of this regulation will be penalized.

Student Name Students Signature

Student Number Date

Abstract

Since the reform and opening up China's economy development rapidly, the industries

such as infrastructure, real estate, construction and decoration industries grow up quickly, so

as China's steel industry. According to 2013 annual report of the World Steel Association, it

shows that Chinas steel output 717 (million) tons in 2012, accounting for 46% of the global

total output, ranking first in the world. What is more, chinas steel output is much large than the

second one Japan which is 107 (million) tons.

But the problem China's steel enterprises faced is that very low profits or even losses.

The reason lies in the price of raw materials of smelting of iron and steel - iron ore. The iron ore

market which Chinese steel companies faced is an oligopoly seller's market, and look at the

domestic iron ore buyers that steel companies are divided into two categories: large

state-owned enterprises, small and medium private enterprises or joint ventures. The rights and

interests of large state-owned steel enterprises are represented by China Steel Association and

they will negotiation with four iron ore companies. But for the small and medium private

enterprises or joint ventures, in order to survive, they have had to buy the spot iron ore from

large state-owned steel companies or trading companies in high-price before the unified

long-term agreement price.

Meanwhile indirectly undermine the price bargaining power between the CISA and four

iron ore. It makes the Chinese steel companies (buyer) of iron ore become a free market

competitor against the oligopoly competitor when faced four big iron ore (seller). At last, they

loss the initiative and bargaining power to negotiate trade in the world iron ore market and

trampled passive state.

Due to the soaring prices of iron ore, resulting in profits of domestic steel companies is

minimal, or even zero profit or loss. Steel companies have to raise the steel raw materials

prices in order to survive, but this affect the country's 13 major downstream steel companies

such as real estate, infrastructure, transportation, energy, machinery manufacturing,

automotive, shipbuilding, etc. this raise prices to pass on the entire national economic system,

and eventually passed on to consumers.

Under this situation, this article studies on these problems, propose effective solutions

which are unite all domestic steel companies and set about establishing a new procurement

system for iron ore, form iron ore purchasing alliance. In this way, it can improve the overall

bargaining power of chinas steel industries in the international iron ore procurement

competition. To solve the problems facing by the steel industry in China which are the process

of globalization of the market and the transformation process itself. So that China's iron and

steel enterprises could enhance their competitiveness, respond to international competition

actively, maintain a healthy and stable operation and experience the transition of the industry

market smoothly.

Key Words: iron ore; steel industry; bargaining power; integration; government

Table of Contents

Abstract ........................................................................................................................................................... 3

1. Introduction ................................................................................................................................................. 6

1.1 What is steel? ......................................................................................................................... 6

1.2 Steel production ..................................................................................................................... 7

1.3 Global steel market ................................................................................................................. 9

1.3.1 Current market structure ............................................................................................. 10

1.3.2 A dragon emerges ...................................................................................................... 11

1.4 Chinese steel market ............................................................................................................ 12

1.4.1 Iron ore produce ........................................................................................................ 12

1.4.2 The huge demand of iron ore ...................................................................................... 12

2. Evolution of government policy on the iron ore procurement after the reform and opening up ...... 14

2.1 Stage of no interventions from government ............................................................................. 17

2.2 Stage of delegation by BaoSteel ............................................................................................ 18

2.3 stage of intervening by CISA .................................................................................................. 19

3. Main problems in international purchases of iron ore for Chinese steel industry ............................. 22

3.1 Chinese steel industry ........................................................................................................... 22

3.1.1 The emotional steel Industry ....................................................................................... 22

3.1.2 The steel industry today .............................................................................................. 24

3.1.3 The internal conflict during the purchase of iron ore ....................................................... 27

3.2 What is the problem with the Chinese steel industry? ............................................................... 28

3.3 Chinese iron ore market ........................................................................................................ 30

3.4 Government interventions ...................................................................................................... 31

3.4.1 Government structure ................................................................................................. 31

................................................................................................................................................ 34

3.4.2 Government influence on iron ore prices ...................................................................... 34

4. The future .................................................................................................................................................. 36

4.1 CISA and MIIT: current activities ............................................................................................. 36

4.1.1 MIIT .......................................................................................................................... 36

4.1.2 CISA ......................................................................................................................... 37

4.2 Changes in import regulations ................................................................................................ 37

4.3 The future about Chinese iron ore .......................................................................................... 38

4.4 New iron ore trading platforms ............................................................................................... 40

4.5 A critical view ........................................................................................................................ 41

5. Suggestions and advice ........................................................................................................................... 43

5.1 Integrate the government interventions ................................................................................... 43

5.2 Government should encourage the merging in steel industry ..................................................... 44

5.3 Broaden the import channels of iron ore by government ........................................................... 46

5.4 Establish the national strategic reserves system of iron ore ....................................................... 49

5.5 In my opinion ........................................................................................................................ 50

Bibliography .................................................................................................................................................. 52

Acknowledgements ...................................................................................................................................... 55

1. Introduction

Steel is a product that is essential for any modern society to function. The material has always

been important for investments in construction and infrastructure, but lately also for

consumption products such as cars and white goods. The world's steel production is

completely dominated by China that manufactures almost half of all the steel in the world today.

The Chinese steel industry is almost entirely controlled by the state, which in other words

means that the Chinese Communist Party has a great deal of influence on the world's steel

market.

As world production of steel has doubled in less than 20 years, the world's steel producers

have become more and more dependent on the iron ore suppliers. These companies now

enjoy a very strong bargaining position that leads to higher profits while the steel producers are

suffering.

If someone were to change this power balance, it would be the Chinese government. I will in

this paper analyse how government interventions may be carried out to reform the Chinese

steel industry. A transformation of the industry in China may also have implications for the

entire world market and especially for iron ore producers.

1.1 What is steel?

To understand the world's steel market it certainly helps to know what steel actually is. Steel is

an alloy that mainly consists of two materials, iron and carbon. Other trace elements such as

manganese, nickel, chromium, molybdenum, and niobium may be added in smaller quantities

to give the steel the desired quality. Iron, which is a rather soft material, is the main element of

steel. Carbon may be added up to two percent to make the material harder and stronger. When

too much carbon is added the material turns into cast iron, a material that must be melted to

change its shape.

The industrialization of steel production started

in the United Kingdom, but at the turn of the

20th century it was the United States that

Early steel production in the UK

became world leading in steel production. The first half of the 20th century also saw two world

wars. During this time many countries nationalized their steel production since most of its

output was aimed at the military. After World War 2 the world finally began commercializing and

trading in steel again. Private consumers now started purchasing steel products such as white

goods and automobiles. However, infrastructure and construction, two sectors essential for

economic growth, still remain the most important segments for the steel industry. Developing

countries such as China are currently fueling the world demand for steel. As many countries

are continuing their industrialization process and consumers increase their purchasing power,

the demand for steel will continue to increase in the future.1

1.2 Steel production

Combining the two elements iron and carbon to the right proportions produces steel. The

accessibility to these two raw materials is however very different. In steel mills, carbon is

usually added through coal, natural gas, or oil. The choice of resource used as carbon source

depends on the availability of the resource where the steel is produced. Access to oil and

natural gas usually go hand-in-hand,

while coal is abundant in most parts of

the world.

Iron, on the other hand, can only be

found in a material called iron ore. Iron

ore is a commercial concept that

principally means rock that contains

iron to such a degree that it is profitable

to extract and sell the resource. With

today's technology, rock that contains

around 20-30% iron is considered

economical to extract. One problem

with iron ore is that it can only be found

1 World Steel Association, 2012, pp. 21-31

Country Iron ore

reserves (Mt)

Average iron

content (%)

Ukraine 30,000 30

Brazil 29,000 55

Russia 25,000 56

Australia 24,000 63

China 23,000 28

Kazakhstan 8,300 40

India 7,000 64

Canada 6,300 37

Venezuela 4,000 60

Sweden 3,500 63

World's 10 largest iron ore reserves and their average iron

content (Bielitza, 2012)

(World Steel Association, 2013)

of high quality in very few places in the world. Many of the iron ore deposits also have low iron

ore content, thus making it more costly to commercialize. Today there are four companies,

mainly operating in two countries, which completely dominate the world's iron ore production.

These four companies are commonly referred to as the Big 4.

In the value chain of steel production we have two key players: raw material producers and the

steel manufacturers. The steel is sold to the end users, which are firms manufacturing goods

sold to either the investment or consumption sector. In the coming chapters of this paper we

Company

name

Base Largest owners Iron ore exports

2012 (Mt)

Share of world

export (%)

Vale Brazil Brazilian investment

funds

Brazilian government

263 22

Rio Tinto UK,

Australia

HSBC

JP Morgan

National Australia Bank

239 20

BHP

Billiton

UK,

Australia

HSBC

JP Morgan

National Australia Bank

171 14

Fortescue

Materials

Group

Australia The Metal Group

HSBC

Valin

64 5

The Big 4: The four largest iron ore producers in the world

will focus on the activities and the relationship between the world's iron ore and steel

producers.

1.3 Global steel market

The world's steel production has doubled since the beginning of the 1990s. Urbanization and

industrialization of developing countries have contributed to the increase in demand for steel.

Unlike the iron ore industry, steel

production is carried out locally by

steel plants all over the world to

supply their domestic or regional

markets with steel. However, due to

the scarcity of iron ore, all steel

companies in the world are more or

less dependent on very few iron ore

producers. While the global demand

for steel has increased rapidly, the supply of iron ore has not been able to keep up with this

increase, thus causing a surge in iron ore prices. 2

2 Wood Mackenzie, 2013, pp. 2-7

Coal

Natural gas

Oil

Iron ore

Steel

production

Consumption

Investment

Iron ore price (USD/ton) FOB Australia (Wood Mackenzie, 2013)

1.3.1 Current market structure

The world's steel industry has gone

through a number of changes since the

end of World War 2. Steel companies had

traditionally been producing steel used for

military equipment and warfare, but in the

middle of the 20th century the production

shifted mainly to infrastructure and

construction. With improved economic

conditions in the world, steel producers

also started shifting more towards the consumption sector. Along with this change in steel

demand, a privatization trend also swept across the world. This move gave steelmakers

incentives to develop process innovation and increase cooperation among firms. South Korea

and Japan are today seen as the markets with the most innovative steel industries.3

In recent years there has been a number of large mergers in

the global steel industry. Consolidation has allowed steel

producers to utilize economies of scale to reduce the cost of

steel production. In Europe, Acelaria (Spain), Usinor

(France), Arbed (Luxembourg) merged to form steel giant

Arcelor in 2001. This conglomerate merged with Indian steel

giant Mittal Steel (with HQ in the Neatherlands) five years later to form the largest steel

company in the world, ArcelorMittal. Today consolidation is taken place both at national levels

(for example in Japan) and at regional level, as evidenced by European mergers.4

3 World Steel Association, 2012, pp. 33-43 4 World Steel Association, 2012, pp. 34-36

0

200

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1000

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1400

1600

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19

95

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World steel production (Mt)

World steel production per year, Mt (World Steel Association,

2013)

Lakshimi Mittal, CEO of the world's

largest steel company ArcelorMittal

The five largest steel producers in the world. (World Steel Association, 2013)

1.3.2 A dragon emerges

The world's steel industry has in the past decades seen a new force emerge. China has gone

from a poor and underdeveloped country to the world's leading steel producer. Economic

reforms in the 1980s fueled both demand and supply of steel in the Chinese society. The

development has continued into the 21st century, and today almost half of the steel in the world

is being produced in China. As most of the steel industries in China are state-owned, it gives

the Chinese government an enormous influence of its domestic market. In other words, one

could say that the Chinese Communist Party is in charge of almost half of the world's steel

production.

Company name Home country Productio

n (Mt)

Share of world

production (%)

ArcelorMittal Luxembourg 94 6.1

Nippon Steel &

Sumitomo Metal

Japan 48 3.1

Hebei Group China 43 2.8

Baosteel China 43 2.8

POSCO South Korea 40 2.6

Country Production

(Mt)

Share of world

production (%)

China 717 46

Japan 107 7

US 89 6

India 78 5

Russia 70 5

World total 1547

The five largest steel producing countries 2012. (World

Steel Association, 2013)

China's Olympic stadium, The Bird's Nest. It is

constructed by 42,000 tons of steel, which makes

it the largest steel structure in the world.

It is obvious that China is the most important player in the world of steel. To understand how

the Chinese steel market functions, it is of course very important to understand the

characteristics of the industry, as well as the importance of steel production in the Chinese

society.

1.4 Chinese steel market

1.4.1 Iron ore produce

First of all, the iron ore production increased year by year. In recent years, with the booming of

steel industry the iron ore production is also increased year by year. In 2005, the iron ore

production reached 420 million tons, compared to last year 35.6 % was increased. In 2012, the

production of iron ore was 1.31 billion tons, during the entire eleventh five-year plan period, iron

ore per capita growth rate has reached 20%.

Secondly, the iron ore production is concentrated on Bohai area. From the region to see, the

iron ore output in Bohai is the largest in China, according to the figures of 2002, Bohais iron

ore production was 720 million tons, almost accounting for about 55% of the total national

production.

Thirdly, low concentration of the iron ore producing area. From a distribution point of view,

except for a few provinces have no iron ore resources distribution, other parts of the country all

produced. Hebei province is the largest producer in China. Subject to geographical distribution,

most of the Chinese iron ore mine is small-scale and low concentration. According to CISAs

figures, by the end of 2011, China's registered iron ore companies in a total is 1596, and the

top 10 manufacturers are all state-owned enterprises, and the total output from the Big 10 is

only 18% of the national production.

1.4.2 The huge demand of iron ore

Since the reform and opening up in 1978, China's economy has begun to explosive

development. The development of infrastructure construction, a large number of housing

construction, urban and rural construction, and the automobile industry led to the great

development of China's steel industry. In 2000 China's steel enterprises total produce crude

steel production 6 tons. In 2011 the total crude steel production was 11.48 tons. At the same

time, in 2011 the worlds crude steel production in total was 15.257 tons, 42.47% of global

output came from China.

Large domestic steel demand directly stimulating the huge purchasing demand for iron ore,

China's iron ore imports in 2011 was 6.86 tons, 55% of the global iron ore total transaction.

Since surpassed Japan to become the world's largest steel producing country, China has

keeping iron ore's largest import country and largest steel consumer title till now, plays a

significant and irreplaceable role in worlds steel industry.

From Europe and the United States, Japan and other developed countries through the

development path of industrialization, the steel industry as a pillar industry of the country's

economy is a symbol of large-scale industrialization process. According to that, the potential

demand of Chinese steel industry is still very huge, and the demand of iron ore import will also

grow steadily.

From the beginning of 2000, with the vigorous development of China's economy, the steel

industry is also booming, demand of iron ore in China has greatly increased, with only the

domestic iron ore production has been far from satisfying the needs of the domestic steel

enterprises. Therefore, China's import from the international iron ore trading platform is

increased year by year, the proportion of the total demand has increased year after year. In

1999 the import iron ore was 28% of total demand, while by 2008, China's imports of iron ore

reached 4.44 tons, an increase of 15.5%, and imports accounted for the total demand reached

58.9%. There is no doubt Chinese has become the world's largest iron ore importer. China's

iron ore imports from 18 countries and regions, of which more than 80% imported from Brazil

and Australia, so China's iron ore resources external dependence is very high. This leads to

monopoly resources elevation pricing joint with Brazil and Australia's Big4 iron ore giants, and

the influence of small iron ore export prices, the international iron ore prices soared.

2. Evolution of government policy on the iron

ore procurement after the reform and opening

up

Since steel products were first time introduced in China, they have played a very important role

in the development of the Chinese economy history. This chapter will analysis the evolution of

government policy on the iron ore procurement after the reform and opening up from a

historical perspective, the author will use some of the historical events as key points to study

into the governments intervention and impact on the steel industry, as well as for the policies of

iron ore procurement development.

The writer used timeline to divide the three stages of the Chinese steel industry development,

and the beginning of the first stage is the first time steel was introduced into China. The first

stage is from 1840 to 1949, called the modern steel age. The second epoch we describe

covers the time from 1949 until 1978, we name it China's new steel age. The third and last part

begins in 1978, and represents the time of reform and opening up of the Chinese economy,

hence the name reform and opening up.

In the first part of the paper we mentioned that the modern steel industry began with the

industrial revolution in the UK. So let us now start by analyzing the effect the development in

the UK had on the Chinese steel industry. The first opium war broke out in 1840 when the

British navy attacked Chinese ports. This was the first time China was exposed to modern

warfare with equipment mass-produced in large factories. The Chinese suffered defeat, but the

Qing dynasty that ruled China during this time recognized the importance of this new material

called steel. The country's leaders decided that China had to develop their own steel industry in

order to build a strong and modern army. The first steel plant in China was built in Fuzhou

province in 1871, 30 years after the first British invasion. This establishment marks the birth of

The modern

steel age

The new

steel age

Reform and

opening up

the steel industry on the Chinese mainland. In 1893 China's first iron and steel complex was

completed in Wuhan. Development of the steel industry sequentially continued to carry on into

the 20th century. However, World War 1 and 2, along with the Chinese civil war blocked further

development of Chinese steel production.

In 1949 the Chinese Communist Party took power of the country and the People's Republic of

China was established. After the many chaotic years involving both World War 2 and a civil war,

China's economy was turbulent and unbalanced. New economic reforms were thus needed. A

new economic system implemented by Mao Zedong and the Communist Party heavily

emphasized the development of the second sector, industry and construction. Mao Zedong

stated the following in 1954:

"Today we are able to produce tables and chairs, tea cups and pots, we can grow food, and

even grind flour and manufacture paper, but we cannot make one car, one airplane, one tank,

or one tractor." - Mao Zedong

China's new economy would make the development of the country's steel industry its number

one priority. Another reason for this shift to heavy industry and steel is the country's ambition to

follow Soviet Union in its industrialization path. This economic plan was also necessary for the

country to strengthen its military power and economic progress.

In 1978 China once again reformed its economic system under the "Reform and opening-up

policy". This implementation led to rapid economic development for the country and its citizens.

With a booming urbanization, the country was now more than ever dependent on steel. From

1978 until 1985 the Chinese steel industry grew slowly. New economic reforms had just been

initiated, but in the first few years they only had a marginal effect on the steel industry. In the

Painting of a scene from the first opium

war.

Propaganda poster from The Great

Leap Forwards, the text reads

"Produce more steel, help us build our

socialist society"

mid-80s the economic development in China truly took off and created a wave of urbanization

and migration to the large cities. In the last ten years, China's rapid economic development has

continued. In 2008 a stimulus package of four trillion CNY was launched to tackle the financial

crisis. The package included massive investments in construction of railroads, airports, and

highways to fuel the economy. The steel consumption has more than tripled in the last ten

years, but the steel companies' profits have now started to decline. A consolidation wave also

started, and many steel companies were turned into steel groups. At this time China took on a

leading position as the world's largest steel producer.

The end usage of steel in China 2010 (BOC International, 2012)

Property 26%

Infrastructure 20%

Transportation facilities

6%

Energy 8%

Machinery 17%

Automotive 7%

Shipbuilding 3%

Household durables

4%

Other 9%

Steel consumption in China by sector

Steel demand in China, from the Great Leap Forward to 2010

(BOC International, 2012)

Urbanization led to development of

many Chinese cities

The last age of Chinese steels timeline is the most important age for Chinese steel industry. To

analysis the Chinese steel industry and the purchase of iron ore we use three stages to

describe how Chinese government developed their policy and has progressed over three

periods of time.

2.1 Stage of no interventions from government

As a result of China's rapid economic development in the 21st century, the iron ore demand

has been increasing. According to statistics, in 2000 China's Iron Ore Imports amount is 2

billion US dollars, in 2004 the amount was increasing to 13 billion US dollars. In 2004, the

National Iron Ore demand was 520 million tons, 60% of the demand could be offered by

domestic producers, and about 40% of the demand needs to rely on imports. Because of the

recovery of the global economy and the huge increasing demand of Chinese steel industry, the

global iron ore prices was pushing up since 2005.

From 1978 to 2003 is the stage of no interventions from government. The large steel

enterprises mainly signed a long-term contract with Brazil and Australia iron ore companies to

import iron ore. However the small and medium steel companies only can get iron ore through

agencies, brokers, or trading companies, and they also import the spot iron ore from South

Africa or India. Add up all the demand of the Chinese small and medium steel companies is

also a huge demand, that pushing up the international spot prices for iron ore directly. And

some brokers even keep large amount spot iron ore to arbitrage, they bid up the price, which

disrupted the international iron ore price system. At the same time, the iron ore Big 4 have

abandoned long-term agreement price and moved the price closer to the spot iron ore price. In

this stage, the purchase of iron ore is a kind of free competition basically. The government has

not made excessively interventions in steel industry.

Because of the steel industry is not that important than before, and also the profits is lower, that

makes the steel industry more competitive. Steel enterprises new strategy is that improve

technology to reduce costs.

2.2 Stage of delegation by BaoSteel

In November 2003, the Chinese Ministry of Commerce entrusted Shanghai BaoSteel to

represent Chinese steel enterprises to carry on the negotiations with the iron ore Big 4, it is a

new pattern that government delegate one company to present all the steel companies in

China. But the BaoSteel seems had no experience and persuasive power to negotiate with Big

4, it only followed the Japanese and Germany's contract price as our price. BaoSteel has not

expressed Chinese steel enterprises interest and the negotiation cannot satisfy with everyone.

This let other large-scale steel enterprises criticize a lot.

But the rising price of iron ore caused the steel products price rising and also have a huge

influence on our economy:

First, increasing the cost of steel products. According to the statistics from the Ministry of

Commerce shows that from April 2005, the global iron ore prices was start to increase. For

large steel enterprises such as BaoSteel, Hebei Group, their added value of steel products is

higher, so they could offset the loss easier. For the small and medium-sized steel enterprises,

they do not have the domestic iron ore supply and need to take spot iron ore in a higher price,

so they are affected by the increasing iron ore price a lot.

Second, the impact on the industry which relies on steel products. The rising of iron ore price

caused the rising of steel products price, however, the steel enterprises transferred the cost to

other industry which rely on steel products, such as the automobile manufacturing industry,

shipbuilding industry, household appliance industry. To use the household appliances industry

as an example, this industry has entered the time of intense competition in the market, there is

very little profit exists and it's hard to pass on the increased costs of production to consumers.

Therefore, the rising prices for iron ore and steel weakened the downstream steel businesses

profit margins and pass on a portion of the costs to consumers.

Third, the influence on native price index. The iron ore and the steel products rising price

seems not have huge influence to our CPI at present, but from the long-term perspective, there

is still a possibility to create inflation. And we need to note that the iron ore and steel products

are the basic element of the entire national economy, sooner or later the rising price will affect

the whole economy system.

Although the government took a series of measures to slow down the domestic steel industry

high speed development and on the same time try to reduce the iron ore demand. But the

property development, the ship-building industry and the automobile industry, the steel demand

just increased year by year, so the iron ore demand inflated suddenly, and the global iron ore

supplier was expected to raise price and profit from it.

The structure of China's steel industry is decentralized, and the concentration is low, so they

had lost the bargaining power during the negotiation with foreign suppliers. With the developing

of industrialization and the urbanization, the demand of steel is increased and many new

companies entered this industry, they expected excess profit from the steel industry. On one

hand, it caused over investment, overcapacity and the greatly boosting of the international iron

ore demand. According to statistics, in the "fifteenth" period, China's steel industry investment

was 680 billion RMB in the fixed assets. In 2005, China's crude steel production was reaching

3.4 million tons, the first time becoming No.1 of the worlds steel output. It was almost about

30% of the entire worlds output, and also 1 million tons was over capacity for us. On the other

hand, the emergence of small and medium-sized steel companies carved up the market share.

In 1992, Chinese largest steel enterprises market share was about 48%, this proportion last for

ten years, from the beginning of 2002 the market share of large steel enterprises began to

decline significantly, this number has been changed to 32% in 2005. While the Japanese

largest 5 steel companies take 75% of the market share, and the largest 6 steel group in

Europe produce 74% of the EU steel production. It is precisely because of these countries

leading enterprises have high market share, and the market concentration is high, that makes

them have bargaining power in the negotiation. On the contrary, China's leading enterprises

market share was gradually declining, and the concentration was lower than before, that makes

us lost discourse right in the international iron ore price negotiations.

2.3 stage of intervening by CISA

Because of BaoSteels failure on the iron ore purchase negotiations, in 2009 CISA (China Iron

and Steel Association) represented Chinese steel enterprises to negotiate with the iron ore

suppliers. From this opened the government to intervene the iron ore purchase new stage ---

collective intervention stage. The negotiations goal of CISA is to drop the iron ore price level

down about 40%, reduce it back to the level in 2007. However the result in 2009 was

disappointed, the iron ore price had not fallen down but instead of increasing a little bit, the

negotiations fallen into the deadlock.

At the same time, there was some questioning about CISA. For example, CISA only

represented the large-scale steel enterprises and ignored the benefit of small steel enterprises.

Only the large-scale steel enterprises can benefit from the long-term contract price policy, but

the middle and small scale steel enterprises only could import iron ore from brokers, trade

companies or large steel enterprises.

Because of the small scale steel companies exist, the concentration is lower than other country,

and it is difficult to integrate all the steel enterprises into a negotiate union. Therefore, the

government want to make all the steel enterprises into a union and start to the collective

bargaining process.

First, the Chinese State-owned Enterprise system weakened the collective bargaining

procedure. By doing the integrate program that means a lot local small steel plant would be

shut down or be a small part of a big steel group, and the local government would not agree

with that, cause usually the local steel plant is always the symbol of the industry and also they

do not want to lose the tax paid by the steel plant. Each local authority wants the local

enterprise can become the leading strength, but central government wants all the steel

enterprises become to a union.

Secondly, the bargaining procedure has its drawbacks in the specific negotiation process.

China is the largest buyer on the global iron ore market, and CISA expects that Chinese

enterprises and other countries enterprises could establish close relations to against the

international iron ore price. However, the others big steel enterprises, such as Nippon Steel of

Japan, South Korea's Pohang Steel, they all prefer long-term supply agreement, and buy the

raw materials from the futures market. In China, the steel enterprises are lack of commodity

trading experience, and also failed on planning ahead, so many of them are buying iron ore

from the spot market. Moreover, multinational companies have strong time cost oriented values,

and our Chinese companies try to delay the time to achieve our goal. This makes all the

multinational companies do not want to establish a strategic partnership with Chinese

companies, also caused the foreign enterprises settle down the iron ore price with suppliers

first, and we can only passively accept the situation.

Through the above analysis about the rising price of iron ore, if we do not want to lose in the

negotiation again we need to enhance our comprehensive strength of buyers. From the

macroscopically perspective, first of all, government should create a supportive environment for

the steel industry productivity, in some aspects (such as trade barriers, pricing) reducing

government intervention, in some ways (such as to ensure market competitive environment)

can play a positive role. Second, invest more on the domestic iron ore prospecting and

development. The reason why our steel enterprises in the international iron ore price

negotiations are constrained is that the dependence of China's imports of iron ore is too high.

At present more than 600 mines have been found in China, there are more than 200 mines has

the potential to be tapped. Improve the supply of domestic iron ore production could reduce

China's dependence on imports and also increase the international bargaining power.

From the microcosmic perspective, first of all, Chinese steel industry should formulate a correct

development strategy, including not only for the pricing power but also the correct positioning of

the future long-term development. The limitation of iron ore resources in China determines that

we need to seek and explore the iron ore resources of overseas market. Therefore, China

should foster the development of multi-national corporation, and encourage domestic

companies to expand overseas market. Secondly, Chinese steel industry should strengthen the

integration of industry, accelerate the elimination of backward production capacity, and improve

the utilization of iron ore. From the global view, acquisition and reorganization is the trend of

steel industry, the steel enterprises were expanded in the short term, and to achieve greater

scale, and also to expand the enterprises in the market share.

In conclusion, at present, the government intervention to Steel Industry about iron ore purchase

is still not mature and the mode is still seeking out. It is necessary to develop the industry

intervention pattern to represent all interests of the steel enterprises. Only in that way, the

biggest importer of iron ore could get more bargaining power.

3. Main problems in international purchases of

iron ore for Chinese steel industry

3.1 Chinese steel industry

3.1.1 The emotional steel Industry

Talks about why Chinese steel industry is spread out we should talks about the history of

Chinese steel industry first. Ever since steel production was first brought to China it has always

played an important role for the country's economic development. The steel industry in China

has historically had a very particular relationship with its people. The mutual dependency

between the industry and the Chinese citizens started in the new steel age and this relationship

to a certain extent remains today. People's emotional ties to steel are a phenomenon that dates

back several decades and still makes industry interference a sensitive issue.

In the beginning of the new steel age the most important economic task for the Chinese

government was to develop the country's heavy industry. Steel production was of course

particularly important. The country had just adopted a new economic system based on socialist

principles. People admired their new revolutionary leader and were eager to help the country

move forward. People passionately obeyed and supported the country's intention to develop

the heavy industries, especially steel. This enthusiastic attempt to advance the entire industry

led to a devastating experiment called the Great Leap Forward (1958-1960). The plan was to

within five years surpass the industrialization level of the United Kingdom and to truly challenge

the United States. To support this development policy, a slogan that praised the country's

industrial movement was commonly used.

"Taking steel as the key link

""

The meaning of the slogan is that steel is the key product and the most important industry

needed to make the country move forward. During the Great Leap Forward, steel

manufacturing was encouraged in all parts of society. Construction of furnaces took place all

throughout China, both in cities and in the countryside. Some people even donated everything

they owned that contained iron. The important thing was to create large quantities of steel, but

very little attention was paid to the quality and for what purpose it would be used. The waste

was enormous and devastating both for the country and its citizens. The agricultural sector was

largely ignored, which caused severe famine all throughout China.

The troublesome development of China's steel industry led to the existence of a steel plant in

almost every Chinese city after the Great Leap Forward. The name of each plant was usually

the city followed by the words "steel plant". Workers who were employed at these steel plants

were usually respected, admired, and looked up to in society. These people represented the

new working class in China, and were considered the most honoured contributors to the

country's economic progress. A stable and prosperous job such as working for a steel plant

was well perceived by the Chinese society. In other words, the employees at the steel plants

were simply the elite of society. It was possible for two to three generations of one family to all

work for one single steel plant. In other words, their employment was basically their entire life

and fate. This kind of life might be difficult to understand for anyone who has not experienced it.

In many Chinese cities you will still today find families and citizens who care passionately about

its local steel plants.

Because of the rapid expansion of the Chinese steel industry during the new steel age, steel

plants were being established all over the country. Especially North China had a very high

concentration of steel manufacturers. Many of these steel plants, although old an inefficient,

are still in operation today. The most likely reason for this is the attachment people and

politicians have to "their local steel plants". Keeping local steel plants alive has become a way

for politicians to maintain popularity among its people. Of course one problematic implication of

this policy is that China's steel industry today is fragmented and inefficient. Unproductive and

loss-making steel plants are kept alive often to maintain harmony in society.

Today there are believed to be as many as 1000 steel manufacturers in China. The 20 largest

steel companies make up slightly more than half of the country's total steel output. These

figures indicate that a large number of these steel plants that have survived into the reform and

opening up period only contribute marginally to China's overall steel production.

3.1.2 The steel industry today

Today the Chinese steel industry is responsible for about 3% of the country's GDP and it

currently employs over three million people. There is a significant number of smaller and

medium-sized steel companies located all over the country. The smallest producers in China

are considered to be the most unprofitable steel producers in the world. The market is also

dominated by inefficient state-owned enterprises. Profits among private steel companies in

China today are about 70 CNY per ton steel produced, while the same figure for state-owned

enterprises is 2.6 CNY. Blast furnaces from the Great Leap Forward as small as 1m3 are in

some parts of the country still in use today.5

The Chinese steel industry is today extremely fragmented. As most other steel producing

5 Bielitza, 2012, pp. 35-37

China's largest

steel companies 2012

1 Hebei Group

2 BaoSteel

3 Wuhan Group

4 Shagang

5 Shougang

6 AnSteel

7 Shandong

8 Maanshan

9 Benxi

10 Valin

11 Jianlong

12 Rizhao

13 Baotou

14 Taiyuan

15 Jiuquan

16 Pingxiang

17 Zongheng

18 Jinxi

19 Xinyu

20 Guofeng

1

2 3

4

6

7

8

9

10

11

12

13

14 15

16

17

18

19

20 5

countries have managed to concentrate their steel production, China still has a long way to go.

The dispersion of steel producers initiated in the new steel age and the close ties to local and

List of China's 20 largest steel manufacturers. Companies marked grey are private owned. (World Steel

Association, 2013)

Company

Province

Production

(Mt)

Comments

Hebei Group Hebei 42.8 Conglomerate consisting of multiple steel producers

BaoSteel Shanghai 42.7

Wuhan

Group

Hubei 36.4

Shagang Jiangsu 32.3 Largest privately owned steel company

Shougang Beijing 31.4 Forced out of Beijing to Hebei due to 2008 Olympics

AnSteel Liaoning 30.2 Merged with Benxi in 2005

Shandong Shandong 23.0

Maanshan Anhui 17.3

Benxi Liaoning 15.1 Merged with AnSteel in 2005

Valin Hunan 14.1 Cooperation with ArcelorMittal

Jianlong Hebei 13.8 Located in Tangshan

Rizhao Shandong 13.2 Belongs to Shandong

Baotou Inner

Mongolia

10.2

Taiyuan Shanxi 10.1

Jiuquan Gansu 10.1

Pingxiang Jiangxi 9.1

Zongheng Hebei 9.1 Handan, co-owned by local gvt. and HK investors

Jinxi Hebei 9.1 Tangshan, private company becoming state-owned in 1997

Xinyu Jiangxi 8.7

Guofeng Hebei 8.0 Tangshan, co-owned by local gvt. and HK investors

China total 716.5

central government still remain. 17 of the country's top 20 producers are today state-owned

and together all these companies just make up slightly more than half of the country's steel

production. In OECD markets, the top three steel producers on average make up 60-85% of

the country's steel output.6

The large steel industries in China today can be found in the coastal regions and in northern

China. Hebei province, surrounding both Beijing and Tianjin, is home to many large steel

enterprises. The location is of strategic importance due to its proximity to both Beijing and the

port in Tianjin. Other major steel plants can be found in the Yangzi Delta around Shanghai. The

province of Liaoning, squeezed in between Hebei and North Korea, is home to two large-scale

steel industries that merged in in 2005, AnSteel and Benxi. This was the first merger of two

major steel companies in China. However, the merger is regarded as unsuccessful as both

companies still operate relatively independently. Analysts believe that the merger was forced

upon by the central government, despite management opposition from both sides. Even today

the companies operate as two different entities with very little cooperation.

Steel production continues to be a vital part in the Chinese society. Despite recent slowdowns,

the country's economy is still growing and urbanization forces continue investment in both

infrastructure and construction. Steel intensity is a measurement that shows how important

steel consumption is to a country's economy, and it is measured in kg of steel consumption per

1000USD GDP. Statistics show that steel production today is more important than ever.

6 List of China's 20 largest steel manufacturers. Companies marked grey are private owned. (World Steel Association, 2013)

Steel intensity measured in kg of steel consumed per 1000 USD of GDP.

3.1.3 The internal conflict during the purchase of iron ore

At the beginning of 2005, China's Iron and Steel Industry Association passed a standardiron

ore import enterprise qualified standards and reporting procedures, with the new standard that

iron ore imported quality enterprises reduced to 110. It is said that most domestic small and

medium-size steel enterprises do not have the quality to import iron ore from foreign suppliers

directly, and only could buy the second-hand iron ore from traders, brokers, or large domestic

steel enterprises. 30%-50% of the iron ore price will be charged as auxiliary expenses, in 2008

the second-hand trade was 20 billion. This kind of resale was criticized by the entire steel

industry, so CISA has to forbidden the high auxiliary expense trade, the rate could only below 5%

of the iron ore price.

Because of the large steel enterprises could pass the increasing iron ore price to the small

steel enterprises, therefore they do not have much motivation to negotiate with the large iron

ore suppliers. And for the small steel enterprises, they cannot benefit from the long-term

contract so they have to contact with the iron ore suppliers privately. In 2009, when CISA

negotiate with the iron ore Big 4 and make no progress, suddenly there came the news that

more than 30 small domestic steel enterprises were signing contract with one of the Big 4 Vale.

Of course, they set CISA in a very passive situation and finally CISA failed about reducing 40%

of the price.

It is not the time to blame the small and medium-sized steel enterprises betray CISA or have no

honor of native blindly. The real reason is the low concentration of steel industry. There are

more than 1000 steel enterprises in China now, only 45 of them are large steel enterprises. The

state council has proposed "the steel industry adjust and revitalization plan", hope to reach 45%

concentration of the steel industry by 2011, but now it is far from reaching this goal. And the

component of the 1000 steel companies are very complex, a plenty of them are state-owned

enterprises, affiliated to the state-owned assets supervision and administration, some of them

are enterprises under collective ownership, belonging to local government, also the others are

private enterprises or joint ventures. They all have their own interests, and there are some

internal competitions between them. So it is difficult to form a unified and powerful strength to

represent all the Chinese steel enterprises to negotiate with all the iron ore suppliers.

In addition, an artificial reason for raising the iron ore prices should not be ignored, that is the

brokers and traders took the opportunity to storage spot iron ore and drive up prices. Need to

be fair and equal competition in market economy environment, and such kind of speculation

should be punished strictly.

3.2 What is the problem with the Chinese steel industry?

As the Chinese economy has continued to develop, it is clear that the evolution of China's steel

industry has not been able to keep up with the progress of the country's economy. The market

structure and characteristics are believed to cause a number of problems that will prevent or

interrupt further economic development for the country.

The governance model of the industry is relatively vague. On one hand, the central

government is not directly imposing absolute power of the industry. On the other hand,

the firms are also not operating in a market ruled by free competition. Today steel

enterprises in China are embedded in a network of various government agencies and

institutions that influence their business on both operational and strategic levels.

The fragmented Chinese steel industry is currently suffering from overcapacity. The

figure is as high as 100-150 million tons, almost 10% of the annual world production.

One reason for this is that 70% of the steel in China reaches its end users through

traders. The steel mills alter their production according to orders from the traders and

not the actual demand of the end customers. The overcapacity is particularly harmful

for smaller steel companies.

The Chinese iron and steel industry is

one of the country's main sources of

pollution. This problem has become

severe in the last decades, and is now

a major concern for the government

and the Chinese people. The country's

Steel mills Traders Steel users

Smog in China's capital Beijing

steel producers are relying on old technologies, small-scale production, and labor

intensive operations. A more efficient steel industry is essential for China to continue

its economic development and to improve the living standards for the people.7

The steel industry will continue to be dependent on foreign supply of iron ore. However,

a poorly organized domestic steel industry has allowed iron ore producers to fully

utilize their oligopolistic market position. Despite the fact that the Chinese government

is the world's largest owner of steel companies, they have very little bargaining power

in the global supply chain. The fragmentation together with poor coordination and

organization among the firms is one of the most problematic aspects of the Chinese

steel industry today.8

In a country governed by market principles, there are essentially two ways to solve economic

problems. You can either rely on the principles of the neoclassical approach and let the market

fix itself by eventually reaching market equilibrium. The other way is for governments to

intervene and adjust important parameters to achieve desired market structure. Let us have a

look at how these two methods are being used to influence the Chinese steel industry.

We believe market-based methods are not sufficient to solve the structural problems currently

observed in the Chinese steel industry.

Small and middle scale steel producers can be found everywhere in China today. The entire

industry must be ruled by industry evolution and market competition. This means consolidation,

mergers, and acquisition are all needed to restructure the industry. Large-scale steel

corporations instead of smaller plants are crucial to transform the market. During the Great

Leap Forward small steel plants were built everywhere in China. This creates a very difficult

market situation where mergers and consolidation become difficult from a political point of view.

Closing down a local steel plant means making the city's symbol of industrialization disappear.

The memories of peoples contribution and the hard work by several generations would thus be

erased. During the period of reform and opening up, a wave of consolidation spread across

many industries, especially light industries. Steel was however one of the industries that was

not caught by this consolidation wave.

7 Ernst & Young, 2013, pp. 22-24 8 Bielitza, 2012, pp. 34-39

3.3 Chinese iron ore market

One major problem for China and its steel industry is the scarcity of high quality iron ore. The

country has rapidly ramped up its steel production, but its supply of iron ore has not been able

to follow the increase in demand. As we saw earlier, the iron ore reserves have an average iron

ore content of only 28 percent. The deposits are also spread out across the entire country and

the ore usually contains significant amounts of impurities.

However, the problem with Chinese

iron ore is not only the low content of

iron. The structure and the

organization of the mining companies

are also problematic. There are

believed to be as many as 3000

companies currently engaging in iron

ore mining.9 The rest of the world's

mining industry is deploying automation and machinery to extract the ore, but Chinese firms still

rely on manual labor to carry out the operational activities inside the mines. This industry will

thus suffer as Chinese wages continue to increase. Today China has 630,000 people working

in the iron ore industry, and they produce less iron ore than Australia does with 30,000 people.

Because of the underdeveloped iron ore industry

in China, the country is still greatly dependent on

imports to supply its domestic steel industry. 68%

of all iron ore consumption in China today comes

from imports, and this figure is expected to

increase to close to 90% by 2030.10 In order to

promote procurement of iron ore from the

domestic market, the Chinese government

created import barriers by setting up an iron ore

9 Wood Mackenzie, 2013, pp. 19-20 10 Wood Mackenzie, 2013, p. 8

According to Bernstein Research, Chinese iron ore mines

operate in a way similar to what could have been observed

in Europe and the US around 1850.

Iron ore in China

Most iron ore in China today is mined

in Hebei province (40%), followed by

Liaoning and Sichuan (12% each). With

its current mining rate, Hebei province

is expected to run out of iron ore

before 2020. Liaoning province has the

largest iron ore reserves and also the

most consolidated mines. Most of

them are owned by the steel producers

AnSteel and Benxi.

import license program in 2005. The number of companies that qualified as iron ore importers

was reduced from 523 in 2005 to 112 in early 2013.11 Overall, the Chinese steel industry is in

the near future going to rely on iron ore imports, especially from the Big 4. Meanwhile, China

will also still remain the most important export market for iron ore producers.

The Chinese steel industry today is in many ways a result of its industrial past. The government

ties and the fragmentation of the market established in the new steel age are still present today.

However, due to the domestic supply and demand gap caused by rapid increase in production,

a new characteristic of the Chinese steel market has emerged. The country is no longer able to

carry out all activities in the value chain by themselves. They are now more and more

dependent foreign suppliers of raw material to be able to produce their steel.

3.4 Government interventions

3.4.1 Government structure

The other way to solve these problems would be through government interventions. Let us take

a closer look at how the government's influence of the steel industry is organized.

China is first of all a country that is unanimously ruled by the Chinese Communist Party (CCP).

The state president is the country's highest ranked official and also the head of the CCP. The

title "State President" involves few actual duties and the tasks are typically to act as a symbol

and an official representative of the country.

The National People's Congress (NPC) is China's parliament that serves to represent the

people. The NPC, of which about 70% are members of the CCP, appoints its executive body

called the State Council. This is China's official government, and it is headed by the country's

Premier (or Prime Minister, depending on how you translate it). Under the State Council you

will find China's ministries and commissions, which are all in charge of governing various

aspects of the country.

Besides the ministries and commissions, the State Council also directly controls some

organizations and institutions such as the China Customs, National Bureau of Statistics, Xinhua

11 China Daily, 2013

News Agency, National Tourism Administration, etc. There is also a special organization

directly under the State Council called "State-owned Assets Supervision and Administration

Commission of the State Council" (SASAC). This is a powerful commission that is in charge of

managing all the state-owned enterprises in China.

To find the responsibility of China's steel industry, one first has to look at the Ministry of

Industry and Information Technology (MIIT), which is organized into 28 departments. The

department in charge of the steel industry is called "Raw and Semi-Finished Materials

Industries" or sometimes just the "Raw Materials Department".

One of the main tasks of the State Council is to presents a five-year plan that serves as

strategic guidelines for how the country shall progress in the coming years. According to the

State Council's official website (2013), there are three main assignments delegated to each

ministry:

Create a detailed five-year plan for each ministry

Provide specific details and explanations for each five-year plan

Implement orders given directly by the State Council

The MIIT also has specific duties assigned to its Raw Material Department. According to the

State Council (2013), the department currently has the following obligations for the steel

industry:

Hold regular meetings with CISA (see below).

Inform key stakeholders of the status of domestic iron ore supply.

Monitor and inform industry participants of current market development.

Discuss and study current production technologies.

Create an annual market report.

Create an annual market plan.

Regulation and supervision of the market.

It is also important to keep in mind that the steel industry in China is not only managed by the

MIIT. There is a complex network of stakeholders in the Chinese government who in one way

or another possesses the power to influence the steel industry. Taube and in der Heiden also

list four other actors besides the MIIT who directly influence the events of one of the nation's

most important industries.

National development and reform commission (NDRC). This commission is one of

the most powerful economic policy organizations in China. It is involved in decisions

that relate to China's macroeconomic development and market reforms.

China Iron and Steel Association (CISA) - The Ministry of Metallurgical Industry was

a government institution that managed the countrys steel and metal industries. This

ministry was shut down in 1998 and replaced by CISA, which is now considered the

steel industry's interest and lobbying group. At present the organization is regarded as

"stuck in the middle", neither enjoying full government authority nor acting as an

independent interest group. CISA is supported by the large steel enterprises, and its

tasks mainly involve data collection, coordination of industry development, and carrying

out research and market regulation. Until this year CISA has had two very important

assignments. The first one is to qualify Chinese steel companies as iron ore importers.

These companies have to live up to the regulation and consistently report their

activities to CISA to maintain their license. The second assignment is to represent

large Chinese steel companies in negotiations with the Big 4.

State-owned Asset Supervision and Administration Commission of the State

Council (SASAC) - This "special" commission is responsible for the microeconomic

coordination and regulation of all the country's state-owned assets and enterprises.

This organization also has the right to grant SOEs with preferential policies to make

them more competitive on the international stage.

Top managers of large steel enterprises. The top managers of the largest steel

corporations all belong both to China's business and party elite (both at state and

provincial levels). For example, BaoSteel's former CEO was at one point the

vice-premier of China (2nd rank in the State Council). These managers simultaneously

have a profit-maximizing responsibility for the company, but must also respond to the

interest of the CCP. SASAC is the institution that appoints and monitors the top

managers of all the state-owned steel conglomerates.

3.4.2 Government influence on iron ore prices

The Chinese government and all its institutions have plenty of influence on the steel industry. In

recent years this influence has had a major impact on the world's iron ore pricing system. Let

us take a look at how the iron ore pricing model has evolved over the last few years.

Since the early 1970s iron ore prices have been determined by a model called benchmark

pricing. This means that FOB (Free on board) prices were negotiated and agreed upon

between major steelmakers and iron or suppliers in Europe and Asia separately. The European

price was negotiated with Brazilian iron ore producers, while the Asian price was determined

mutually between Japanese steelmakers and Australian iron ore suppliers. However, with the

emergence of the Chinese steel industry, CISA became one of the major negotiators of the

Asian benchmark price. Negotiations on both parts in the world took place once a year and the

price also acted as an indicator for other iron ore producers in the world.

Although contract prices have traditionally dominated the iron ore trade, there has always been

some trade carried out in the spot market. For iron ore, that means the price is determined at

physical delivery to port. These spot prices changed the entire pricing mechanism of iron ore in

2009. With the financial crisis sweeping across the world in 2009, the spot prices suddenly fell

way below the benchmark price. This caused many steel producers in Asia to abandon

contracts and instead they started buying iron ore on the spot market. At this time, the spot

market was very lucrative for the Chinese steelmakers. To support its steel industry after the

NDRC CISA

SASAC Top managers of large

steel enterprises

Chinese steel industry

Institution and interest groups influencing the Chinese steel industry (Taube & in der Heiden, 2010)

crisis, the CCP issued a large stimulus package to increase demand.12 This lead to a quick

recovery of the country's steel industry that immediately caused a surge in the iron ore spot

price. When the next benchmark price was to be negotiated between CISA and the iron ore

producers, negotiations fell through and the benchmark price was completely abandoned.13

Since 2009, iron ore contract prices are based on the spot price instead of the benchmark price.

Because of this change, there is an increased need for iron ore price indices in the world. The

prices are however not as transparent as for other minerals such as copper or nickel. Today

there are three recognized price indices that being used to measure iron ore spot prices. All

three indices base their price on iron ore fines with 62% iron delivered CFR (Cost and freight)

to various Chinese ports.

China is in the process of transforming into a market economy, but right now is considered a

market economy ruled by socialist principles. The country is stuck in a situation where it is

experiencing both advantages and disadvantages of a planned economy and a market

economy. The steel industry is still largely state-owned, a common characteristic of a centrally

planned industry. However, the supervision and the support from government are weaker than

before, a significant step towards market based economy.

12 The Economist, 2009 13 Ericsson, Lf, & stensson, 2010

Iron ore spot pricing indicies currently used by iron ore traders.

Index Port of measure Owner

Metal Bulletin Iron Ore Index Qingdao Euromoney Institutional Investor, a business

publisher based in London

Platts IODEX Iron Ore Index Qingdao McGraw Hill, also owns credit rating agency

Standard & Poor

The Steel Index Iron Ore Series Tianjin Purchased by Platts in 2011

4. The future

4.1 CISA and MIIT: current activities

CISA and MIIT are two of the institutions with the great influence of the country's steel industry.

These organizations regularly publish lists of their activities and actions aimed at the country's

steel industry. Let us have a look how MIIT and CISA today are operating to influence the steel

industry tomorrow.

4.1.1 MIIT

By looking at their official website, we found a long list of current assignments and tasks

pertaining to the steel industry. The list mentioned in chapter 3.4.1 mention the overall

responsibilities, while the following list describes assignments related to the current state of the

steel industry. We found seven of these particularly interesting:

Coordination of iron ore prices - in cooperation with CISA, MIIT shall monitor and

supervise the price development of iron ore. This includes ensuring the reliability of

CBMX index and observing price negotiations.

Confirm reorganizations of mergers - when steel companies merge, MIIT is in charge

of coordinating the and restructuring the mergers.

Establishing environmental regulations

Approve steel companies' compliance with new regulation - in September 2012 MIIT

established new regulations that steel companies would have to live up to. 45 steel

enterprises have since then been qualified.

Monthly meeting with CISA to strengthen their cooperation.

Promote technological development of the steel industry

Encourage exchange and collaboration between Chinese and foreign steel enterprises

4.1.2 CISA

CISA themselves describe five key strategic areas where the organization has important

responsibilities for the development of the steel industry. As an official interest group of China's

steel companies, their tasks according to themselves mostly involve communication and

representation. (CISA, 2013)

Overall responsibility of the accuracy of the CBMX iron ore price index.

Representing its members in negotiations with the Big 4.

Information exchange - provide market data and statistics to create more

transparency and openness in the industry

Conducting research on technology and process development

Setting industry standards

4.2 Changes in import regulations

To cope with increasing iron ore prices, the Chinese government has launched a number of

initiatives to consolidate iron or purchases and to gain a better bargaining position in the

market.

One of the measures is the import licensing mentioned in chapter 3.2. The number of qualified

importers has been reduced from 523 in 2005 down to 112 today. However, in the summer of

2013 China decided to scrap its licensing system completely, allowing many smaller and

medium-sized companies to import directly from the Big 4. While large steel enterprises will not

be affected, this will benefit the producers that previously failed to acquire an import license

from CISA. Another affected party will be Chinese iron ore traders. Their entire business was

based on circumventing the regulations by selling imported iron ore from the Big 4 to the

unlicensed steel producers. The commission they charged was usually 0.5 CNY per ton

imported iron ore.

Although the license program was initiated by the Chinese government as a way of

encouraging domestic iron ore production, the scheme was managed by CISA who is after all

representing the steel companies.

Besides the scrapping of the import license system, the Chinese government has through MIIT

taken another measure to increase competition in the Chinese steel industry. In early 2013 the

ministry published a list of 45 steel companies that met the new regulations we mentioned in

chapter 4.1.1. The noteworthy part of this news is that 15 of the 45 qualified steel producers are

private companies. This is a long-awaited recognition for many of these private companies that

have for many years operated in uncertainty.

The 45 qualified steel producers together make up 41% of the country's steel output. The

implications of this consolidation effort are that companies that fail to qualify will have to pay

higher electricity costs and also face more administrative measures. The list of qualified steel

producers will continue to grow as more companies are currently in the qualification process.

The goal is to have 80% of China's steel output qualified by the end of 2015.

The qualified companies will also enjoy government support in terms of technology

improvements and also beneficial policies to reduce energy consumption and pollution.

4.3 The future about Chinese iron ore

Better access to high quality iron ore would certainly help the Chinese steel industry. However,

the domestic iron ore market provides very little hope for the Chinese steel makers. The iron

ore still has a very low iron ore content and plenty of impurities. The ore available in China is

also a type called magnetite, which is expensive to process when the iron content is low.

The iron ore trading system currently being abolished in China.

Big 4

Iron ore

traders

Qualified

importers

Smaller steel

enterprises

There was an increase in demand during the period of reform and opening up, but the domestic

industry could not keep up with the increased steel production.14 Despite encouragement by

the Chinese government to increase iron ore output, the gap between domestic supply and

demand continues to increase. As the graph below illustrates, iron ore mined in China in 2011

had an average content of 14%. During the New Steel Age, China was completely

self-sufficient on iron ore. Today only 30% of the country's total demand comes from the

domestic market.15

In other words, there is little hope of any significant changes in the domestic iron ore industry.

China will remain highly dependent on foreign iron ore. The share of iron ore imported will

simply continue to increase in the foreseeable future.

14 Bielitza, 2012, ss. 39-41 15 Bernstein Research, 2012, ss. 64-65

The blue line shows the average iron content in Chinese iron ore mines. The green line ilustrates the percentage

of iron ore that is supplied in the domestic market.

0

10

20

30

40

50

60

70

80

90

100

China's domestic iron ore inustry

Average iron content ofdomestically mined ironore (%)

China's self sufficiency ofiron ore (%)

4.4 New iron ore trading platforms

It is obvious that China will continue to be dependent on foreign iron ore to supply its domestic

steel industry. To increase its bargaining power relative to the Big 4, the Chinese government

in 2012 launched an iron ore trading platform to create more control and increase the

transparency of iron ore spot prices. The name of the platform is China Iron Ore Spot Trading

Platform (also referred to as the China Beijing Mining Exchange - CBMX) and its main task is to

facilitate iron ore trading through derivatives, futures, and swaps. The following three

institutions sponsor CBMX:

CISA

China Chamber of Commerce of Metals Minerals and Chemicals Importers and

Exporters

China Beijing International Mining Exchange.

In addition, there is another iron ore trading platform currently used by Chinese steel

companies. GlobalORE is an exchange based in Singapore that has recently entered into the

Chinese market. Access to this platform is however restricted by government regulations since

it is not based in China. GlobalORE is operating with less transparency and restrictions in

comparison with the CBMX which set requirements on the origin of the imported ore. Another

interesting aspect is that Global Ores largest shareholder is BHP Billiton. Chinese authorities

have long opposed the idea of its domestic steel producers to purchase iron ore from the

platform due to the fact that it is a foreign trader, and that it is owned by a member of the Big 4.

As if the sudden emergence of two iron ore platforms was not enough, a third trading platform

was established in the summer of 2013. Rizhao International Iron Ore Exchange was originally

started up by private iron ore traders in 2009. The platform was quickly shut down by CISA in

order to prevent speculation. It was not until January of 2013 when a stat-owned trader

invested in the platform that it gained recognition and approval from the Chinese authorities.

China today has three iron ore trading platforms. One is controlled by the government, another

is established outside of China, and the third one is largely private-owned. The Rizhao platform

opened up in July 2013 by trading 240,000 tons of iron ore. The total turnovers on the other two

platforms are after 12 months of existence:

1. CBMX - 15 Mt

2. Global ORE - 14 Mt

Overall the interest in these iron ore trading platforms has been relatively weak. In 2012 China

imported 700 million tons of iron ore, which means that the trading platforms represent less

than 4% of the total iron ore imports in China.

4.5 A critical view

One of the most outspoken Chinese newspapers, Southern Weekend (, Nanfang

Zhoumo) has recently published a series of articles critical towards the government's efforts of

steel industry interventions. The newspaper is especially critical towards CISA's role as a

representative of the steel companies.

In an article called "7 years of iron ore negotiations, not even 1 cent of savings" (

), the newspaper heavily criticizes CISA's negotiation efforts.

Talks began in 2003 between CISA and the Big 4 (at that time referred to as the Big 3.

Fortescue had yet to gain large market shares). At this time the benchmark pricing model was

still in use, and now China wanted to be a part of the negotiations for the Asian price. After

seven years of negotiation, the outcome was clear. Despite representing the world's largest

steel market, the talks ended with the cancelation of the benchmarking price and the birth of a

pricing model based on the spot market. The iron ore prices are today both higher and more

volatile than they ever have been. As a consequence, the Chinese steel market dominated by

SOEs is now suffering heavy losses.

CISA has since blamed the outcome on the poorly organized demand structure of the Chinese

steel industry. According to the newspaper this is a weak attempt to avoid responsibility for

failed outcome. They also see a trend towards a market based iron ore pricing model, which

they claim is inevitable due to the increased international trade and opening up of financial

markets. The unsuccessful seven-year talks and a failure to construct a new iron ore pricing

model beneficial for China are seen as the reasons for China's weak bargaining position today.

Furthermore, the newspaper is also critical towards the organization of CISA, referring to its

conflicting government ties and its role as an independent representative of the steel industry.16

As we have seen, China is by far the biggest steel producer in the world. However, China's

steel industry is fragmented, and many plants are lack efficiency. Many analysts believe the

Chinese steel industry needs to be concentrated and integrated to increase its international

competitiveness.

16 Nanfang Zhoumo, 2010

5. Suggestions and advice

In this paper we have analyzed the Chinese steel industry and its characteristics. The Chinese

government has an enormous influence of its development, and most of the steel companies

are today state-owned enterprises. The reason for this market structure can be found in the

country's industrial history. However, a number of problems have in the last few years emerged.

Pollution, rising iron ore prices, unclear government strategies, and overcapacity are some of

these problems that are now pushing for further market restructuring.

A new iron ore pricing model has recently raised the need for further market adjustments. The

Chinese government has responded by dropping iron ore import barriers, increasing its efforts

to consolidate the market, and establishing iron ore trading platforms to create more

transparency in the market spot price. Limitations in the domestic iron ore supply will maintain

China's dependency on foreign iron ore producers.

Faced with the favorable and unfavorable situation of negotiation requirements of iron ore, it is

important for the government department to think about how to take effective measures to

acquire better negotiation results under certain conditions, how to keep a relatively long

dominant advantage in the process of iron ore negotiations. According to the above analysis,

the author puts forward some strategic suggestions and policy advices.

5.1 Integrate the government interventions

As to the issue of steel industry managed by several sectors of gove