One of the surprise developments that has come out of the commodities market this week is the news of China's purchase of iron ore from India zooming to a eight-year high in the first six months this year.

The development is not surprising given the annual shipments trend, particularly since India began exporting iron ore pellets from 2016.

However, the lay man could be surprised given the standoff between India and China at the border since May this year.

According to China’s Customs data, Beijing imported 20 million tonnes (mt) iron ore from India during January-June this year compared with the same period a year ago.

The 20 mt shipment was the highest since Indian exported 27.8 mt during January-June 2012, Bloomberg News reported.

There are two main reasons for this jump in Indian iron ore exports. One, despite being world’s third-largest producer of the ferrous metal ore, China depends on imports to meet two-thirds of its domestic demand.

This year, China has been buying more iron ore from the global market as demand from its steel mills, the major ore consumer, has shot up sharply.

Coronavirus Pandemic Hits Ore Supplies

Two, supplies from major producers, particularly the world’s number two producer Brazil, have been affected due to the spread of novel coronavirus pandemic. In Brazil, huge backlogs of cargo dispatch have built up due to the pandemic affecting normal life.

China’s problem is that it sources 65 per cent of its imports from Australia and over 15 per cent from Brazil. This dependence has hit it badly when the supplies from the sources have been affected.

For Indian iron ore miners, the demand from China, which has imported nearly 550 mt in the first half of this year, is a blessing in disguise in view of a weak domestic demand.

The relief comes on the heels of India’s iron ore production rising 19 per cent last year to 231 mt. It helped to cut India's ore imports by over 80 per cent to 2.25 mt.

Last year, iron ore exports, including pellets, increased 70 per cent compared with 2018, to 32.1 mt. Of this, China bought 19.08 mt, including 13.01 mt pellets, against 10.6 mt, including 8.19 mt pellets in 2018.

India has also benefitted from a 20 per cent rise in iron ore prices since January. Earlier this month, they zoomed over $110 a tonne. This week, the prices have tended to ease to around $105.59, though.

Why Indian Ore Imports Are Crucial For China

China’s record import of Indian iron ore is crucial since it makes up 70 per cent of total exports of the ferrous metal ore. This, to an extent, has kept its prices in India firm.

What makes India an attractive destination for purchase of iron ore by China? The answer is: economics.

China buys iron ores of grades with ferrous content of 63.5 per cent, 61 per cent, 57 per cent and 52-55 per cent. Many Chinese steel mills buy iron ore from the spot market and mostly use the letter of credit (LC) route for their purchases.

This is because Chinese banks give only two loans to these industries in cash or through LC. Most steel mills prefer cash over LC.

When a small or medium steel mill in China looks to buy iron ore, it usually purchases it in small quantities. Therefore, they cannot purchase iron ores from Australia or Brazil which supply ores in Capesize ships that have the capacity to haul over one lakh tonnes at one go.

These small firms cannot buy such a huge quantity since it will take 2-3 months to consume it. Such a purchase will force them to take a risk and incur a higher financial cost.

Most of the mills buy from traders and pay them interest too for the imports. Thus, India becomes a natural choice since it can supply iron ore in Handysize ships which have the capacity to haul cargo up to 60,000 tonnes.

Even big Chinese firms do not take risks in purchase of iron ore despite having adequate bank facilities, according to Susan Zhang, deputy general manager, Kailuan (Hong Kong) Co.

Small Traders Take The Risk, Enjoy The Fruit

These mills allow small traders, who lack bank funding facilities, to take positions in the spot market. The mills make a deposit with the small trader and pay interest by entering into a separate agreement for the purchase of iron ore.

Following this, the small traders execute an LC with the iron ore seller, take the risk and enjoy the profit.

Similar deals are entered into with Australian and Brazilian sellers too but India’s advantage is that its buyers offer the ore at a fixed price, which is lower than the benchmark index price that other sellers prefer.

Chinese buyers prefer these fixed rates as it helps them to swap their hedges in the futures market and cut down their risks, Zhang told a webinar organised by SteelMint.

Thus, China has remained the largest buyer of Indian iron ore over the years and the trend is only continuing this year.

China’s purchase has also come at an opportune time since the first half trend of this year is unlikely to continue for the rest of the year.

Australia has projected iron ore prices to drop to $55 a tonne by the end of the year.

Whether India's iron ore exports to China will be affected particularly after India has banned various Chinese apps and restricted Chinese imports, remain to be seen.

Chinese steel mills

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