Shipping companies will benefit as China relies more on imports

China’s iron ore output always interests dry bulk shipping companies, because it provides a perspective on the global trade dynamics. When a country relies more on foreign imports, dry bulk shippers benefit. Conversely, when domestic supply rises, imports and dry bulk trade will be negatively affected.

In September 2013, China’s domestic iron ore output hit a new high of 13.7 million metric tonnes, according to Antaike Information Development Company. As a percent of total supply, though, domestic output fell from 65.30% in August to 64.69% in September.

Over the past six years, we’ve seen overall growth in the share of domestic output, increasing from ~61% to ~64%. During the overall increase throughout the six years, however, there were periods when iron ore gained shares and then some periods when it lost shares.

Background on historical trends

Throughout late 2008 and early 2009, domestic producers’ shares fell from 70% to 50%. This was because Chinese iron ore producers are one of the most expensive producers in the world. As economic growth slowed and major foreign suppliers such as BHP Biliton, Rio Tinto, and Vale didn’t cut output right away, domestic producers had to scale back their production.

Yet, because China was starting to slow considerably, the decline in domestic producers’ share of iron ore supply wasn’t particularly beneficial for shipping companies like DryShips Inc. (DRYS), Navios Maritime Shipping Inc. (NMM), Navios Maritime Holdings Inc. (NM), Safe Bulkers Inc. (SB), and Diana Shipping Inc. (DSX). Again, while the Guggenheim Shipping ETF (SEA) wasn’t around back then, everything fell.

Domestic suppliers were saved with the government’s massive injections thereafter, and economic growth soared higher while investment flowed into iron ore mines in 2009. As long as demand for iron ore was growing faster than foreign suppliers were increasing supplies, domestic producers had business, and their share rose back to 70% in 2011.

But that trend reversed again when the Chinese government restricted lending and raised interest rates to combat high inflation in mid-2011. Because foreign suppliers incur much lower costs of extracting iron ore, they were able to take advantage of China’s weaker growth by increasing output, which pushed some domestic suppliers out. This coincided with a temporary rise in shipping rates in the late 2011. Nonetheless, it wasn’t enough to combat significant increase in ship orders, so shipping companies fell.

A reversal of the historical pattern is possible

In the next few years, though, we could see the opposite happen. Domestic suppliers’ share of the total could fall as cheaper producers like the big three iron ore suppliers ramp up production. This would support demand for dry bulk shipping stocks. If the Chinese government doesn’t want to see its iron ore industry collapse right away, it’ll have to somehow manage demand (steel production and demand) and smooth the transition. Imposing tax on foreign imports isn’t feasible given the consequence they could face with the WTO and how detrimental it can be to its own economy via rising input costs for steel manufacturing. Should investors worry? No, because the country has anticipated this and a large part of 2009′s stimulus was for making resource acquisitions overseas.