China is taking more seriously its efforts to tackle air pollution and may increasingly prioritize use of imported high grade iron ore, coking coal, and natural gas, along with expanding steel sector operating controls, consultants Wood Mackenzie said Monday.
The measures may lead to uncertainty for commodity prices, especially as the transition to adopt the recommended measures is likely to be gradual, Wood Mac's Prakash Sharma, head of China research, said in a note.
China's "'blue sky action plan' offers tougher limits and proposes a quicker shift to cleaner fuels such as LNG and electricity, and high grade iron ore, coal and metals," Sharma said.
"The measures taken so far are falling short of government goals and public expectations."
China's import iron ore pellet premiums have surged, with the S&P Global Platts weekly assessment hitting a record $61.95/dry mt on July 4.
Demand for the direct charge feedstock rose on steel margins incentivizing utilization, and measures limiting domestic iron ore material and sintering of iron ore fines. Lump iron ore premiums have also picked up over June, with imports mainly from Australia and South Africa.
"The challenge is many of these commodities are not produced competitively locally and need to come from outside," he added.
The ability of the steel sector to use more domestic ferrous scrap may need new EAF plants, which melt iron and need electricity.
For natural gas, switching quickly to more expensive gas and reliance on LNG imports would be difficult, while China's power sector works around capacity controls for new coal-fired and gas power plant, it said.
Heating demand in northern China is 300 Bcm gas equivalent, according to Wood Mac, which estimates actual gas consumption at 30 Bcm.
China's State Council released a three-year action plan to cut air pollution on July 3 which extended the target area to more cities, mainly in northeast and eastern China.
The plan, which could also lead to more usage and imports of natural gas and renewable energy, along with effects on logistics and transportation, may raise domestic costs, Wood Mac said.
"With expansion of the target area, we estimate more than half of China's steel-making capacity will now come under scrutiny on emissions control and will be subject to production curbs during autumn and winter."
"This means steel production growth could slow later this year keeping the market tight and prices higher. Demand for high grade iron ore will continue to find support as mills will chase productivity to maximize output."
Wood Mac expects domestic iron ore and bauxite mines in Shanxi, Shaanxi and Henan provinces will fall under greater supervision for emissions and dust control. This could lead the areas to struggle to raise or maintain production levels, it said.
As for China's goal to eliminate trucking of raw materials such as coking coal, iron ore and limestone from port to plant by 2020, this could lead to higher costs, Wood Mac said. It may improve supply consistency, as haulage via rail would be less affected by weather, it said.
"In the near term, the move could result in increased clearance time for imported coal cargoes, as witnessed last winter," Wood Mac said.
China's plan aims to ban new capacity additions in the steel, coking and aluminum smelter sectors in the target areas, which is home to just over half the country's total 1.115 billion mt/year crude steel production capacity, 54% of hot metal production and 46% of met coke production, Wood Mac estimates.
Wood Mac expects smelting capacity for copper, zinc and lead in the target area will need to either upgrade to meet new emission guidelines or face production curbs. Up to 2.6 million mt/year of copper smelting capacity could be affected along with 1.4 million mt/year of primary and secondary lead capacity, it said.
As for power, Wood Mac expects it will be a challenge to switch to gas completely, because of the cost and limited domestic supply to meet demand.
"One can imagine the potential impact on global gas markets if China were to switch fully, or quickly," it said.
"We expect gas supply prioritization and rationing to continue to serve heavily polluted residential areas of the Beijing-Tianjin-Hebei cluster and Fenwei plain."