China Weighs New Measures to Punish Australia

Policy rifts divide trading partners, raising risks for energy and commodity deals.
An analysis by Michael Lelyveld
2021-05-21
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China Weighs New Measures to Punish Australia A truck is loaded with iron ore at the Christmas Creek iron ore mine located south of Port Hedland, Australia, in a file photo.
Reuters

China may be running out of retaliatory steps that it can afford to take against Australia after cutting off communications on economic affairs with its key commodity supplier this month.

On May 6, China's top planning agency announced that it had suspended all contacts under its bilateral Strategic Economic Dialogue with Australia "indefinitely."

"Recently, some Australian Commonwealth Government officials launched a series of measures to disrupt the normal exchanges and cooperation between China and Australia out of Cold War mindset and ideological discrimination," the National Development and Reform Commission (NDRC) said in a statement.

China's Ministry of Commerce adviser Mei Xinyu blamed the cutoff on the "wildness of Australian politicians," while Foreign Ministry spokesman Wang Wenbin cited an "insane suppression targeting China-Australia cooperation," the Daily Mail and Reuters reported.

Although no specific reasons were given, the references were to Prime Minister Scott Morrison's decision in April to cancel the state of Victoria's agreement to cooperate with China's Belt and Road Initiative (BRI). Beijing's far- reaching trade and infrastructure building program was not in Australia's "national interest," Morrison said.

In practical terms, the closure of the dialogue channel may have little effect since the two sides have not met under its auspices since 2017.

"Successive Australian trade ministers have been unable to secure a phone call with Chinese counterparts since diplomatic tensions worsened in 2020," Reuters said.

Differences between the two trading partners date back several years with issues ranging from Australia's ban on China's 5G phone network developers to criticism of its sovereignty claims in the South China Sea.

Disputes have also erupted over China's repression of Uighurs in Xinjiang and Australia's support for tracing the origins of COVID-19.

Last November, China issued a list of 14 grievances against Australia including its support for policy positions of the United States.

In December, the NDRC raised the economic stakes for its leading foreign coal supplier by barring further shipments from Australia, stranding dozens of cargoes offshore at Chinese ports.

Despite a free trade agreement between the two countries in 2015, China has slapped high tariffs and other barriers on Australian products including wine, barley, lobsters, cotton, and timber.

The value of Australia's exports to China has been propped up by China's continuing demand for iron ore, but trade in most categories has dropped by 40 percent, Australia's ABC News reported in late March.

Last December, the country's coal exports to China plunged 83 percent from pre-pandemic levels a year earlier, the network said.

Limited retaliation

But the patterns of China's punishments indicate that it is carefully limiting retaliation to measures that it can afford.

The cutoff of the strategic dialogue mechanism has grabbed headlines, but talk is relatively cheap compared with the potential economic impact of China's trade curbs.

China accounted for 35 percent of Australia's merchandise exports in March, Argus Media said, as demand continued to support supplies of liquid natural gas (LNG) and iron ore to the Chinese market.

Analysts suggest Australia will continue to be China's indispensable source of those commodities, although Beijing's anger over policy differences may spare little else.

In the wake of the strategic dialogue suspension, industry sources "mostly dismissed" the risk that China would retaliate against Australia's LNG trade, Argus said.

"Surely, China can't do without Australian LNG in this market," the news service quoted one Europe-based trader as saying. "That would be nearly impossible," the insider said.

Australia supplied 43.4 percent of China's LNG imports last year and 44.5 percent of its intake in March, Argus reported.

In April, China's LNG imports of over 3 million metric tons (mmt) hit a record high, Reuters said Friday, citing Chinese customs data.

Such large volumes are unlikely to be replaced by other suppliers, and major cuts could incur higher costs.

Much of Australia's LNG exports to China have been covered by long-term contracts, which protect buyers from spot market price spikes in winter but may be seen as a disadvantage when prices slump, as during last year's oil glut.

Rising tensions reportedly made China's national oil companies wary of seeking new long-term contracts with Australia as old ones began to expire last year. Investment in new projects has also been under a cloud.

But despite the wide swings in the spot market, China is committed to increasing gas use as it tries to reduce reliance on high-polluting coal.

In March, energy consultancy ICIS forecast a 13-percent increase in China's LNG imports to 76 mmt this year, the official English-language China Daily reported.

"As China is pushing to increase the share of gas in the energy mix by substituting for coal, this requirement for LNG will continue to grow," said Philip Andrews-Speed, a senior principal fellow at the National University of Singapore's Energy Studies Institute.

"Despite the growth of the spot market, the sale of LNG continues to rely on long-term supply contracts, especially for new, very large projects, unlike coal, which is much more flexible," he said.

Andrews-Speed also cited the stoppage of a major LNG project in Mozambique following attacks by Islamic State-affiliated militants in March. The deadly conflict caused Total of France to withdraw all staff, calling a halt to the U.S. $20-billion (128.3-billion yuan) development.

As a result, "the medium-term outlook for global LNG supply looks rather tighter now than it did a few months ago," Andrews-Speed said.

Uncertain confidence

But confidence in the immunity of Australia's LNG exports from China's retaliatory measures is not set in stone.

On May 10, Bloomberg News reported that two of China's smaller importers have been effectively barred from buying new LNG cargoes from Australia.

"The firms have received verbal orders from government officials to avoid purchasing additional LNG from Australia for delivery over the next year," Bloomberg said, citing unidentified "people with knowledge of the directive."

So far, major buyers have not received similar orders, and the NDRC has not responded to inquiries, the report said.

The ban for smaller buyers may be China's way of demonstrating its displeasure, suggesting major economic consequences for trade in a commodity that was considered exempt from the retaliation campaign against Australia.

On May 19, Reuters reported that China's national oil companies had entered into talks with Qatar to take part in its U.S. $28.7-billion (184.7-billion yuan) North Field expansion, the biggest LNG project in the world.

China's interest could be a sign that it plans to dispense with Australian LNG in the longer term.

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A miner holds a lump of iron ore at a mine located in the Pilbara region of Western Australia. File photo: Reuters

Tensions over iron ore

Tensions are also rising over iron ore, Australia's top export to China and an irreplaceable resource for the world's leading maker of steel.

Last year, Australian ore exports of 713 million tons accounted for 61 percent of China's ore imports, according to data from Beijing Lange Steel Information Research Center, cited by China's Communist Party tabloid Global Times.

China has been running out of patience and options for punishing Australia, raising the risks for the iron ore trade as prices climb, the South China Morning Post reported this month.

"Neither side wants to use this card. We are basically holding each other's neck," the paper quoted a diplomatic source as saying.

Record prices for iron ore supplies have increased concerns over growing cost pressures in China's steel industry, although the major cause of the price spike has been Chinese demand.

Last year, China's output of crude steel topped 1 billion metric tons, setting a record as production rose 5.2 percent on the strength of COVID recovery and infrastructure investment. Production has climbed again so far this year, gaining 15.6 percent through March.

The government has ordered major changes in the steel industry to reduce reliance on iron ore imports, but pre- emptive buying has given an added push to prices before the changes can take effect.

"Some Chinese importers also rush to stockpile iron ore over political risk-aversion concerns, which also drove up the trade volume in April," the Global Times said.

Analysts are split over how far China will go to break ties with Australia on the critical commodities of iron ore and steel.

The website of Australian Mining magazine quotes principal analyst Shirley Zhang at the international consulting firm Wood Mackenzie as saying that China is "unlikely to ban imports of Australian commodities it has a heavy reliance upon, including iron ore."

Instead, China is expected to raise administrative costs for imports, Zhang said.

But the Global Times sounded a more ominous note, quoting unnamed analysts as saying that "a trade decoupling between the two countries is imminent amid icy bilateral relations."

This week, the NDRC said that China should diversify its iron ore sources, sending another warning signal to Australian suppliers.

"Chinese firms should boost domestic exploration for the steel-making input, widen their sources of imports, and explore overseas ore resources," the agency said, according to Bloomberg.

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