A worker examines stainless steel wire in Dalian, Northeast China's Liaoning Province. Nickle pig iron is an integral part of China's stainless steel supply chain. File photo: CFP

What sort of threat does the election of a new government in the Philippines pose to China's nickel pig iron (NPI) sector?

Incoming Philippine President Rodrigo Duterte has already fired several warning shots at the country's mining sector, calling on local operators to "shape up" and stop "the spoiling of the land."

His actions speak as loud as his words.

He has just appointed a committed environmentalist, Gina Lopez, as Secretary of the Department of Environment and Natural Resources, a position with broad oversight of the mining sector.

The Philippines produces a wide range of minerals, but the immediate focus is on the huge amounts of nickel ore it ships every month to Chinese producers of NPI.

China's NPI sector, an integral part of the country's stainless steel supply chain, has become increasingly dependent on Philippine ore since 2014, when its previous main supplier, Indonesia, banned all exports of unprocessed minerals.

Since nickel ore is largely produced by open pit mining, likely to be specifically targeted by the new Philippine administration, there is a ripple of bullish expectation running through the nickel market.

China's NPI sector was already supposed to have imploded by now, crushed by the loss of Indonesian ore and increased production costs associated with treating lower-grade material from the Philippines.

The fact that it hasn't says much about the resilience of Chinese NPI producers.

And as long as they continue operating, other nickel producers will be tempted to hang on in there rather than curtail output, limiting the potential for a sustained rebound from current low prices.

Replacement pipeline

China's imports of Indonesian nickel ore collapsed almost immediately after the ban on exports of unprocessed ore came into effect at the start of 2014.

Indonesian imports plummeted from 41 million tons in 2013 to 10.6 million tons in 2014 and to just 174,000 tons in 2015. The latter may have been no more than a misclassification of iron ore with relatively high nickel byproduct content.

Philippine ore producers stepped up their production and exports in response. Chinese imports accelerated from 29.7 million tons in 2013 to 36.4 million tons in 2014 and largely held steady in 2015.

The scale of that response surprised just about everyone in the nickel market and was probably the single biggest factor in halting the post-Indonesia price rally that saw the London three-month price peak at over $20,000 per ton in the middle of 2014.

Chinese imports from the Philippines are running lower this year, even allowing for the "normal" seasonal impact of the rainy season on output and shipping. The reason is the current low price environment rather than the environment.

The Philippines Nickel Miners Association warned in March its members planned to reduce output by as much as 20 percent this year as prices slid to 13-year lows of $7,550 per ton in February.

That threat seems to have materialized.

National output of mined nickel slumped 38 percent year-on-year to 75,300 tons from January to April, according to the International Nickel Study Group.

Chinese imports of Philippine ore were down by 27 percent in the first five months of 2016.

No alternative supplier has so far emerged to pick up the renewed supply slack, although one renewed appearance in China's nickel import profile is worth noting.

Imports of ore from New Caledonia have restarted after a gap of three years. This is a displacement effect resulting from the well-publicized troubles of Clive Palmer's Queensland Nickel, a major buyer of New Caledonian material.

The Australian plant is currently shuttered and New Caledonia has exempted two local nickel producers from a long-standing ban on exports to China, albeit with a maximum ceiling of 700,000 tons.

China imported 113,200 tons of ore from New Caledonia from February to May.

New-found flexibility

All of which begs the question as to how China's NPI sector is still operating at all with no Indonesian ore, reduced flows of Philippine ore and only marginal offset from new suppliers.

But not only is it doing so, all the indications are that the worst of any contraction may be over.

Analysts at the Beijing office of research house CRU expect national production rates to hit 300,000 tons this year after sliding from a peak of over 500,000 tons in 2013.

But they are then expected to "stabilize and increase again in 2017."

Key to understanding this surprising development is the now proven flexibility of China's NPI operators.

CRU says, for example, that China's NPI production costs have fallen by a staggering 25 percent since the start of last year and margins were positive as of the start of 2016.

Not bad for a sector that was once widely assumed to have the highest production costs of any part of the nickel supply chain and that was expected to be out of business at prices below $20,000 per ton.

Moreover, the sector is still evolving and consolidating. The clearest manifestation is the offshoring of NPI production in Indonesia itself by Tsingshan Group, one of China's largest stainless steel makers.

It has been shipping intermediate material to China in ever greater quantities, though confusingly this flow shows up in the "ferronickel" component of Chinese customs figures.

Imports of such Indonesian material, higher purity than ore but lower purity than ferronickel, totaled 256,000 tons in the first five months of 2016.

Tsingshan has just started up a stainless steel plant in Indonesia, which may serve to reduce NPI shipments to China but which should serve as a warning of how Chinese stainless producers are integrating NPI flows into their core operations.

This process of continuous adaptation explains why reports of the death of NPI have so far been exaggerated.

Reuters
Newspaper headline: Steeled against supply disruptions