China's waning commodities appetite puts miners' fortunes at risk

People walk on top of a mound of slag inside Sichuan Hongda's factory, where a new Hongda plant is due to be built in Shifang, Sichuan province, July 4, 2012.

SINGAPORE/SHANGHAI (Reuters) - Slowing Chinese growth could create a global surplus of copper and iron ore supplies in 2013, hurting mining giants that may also find future demand for raw materials expanding more slowly than the economy as China reduces infrastructure spending.

China is the world's second biggest economy, using the most copper, aluminium, iron ore, steel and coal and the second-largest consumer of oil. Chinese demand has fuelled commodity market rallies for a decade and created a bonanza for many of the countries and companies that supply it.

But after almost a decade of growing at about 10 percent a year, the economy is slowing, reined in by softening domestic demand and the financial and economic woes of its top two trading partners, the European Union and the United States.

Gauging the extent of the slowdown is crucial for the miners and producers whose expansion plans depend on China soaking up additional supplies.

For every percentage point China's economic growth rate slows, the value of its industrial commodity demand falls by about $10 billion, according to Reuters calculations based on GDP and consumption growth over the last six years.

The calculations do not factor in changes in inventories.

BHP Billiton (BHP.AX)(BLT.L), the world's biggest miner, and rivals such as Rio Tinto (RIO.AX)(RIO.L) are already feeling the pain from falling iron ore prices due to slackening Chinese demand. Prices will fall more if supply exceeds demand.

"We are expecting a supply glut from 2013 due to slower demand increase in China and more supply from Australian suppliers driven by huge investments during the past two years," said Daiwa Capital Markets analyst Jiro Iokibe.

Daiwa is one of a growing number of analysts forecasting a surplus next year, a little earlier than the previous consensus for a surplus to develop in 2014.

Benchmark iron ore prices .IO62-CNI=SI are at around $128 on Thursday, the lowest since November 2011 and down over a quarter from a year-ago as Chinese steel mills cut stocks of their raw material.

The price is still nearly four times the production cost for miners in Australia, who continue with aggressive spending to build capacity.

"Global miners have yet to adjust to the overcapacity and are still rushing to sell into China because they are still able to profit at current levels," said Helen Lau, senior commodities analyst at brokerage UO B -Kay Hian.

Rio said this week sales of its iron ore fell slightly short of its flat June quarter output, and is still planning to spend $3.7 billion on expanding its Australian capacity by another 25 percent.

BHP also posted strong growth in iron ore production in the June quarter, and said it expects to lift Australian iron ore output by 5 percent in the 2013 financial year despite the risks of weakening Chinese demand.

China's slowing consumption will also throw copper markets into surplus next year, a Reuters polls showed.

The mean estimate from analysts polled was for a tiny surplus of 9,000 tonnes, but that could widen further if Chinese growth disappoints this year.

China consumes around 7.6 million tonnes of refined copper annually, and every percentage point less growth equates to around 64,000 tonnes less demand.

WHITE KNIGHT NO MORE

At 7.6 percent, China's GDP growth in the second quarter was its weakest in over three years and prospects for the rest of the year are unclear. The government target for 2012 is 7.5 percent, after registering expansion of 9.2 percent in 2011.

A one percent slower growth rate equates to 80,000 barrels per day (bpd) less oil demand, as well as about 22 million tonnes less coal. That is 15 very large crude carriers of oil, and over 200 typical shipments of coal.

While those declines are small compared to China's total demand -- it consumed around 9.5 million bpd of crude in the first six months of the year and coal demand was over 3 billion tonnes in 2011 -- they have the potential to make a big difference to the physical markets which set benchmark prices.

China burns coal for about 80 percent of its power generation, and buyers are deferring or defaulting on purchases as industrial output growth slows. Declining demand combined with strong output has pushed global prices to two-year lows.

"China is no longer the white knight for commodities, at least in the very short term," said Vishnu Varathan, market economist at Mizuho Corporate Bank, adding that weak property and construction sectors could slow the economy further.

LESS IS NOW MORE

China is becoming less dependent each year on raw material consumption to fuel growth as its economy develops.

The volume of commodities China consumed in relation to GDP peaked in 2003-2005 when the economy was booming on strong exports and huge infrastructure spending, said Henry Liu, chief commodities analyst at Mirae Asset Securities.

"But as Beijing remodels its economy to be less investment intensive and more consumption-orientated, there will not be a repeat of that boom in the foreseeable future," he said.

For every $1,000 of GDP, China consumed 135 kilograms of iron ore last year, down from 236 kg in 2006. Energy efficiency has also improved, with oil demand per $1,000 of GDP falling to under half a barrel in 2011 from over one barrel in 2005.

China has previously taken advantage of a decline in commodity prices to build stockpiles, so a softening in the markets triggered by a flagging global economy may whet China's appetite. That, in turn, would cushion the impact on prices of the slowdown.

What is clear, however, is that there will be no return to China's 2008-2009 stimulus-inspired commodities shopping spree.

"When enough bridges, railways, highways, and basic urban infrastructure have been built around each person, it will be difficult to keep finding more things to build," Credit Suisse analyst Trina Chen said in a report.

(Additional reporting by Randy Fabi in Singapore; Editing by Simon Webb and Miral Fahmy)