Chinese steel production slowed in the fourth quarter of 2011, but that did not prevent Australia's major iron ore exporters (BHP Billiton, Rio Tinto and Fortescue Metals) from aggressively expanding their iron ore production capacity. China represents more than 60% of Australia's iron ore exports.

Increasing ore capacity to supply a country undergoing a slowdown seems counterintuitive. But the Australian resource giants' expansion plans are based on the prospect of long term growth in Asian emerging markets, led by China, instead of the outlook for demand in the next two or three years.

Fitch Ratings considers BHPB, Rio Tinto and Fortescue high grade and low-cost iron ore producers compared with others in the industry. If the Chinese economy were to slow significantly (in addition to the current slowdown in its private housing market) we would expect the major Australian iron ore producers to fare relatively well, even taking into consideration the damage to their operating and financial profiles.

The Chinese government said that it intends to boost reliance on domestic iron ore supply and will aim for 40% of its imported iron ore to be sourced from mines owned or invested by Chinese firms by the end of 2015, creating potential risk for producers.

However, we believe iron ore prices are likely to soften in 2012. Given that Chinese domestic iron ore production is typically low-grade and therefore costs more to produce than imported ore, the viability of domestic production will come under pressure, making it more difficult for the Chinese to significantly increase output. Chinese demand for higher-grade ore that is blended with local product will support demand from BHPB, RT and Fortescue, given Australia's close proximity.

(Sourced from Thomson Reuters)