Fortescue is dependent on Chinese economic growth to support the iron ore price

About Fortescue Metals Group Ltd

Fortescue Metals Group Ltd (‘Fortescue‘, the ‘Group‘, ASX: FMG) is Australia’s third-largest iron ore producer, conducting its operations in the Pilbara region of Western Australia, from three mining hubs that are supported by fully integrated rail and seaport facilities located at Port Headland. These facilities are complemented by a tug fleet and eight purpose-built 260,000 tonne capacity Fortescue Ore Carriers.

The Group has recently embarked on a decarbonisation strategy and is progressing to become an integrated player in the renewables and green resources sector, on a global scale. It is currently developing a global portfolio of renewable energy and green hydrogen projects. The strategy seeks to use 100 percent renewable energy to produce green electricity, green hydrogen, green ammonia, and other green industrial products, to de-carbonise the steel, power generation and transport industries. This strategy is in support of Fortescue’s stated intention to achieve carbon neutrality in its own operations by 2030 and in its customers’ operations by 2040.

Strengthening self-reliance of the Chinese economy

In the past China’s economy has been driven by cheap labour, infrastructure investment, manufactured exports, a rising middle-class, and foreign direct investment. These market-led activities were intertwined with state intervention, resulting in double-digit economic growth rates of the Chinese economy between 2000 and 2010. In more recent times a weak and heavily indebted Chinese property market, rising geopolitical tensions, COVID-induced supply chain shocks, and falling demand for Chinese manufactured goods due to trade restrictions imposed by the US and the EU, are seeing the Chinese government emphasise the need to strengthen the self-reliance of the Chinese economy.

China turns to technology and Artificial Intelligence to boost their economy

The focus of China’s Two Sessions annual parliamentary meetings in Beijing earlier this month has turned to technology and Artificial Intelligence as the linchpin to drive long term economic growth in the face of an ageing and diminishing Chinese population. China announced that in 2023 its population declined from 1.412 billion people to 1.401 billion, and that its birth rate has declined significantly from 17.86 million births in 2016 to 9.002 million in 2023. The United Nations have forecast that based on this declining birth rate, China’s population will decline to 1.313 billion by 2050. A declining population is weakening the labour supply. This demographic trend is having a negative impact on the Chinese economy and is likely to have a knock-on effect on the global economy, including the Australian economy. China is Australia’s largest trading partner and accounts for about eighty-five percent of Australia’s iron ore exports.

The Chinese government is targeting five percent GDP growth in 2024, which is slightly above the International Monetary Fund’s forecast of 4.6 percent. A key element of this five percent growth target is a focus on technology and innovation that includes Artificial Intelligence (AI) to boost productivity at a time when the workforce is diminishing because of the ageing population. China is already successfully applying AI technologies in that Beijing, Shanghai, and Shenzhen are all smart cities where AI, cloud computing, and big data are applied to transport, urban planning, and public security.

Implications for Fortescue

World Bank data shows that China’s US$18 trillion economy accounted for 16.9 percent of global GDP in 2023, making it the world’s second-largest economy after the United States. Putting the size of the Chinese economy in context, economic growth of 5.2 percent of this massive economic base of US$18 trillion is arguably highly positive for Australia, and anything that is good for Australia is good for Fortescue. Less of this Chinese GDP growth is going into the over-leveraged Chinese property market and instead is being directed at fixed asset investment which grew by 4.2 percent in January 2024. This is a strong start to the year for the Chinese economy. The bulk of this investment is being directed at manufacturing and infrastructure. These two sectors consume significant volumes of steel which consumes around 1.6 tons of iron ore to produce one ton of steel.

Fortescue is highly leveraged to the iron ore price because iron ore sales speak for over ninety-five percent of Fortescue’s earnings. This contrasts with Australia’s other two major iron ore producers in BHP and Rio which have more diversified operations and revenue sources. Weakness in the iron ore price in recent months is already reflected in the Fortescue share price which is up about 19 percent for the 12 months to 20 March 2024, and down around 16 percent on a year-to-date basis.

Fortescue’s strong balance sheet, and with the Chinese economy growing at about 5 percent per annum off a US$18 trillion base, Fortescue’s medium-term outlook remains favourable