The iron ore market is wrong-footing forecasters again, as it has throughout the past 20 years. No one expected the iron ore price to surpass US$200 a tonne as it did in May, and no one predicted it would then plunge below US$100 as it has this week.

There have been numerous unpredictable events shaping the balance of supply and demand, including the collapse of tailings dams in Brazil, a 2014 credit squeeze in China and now the slow-motion collapse of one of China’s largest property groups, Evergrande.

The biggest problem since the early 2000s has been forecasting China’s demand. China’s 2016 five-year plan said there would be no further growth in China’s steel production, but output last year was up by a massive 33%.

China’s latest five-year plan, released early this year, again orders that steel production show no further growth from this year onwards, but in the first half of the year, output rose 12%.

Iron ore prices started falling in July and August as it emerged that the Chinese government was determined to cap production to meet its emissions-reduction goals. The managed decline turned into a rout in September as fears for the health of the Chinese property market, which consumes a third of the country’s steel production, were fanned by Evergrande’s debt crisis.

The iron ore market has seen such volatility before, albeit spread over years rather than months, diving from a 2011 peak of US$190 to less than US$40 in 2014.

As a new ASPI report ^[1] explains, there are several possible futures for the iron ore market beyond the current turbulence for the medium term. The path that is taken will have implications for Australia’s troubled relationship with China.

A central view, which is similar to the outlooks published by the Department of Industry in March ^[2] and BHP in August ^[3], accepts that China’s steel production has peaked but says iron ore will remain in short supply for the next year or two as demand grows in India and elsewhere.

Beyond that, Brazil’s production should recover and late in the decade there should be new production out of Africa. The price will drop to around US$50–70, which would still be more than double the production costs of Australia’s biggest miners.

Unlikely as it seems when the market is plunging, it’s also possible that the shortages that propelled the iron ore price to records in the first half of this year may re-emerge next year.

The default response of the Chinese government to economic downturns has been to stimulate steel-hungry infrastructure and building construction to ensure that growth targets are met.

The central government has less control over what happens in China’s provinces than is generally supposed, and there’s a momentum behind the growth of the steel industry that has proved difficult to stop. According to a Finnish non-government organisation, in the first half of this year Chinese authorities approved the construction of 18 new blast furnaces with a combined capacity greater than that of Germany’s steel industry.

The directive in the 2016 five-year plan that steel industry consolidation should result in the top 10 steelmakers generating 60% of China’s output was disobeyed, with the share only rising from 34% to 36%.  The demand that the use of scrap steel as feedstock rise from 10% to 30% also achieved only marginal gains. BHP estimates that it will take China until 2050 to reach a 20% share for scrap.

China’s hopes that Guinea on Africa’s west coast could become a rival to Australia and Brazil may come to naught. Although the Simandou mountain in Guinea contains vast reserves of high-quality ore, getting it onto ships involves a 650-kilometre rail link through rugged country to a jetty that must traverse 15 kilometres of mudflats before the seabed can be dredged to allow for supertankers.

Chinese engineers have performed similar marvels at home, but a twist in Guinea is that the rail route must go through heavily populated areas providing commuter and general freight transport as well as transporting up to 2 million tonnes of iron ore a week. And then there’s the political instability, with a military coup ousting the government there a few weeks ago.

Any attempt to replace Australia as its primary source of iron ore will come at a high cost to China. Australia will remain the closest and cheapest source of the mineral.

Continued shortages may see the iron ore price again surpass US$200, potentially ascending to US$300. China’s extensive trade barriers to Australian commodity exports are a disincentive to investment by the major mining companies in lifting Australian supply, making a shortage more likely.

However, if an iron ore glut emerges—whether because China is able to engineer new sources of production or because its economy suffers a lasting downturn—Australia’s largest and most valuable export may become subject to the coercive barriers that China’s government has raised against other Australian exports.

Although the major miners are comfortable that they have the lowest production costs and good relationships with their Chinese steel-mill customers, that may not protect them from Chinese trade barriers. Rather than importing 700 million tonnes a year of Australian ore, a global glut may enable China to cut Australian supplies by several hundred million tonnes.

The distortions China has created in the coal market, with its ban on Australian coal resulting in prices to Chinese steel mills and power stations far above prices in the rest of the world ^[4], shows that the authorities are prepared to bear a cost for their politically inspired trade barriers.

When Chinese barriers to Australian coal became obvious late last year, Prime Minister Scott Morrison warned that a ban ‘would obviously be in breach of World Trade Organisation rules’.

Australia has taken action at the WTO against Chinese tariffs on barley and wine, and China has taken action against Australian anti-dumping duties. However, there has been no action on the broader bans on Australian produce.

The ASPI report argues that the Australian government should follow up on last year’s warning and launch a WTO action against the informal barriers on coal. Success in such an action would create a precedent to stop similar discrimination against Australian iron ore.