Title Understanding Iron Ore Degree of recognition National Media name/outlet ResourceStocks Magazine - Aspermont Media type Duration/Length/Size 1 page Country Australia Date 1/05/15 Description Understanding Iron Ore
Digging Deeper this month looks at the iron ore sector – and the prospects for future price recovery.
The precipitous fall in iron ore prices in late 2014 and into 2015 caught many resources sector investors by surprise. Bargain hunters trawling the sector looking for undervalued iron ore miners have played a game of high stakes when looking for performance turnarounds. Conversely those investors with iron ore short positions have typically won out again and again. That is, the southern hemisphere summer has proven anything but hot for iron ore miners in price terms. Prices of around US$80 per tonne into China for 62% iron ore fines were at first considered relatively depressed. Next however, the iron ore price fell into the US$70 per tonne range – then into the US$60 per tonne range. Without significant demand-side stimulus as the Chinese New Year came and went, spot prices within the US$50 to US$60 per tonne range became the norm.
Lower Prices the result of basic economics
So what are the economic forces at work in iron ore driving prices ever lower? Market observers hardly needed to be expert economists to work that one out. More and more new supply coupled with a period of stuttering demand explains the price fall. So let’s look to the numbers then.
Australia, for so long the beneficiary of high iron ore prices, has now tipped the industry into structural surplus – with devastating negative effect on price. From adding around 40 million tonnes of new export supply per annum for 2010, 2011 and 2012, Australia upped the stakes considerably in 2013 and 2014. A massive 100 million tonnes of new exports in 2014 was followed a year later by a 130 million tonne increase. Majors BHP Billiton (BHP) and Rio Tinto (RIO) are often thought of as the principal suppliers – but in terms of expansion rate it was Fortescue Metals Group (FMG) that expanded production most rapidly.
Devil lies in the product detail
The rise and rise of FMG to sit alongside BHP Billiton, Rio Tinto and Brazil’s Vale as a major contributor to seaborne iron ore trade is a mixed blessing for the sector. Not all iron ores are the same – and the entry of FMG, alongside smaller Australian producers such as BC Iron, Atlas Iron and Mount Gibson has added greater volumes of ores with lower grades into the iron ore supply-side. Discounts to the 62 per cent benchmark specification have grown as a consequence. Those producers able to deliver a lump product, high-grade concentrate and pellets have suffered less in terms of price erosion.
Higher cost producers are now operating with little if any margin – although the strength of the US dollar and consequent weakening in producer currencies, has cushioned the full impact of the price fall.
Resilience the name of the game
The strategy of the major players in pushing through expansions and of the progression of major new projects by new entrants has received widespread media attention. Clearly the business case for additional supply has been weakened, but with commitments already made to construction such as the Roy Hill project in Australia the die has been cast. The challenge in such times of over-supply is that higher cost players do not exit the industry as quickly as might be expected from simple economics. Higher cost iron ore miners are resilient – and will hold on as long as possible – especially in cases where closing out contracts for energy, mining equipment and/or rail access can bring substantial one-off costs. The cost curve can also contorted by government actions – so expect the higher cost Chinese mines, particularly those operated by State-owned-enterprises (SOEs) to be given free-kicks to stay the course. Indeed, Western Australian producers have already received royalty relief from the pro-mining state government. Will such actions just prolong the agony for those companies with tight cash-flow? Such well-meaning government intervention inevitably has that effect in commodity markets.
Prices to rise – but margins to stay tight
There is good news and bad news on the horizon for producers. Prices may yet fall further and iron ore delivered into China could fall to rices below US$50 per tonne for a period. That said, such prices are clearly unsustainable. Prices must then rise again. The dual challenge however is that both fuel costs and freight costs are likely to rise too from their recent lows. So iron ore prices on a 2-3 year timeframe will recover somewhat – but producer margins for all but the majors will stay tight. In the near-term, those investors with short positions will sleep well.
Producer/Author Allan Trench Persons Allan Trench
- iron ore