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Iron Ore: Watch The Emerging Glut

On the face of it, news of a possible halt to Indian iron ore exports is good news for the likes of BHP Billiton, Rio Tinto, Vale of Brazil and Fortescue Metals and a cast of hopefuls.  

It means global iron ore prices are rising again as a dispute in a key Indian producing state threatens to cut supplies to China.

But it is a short term story at a time when most investors in this sector are ignoring a more important medium term trend, the looming oversupply of iron ore as new mines and expansions come on stream.

More of that in a moment.

Exporters in the Indian state of Kanatanka, the country''s second biggest iron ore exporting state, may declare force majeure by the end of this week if a government ban on what it calls illegal mining and export permits continues.

Already, the dispute spot iron ore prices have nearly rebounded to $US150 per tonne with freight for 63.5% iron content up $US10 than last Thursday and ending a recent sharp slide.

India mines around 257 million tonnes of ore and had exported 110 million tonnes in the year that ended last March, most of it to China.

But this is short term. In fact it may help fourth quarter prices rebound from an expected 20% or so fall in the current third quarter, if the dispute in India continues.

It probably won''t, the stakes are too high, so when there''s a settlement, prices will ease back under the influence of slowing demand and steel output in China.

The impact of the surge in iron ore prices is not to be denied.

We saw this week how a sharp rise in prices helped push Australia to a record trade surplus of $3.5 billion in June, with the prospect of a record surplus in the 2011 financial year in store, even after the expected slowdown.

Iron ore prices for Australian ore rose 40% in April alone, according to the Australian Bureau of Statistics.

But we should now start looking out three years and more and wondering what happens to prices when the current expansion plans of the likes of Vale, Rio and BHP, not to mention all the other countries and companies which want to get rich in digging dirt and shipping it to China.

For an idea, we should look at an influential United Nations study which sees a surge in global iron ore supplies from around 2012, and a drop in prices.

It is something you didn''t read in yesterday''s interim profit statement from Rio Tinto. 

The study comes from the United Nations Committee on Trade and Development (UNCTAD) and forecasts an oversupply situation that will cut returns to existing and emerging suppliers.

But, importantly, the study doesn''t forecast a collapse in prices, merely a fall back to levels around 2008, which were substantial in any case.

The report says new iron ore mining capacity taken into operation in 2009 was almost 75 million tonnes.

But a further 685 million tonnes (mt) of new production capacity may come on stream between 2010 and 2012.

That''s more than Australia and India (the second and third producers) are currently producing. 

Steel producers (such as Arcelor Mittal, the world''s largest, and a host of Chinese mills) are increasingly investing in "captive" mines  -that is, mines they own themselves - both for iron ore and coal, the study says.

That''s why Chinese steel mills are buying and investing in small and medium-sized mines in Western Australia, especially in the magnetite rich Midwest area of the state,

UNCTAD predicts that the world iron-ore market will be characterized by tight conditions over the short term, but that supply will gradually catch up with demand, and prices will decline from current levels, although they will stay higher than in the period before 2008.

The report cautioned that supply would continue to lag behind demand in the short term, while pricing had become more obscure following the breakdown of an annual benchmark negotiation process on iron ore markets earlier this year.

"We think that this year and next year the world iron ore market will be characterised by tight conditions," said UNCTAD official Alexei Mojarov in a statement.

He forecast that new iron ore mining capacity coming on stream would slowly bridge the gap between supply and expanding demand in coming years.

"We believe that in the future the supply will gradually catch up and prices will gradually decline from present extreme levels but will stay at a higher level than 2008," he told journalists. 

That would see prices of $US60-$US100 a tonne in China, including freight, well down on the current level, but substantially higher than what the world price was in 2006-7.

At the moment, UNCTAD says the three largest iron-ore companies, Vale, Rio Tinto, and BHP Billiton, controlled 35% of total iron ore production and 61% of the total seaborne trade in iron ore in 2009.

Brazil''s Vale is still the world''s largest producer, but its position has eroded from 17.3% of the market in 2008 to 16.0% in 2009.

Chinese domestic iron ore output is falling and will continue dropping as a result of widespread mine closures. In good news for the producer exporters like BHP, UNCTAD says China likely will pay more for the ore it imports, as the new pricing system gives the major iron-ore producers more leverage.

The study describes the international steel industry (the main customer for iron ore) as "fragmented" and maintains that the industry does not act in a coherent manner, thus allowing the three largest iron ore producers to exercise considerable control in what now amounts to a "sellers" market.

According to various media reports this week, Ian Roper (Rio Tinto''s former head iron ore market analyst in Shanghai and now at broker CLSA) forecasts iron ore spot prices will fall from $US130 to about $US100 by the end of this year, and then steady between $US80 and $US90 a tonne, then take another leg down to about $US60 by 2020.

But this assumes no disruption in supply.

India is the country to watch, not for the current dispute, but for the growing pressure of its own rapid economic development that will see steel demand rise and see more and more iron ore exports to China diverted to local steel production.

Looking at last year, UNCTAD says world production of iron ore fell by 6.2% in 2009 to 1.588 billion tonnes.

Output decreased in most countries, with a few notable exceptions such as Australia and South Africa.

Chinese production figures were 234 million tonnes (mt) in 2009 on a "comparable grade" basis. ("Comparable grade" means that the iron content of the ore is of the same magnitude as the world average of 63-64 %.)

That saw China, once the world''s largest iron ore producer, fall to fourth largest producer behind India (257 million tonnes), Brazil (300 mt) and Australia (394 mt).

The report said mining output declined in most countries last year except in Australia and South Africa, while Chinese domestic production was expected to fall even further this year due to widespread mine closures.

Nonetheless, trade in iron ore reached a record 955 mt in 2009, growing by 7.4% over 2008, thanks to increasing Chinese imports.

Despite the recession, its intake of ore climbed by 41% in 2009 to 628 million tonnes.

Australia exported the equivalent of 92% of its output, an increase of 17%, ahead of Brazil and India.

Australia was the largest exporting country: last year it shipped 363 million tonnes, up 17 %.

Exports from Brazil fell 3% to 266 million tonnes, while India, at 116 million tonnes, was the third-largest exporter.

The seaborne iron-ore trade is estimated to have increased by 11% in 2009 to 890 million tonnes, of which Australia had more than a third.

And, that''s the problem for BHP and Rio as they contemplate their merger of production facilities in the Pilbara. Now reports from China suggest the industry is trying to regain control of imports.

Iron ore imports from Australia, Brazil and India accounted for 62.3% of the country''s total ore consumption last year.

Beijing reports claims that around 40% of Chinese steel mills have to make cutbacks or put plants on maintenance, blaming increasing costs of imported ores and declining steel prices.

Imports are falling, claims the Chinese industry body

The industry association will also reduce the number of licensed iron ore importers to regulate the imported ore market.

Around 112 companies are authorized to import iron ores into China and the steel industry wants to eliminate many of these to allow the industry to regain support of imports.

China claims to have more than 60 billion tonnes of iron ore reserves, but much of it is low grade and can''t match the high iron content on Australian, Brazilian and Indian ore (62-63% Fe naturally) without processing, which adds to the cost.

Aug 9, 2010 08:33
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