Iron ore seen sliding as new supplies hit

September 25, 2013 11:00 am

Iron ore seen sliding as new supplies hit

By Neil Hume, Commodities Editor

Iron ore has defied the pessimists. The price of the key steelmaking raw material has averaged $136 per tonne this year – the second -highest level on record – as Chinahas imported vast quantities of the commodity. But with a wave of new supply about to hit the market are the good times about to end? Prices have already begun to drift lower as new supply from Australia has come on stream and shipments from Brazil have picked up. Benchmark iron ore has slipped from its August high of nearly $143 to $132.Citi estimates fourth-quarter production from the big three Australia producers – BHP Billiton, Fortescue Metals Group and Rio Tinto – will be 34m tonnes higher than the same period a year ago as expansion projects come on line.

“The inventory cycle in China is turning, there’s also seasonality and a big dose of supply coming. All of that will probably push down the iron ore price,” says Ric Deverell, global head of commodities Credit Suisse.

Further pressure on the iron price could come from a reduction in iron inventories by Chinese steel mills andIndia

, where an easing of mining and export bans could lead to additional supplies.

“The decline in Indian iron ore exports has been an under-appreciated factor in maintaining iron ore prices over the past three years,” Citi said in a report circulated this week. Two years ago India was exporting 100m tonnes a year of iron ore.

But with demand in China, the world’s biggest steel producer, still strong, other commentators argue concerns about a ‘wall of supply’ are overplayed. Macquarie Securities believes the iron ore price could reach $150-$160 in the fourth quarter on the back of weather-related restocking by Chinese steel mills and pro-growth comments from the country’s leaders.

Iron ore is critical for the profitability of large miners including BHP Billiton, Rio Tinto and Brazil’s Vale, as well as trading companies such at Mitsui. It is also crucial for the world’s largest steelmakers, including ArcelorMittal and Baosteel Group of China.

Robust steel production and restocking by Chinese steel mills has been the key driver of ore prices, which have surpassed even the most bullish of analysts’ forecasts.

Chinese steel production hit a record annualised rate of 800m tonnes a year in May and has remained in the 760m-800m range since, according to Jefferies, the investment bank. To put that figure in perspective, annual production in 2012 was 717m tonnes.

Jefferies also estimates Chinese iron ore inventories increased by almost 13m tonnes in July and August, a move that helped prices bounce 20 per cent from their May low of $110.

However, with a surge in seaborne iron ore supply expected over the coming months, many industry followers are tipping lower prices. Australia alone is expected to add about 140m tonnes of new capacity over the next two years.

“We are already seeing evidence of new supply coming on line from the expansions atBHP, Fortescue and Rio Tinto,” says Melinda Moore, analyst at Standard Bank in London. “Combined with improved shipments rates by Vale we believe this supply will have a more permanent depression on pricing below $125.”

The world’s big iron ore producers have ploughed billions of dollars into new iron ore projects in an effort to capitalise on China’s seemingly insatiable appetite for raw materials. But many of these new projects, especially the big expansion in Australian iron ore mining, are coming on stream as Chinese growth slows. Exports from Brazil have also picked up after infrastructure problems were resolved.

“Strong Chinese steel production and iron ore imports in recent months have masked weaker fundamentals. Excess steel production has been pushed on to international markets,” says Citi, which sees prices falling to $110 in the fourth quarter as demand in China weakens and tighter monetary policy begins to bite.

Jefferies analyst Christopher LeFemina believes Chinese steelmakers will look to draw down their iron ore inventories because weaker domestic steel prices are affecting margins. “With mills estimated to hold two months of iron ore supply, it is possible we will see some moderate destocking,” he says.

He expects seasonal supply issues related to the cyclone season in Australia and wet weather in Brazil to result in higher prices in the first quarter of next year. But that may prove only a temporary respite.

Mr Deverell of Credit Suisse says: “The market is heading into a really big surplus and at some stage over the next couple of years the price will cut through $100 or even $90 and that will force some redundancy on the supply side.”