A few years ago iron ore was the darling of the mining investment community, prices were within spitting distance of $200 per ton and miners were making money hand over fist. Move on a few years and it’s all changed.
The major miners are still making heaps of money but not as much as they were and may struggle next year to make the kinds of cash returns to investors they had been promising following extensive cost-cutting and project postponement to, paradoxically, improve those same returns. The theory, at least, among the big boys, Rio Tinto (NYSE:RIO), Bhp Billiton (NYSE:BBL) and VALE (NYSE:VALE) is to go for volume, drive down the break-even point and try to squeeze the competition out of the market. The Asian spot price has collapsed as a result and is currently below $80/ton this week, off 58% from it’s record $191.90/ton reached in February 2011 according to Reuters.
Producers in Iran, South Africa, Indonesia and even smaller miners in Australia have thrown in the towel but the closures announced so far at some 85 million tons will not go far in soaking up the 132 million coming onstream this year and the planned 393 million tons coming onto the market over the next few years. Prices that are expected to be below domestic Chinese miners’ cost levels were expected to prompt the closure of some 135 million tons of capacity this year but, in reality, closures have been limited. Maybe, Reuters speculates, because many domestic Chinese iron ore miners are owned by Chinese state steel companies whose priority is as much employment as profits.
With average cash costs of $40-50/ton, BHP and Rio are able to weather the storm. Investors are still falling out of favor with the sector as it dawns on them that falling iron ore prices will deprive these companies of the cash needed to make sizeable share buybacks or dividend payments, which had been expected following investor pressure in 2012 to slow expansion and do a better job of rewarding backers. CISA, the Chinese steel industry trade body, has called a peak on Chinese steel production as investment in housing and infrastructure slows and the economy is steered towards consumption rather than manufacturing for export. If the death of competitors could be hastened, the Big Three could start to restrict output and engineer a price rise back to $90-100/ton, a level they have indicated they would be comfortable with for next year. That is looking more like wishful thinking, at least in the medium term, as demand drops and supply continues to rise.
It would seem the stock market is taking the same view as the miner heavy FTSE 100 marches downwards, BHP has been on a steady downward trend for the last month or more in lockstep with the iron ore price.
by Stuart Burns