This is part two of guest contributor James May’s analysis of the iron ore market in 2015. Check out part one, in case you missed it. James is a director of Steel-Insight.
Year-on-year output of iron ore fell in November for the first time. Chinese output in January-February is always significantly lower due to seasonal closures in northern China due to winter weather, but they may not come back if prices stay low. It is our view that Chinese iron ore output in 2015 will be lower by around 20% year-on-year – taking around 80 m tpy (of 62% Fe equivalent) out of the market.
Therefore, we believe that at current prices, the iron ore market will begin to rebalance in 2015. Now this will not be followed by an immediate increase in prices as inventories accumulated substantially in 2014, but analysts’ projections of surpluses of 150 m tons are wide off the mark – very simply, where would it be stored given the already-high Chinese inventories?
Why Won’t It Go Below $60/Ton?
Well, we look at 2009 – the last time that prices went this low. Of the majors – Rio Tinto (NYSE:RIO) and VALE SA (NYSE:VALE) both cut output (despite still being profitable). BHP Billiton (NYSE:BHP) didn’t cut, but we think that might be partially due to the fact that it was trying to takeover Rio Tinto at the time and prove to anti-trust regulators that it wouldn’t “manipulate” the market.
We think that at below $60/ton, this will hurt the big miners – even the low-cost ones. Remember Fortescue (OTC:FSUMF), for example, is selling at a discount of around 12% to the index price, while some sales from Rio Tinto are at a similar level (Robe River) – making a netback to around $45/ton free-on-board Australia. Looking at Vale’s iron ore division’s EBITDA, we think that its actual costs are higher than its declared unit costs (that don’t take into account royalties, etc.) and maybe closer to $45/ton all-in (although the recent devaluation may have lowered this).
At $60/ton, we think that the majors would cut output and this would be a sign that the market cannot sustain this price and therefore any price dip below this would be short-term. Of course, markets overshoot – do we really think that oil will be below $40/barrel for an extended period? – but unlike in oil, the Big 4 control 70% of the seaborne iron ore market and any cutbacks here would send a huge signal.
In many ways, the iron ore price at $65-75/ton is ideal for the big miners. It is low enough to force out high-cost supply and discourage any new investment with the exception of their own low-cost brownfield expansions. As we highlighted above, it will also rebalance the market, allowing prices to make small gains going forward. In the longer term, the ore is still in the ground and can be extracted at a later date if the price is right. That also means that we don’t expect a major bounce. With the infrastructure in place, the mines can restart quite quickly and that will keep a lid on the iron ore price for an extended period.
by James