Analysts’ ideas of the week – Iron ore continued

Last week, I talked about the recent hype surrounding iron ore and why I expect iron ore producers to see rough times ahead. Over the past week, we have seen a few more developments suggesting that iron ore supply is likely to well exceed demand.

I will start off with the developments suggesting that demand is now outpacing supply, which has been the
primary reason for the hype:

• According to a Xinhua-China iron ore index report, as of Oct 7, inventories of imported iron ore dropped by 0.08%, down 58,000 tons, compared to September levels.
• Chinese imports increased by 8% MOM, and 15% YOY, to 74.58 million tonnes.
• Iron ore is primarily used for steel production. China’s steel production is up 8% YOY so far.

Now, here are the key recent developments on the supply side:

• Rio Tinto (NYSE: RIO), Fortescue Metals Group (ASX: FMG) and BHP Billiton (NYSE: BHP), are all expanding their iron ore production capacity. As I mentioned last week, RioTinto is currently expanding its Pilbara iron ore export capacity from 220 Mt to 290 Mt. The company is also evaluating the potential to increase capacity to 360 million tonnes, which reflects a 64% increase from initial levels.
• Vale (NYSE: VALE) is expected to increase its annual production from 306 Mt to 450 – 480 Mt by 2018. Their Carajas project alone is expected to bring another 90 Mt per year by 2016.
• BHP is expecting to increase its production to 207 Mt in FY2014, after reporting a 17% YOY increase in FY2013 (12 months ended July 2013) to 187 Mt.
• Fortescue Meals is currently raising their production from 120 Mt to 155 Mt per year.
• Anglo American’s (LSE: AAL) Minas Rio project is expected to commence production next year at 26.5 Mt per year.
• The 55 Mt per annum Roy Hill project, which is majority owned by Hancock Prospecting, is expected to be in production by 2015.
• CITIC Pacific’s (OTCPK: CTPCF) 24 Mt per year Sino Iron project in Australia went into production this month.

The new supply that is expected to come into the market in the next few years, plus the fact that cash costs of most producers are well below $75 per tonne, we believe, should soften the commodity’s price from its current level of $130+ per tonne. Even the world’s largest iron ore producer, Vale, stated last week that they expect the iron ore market will be in a supply surplus position in 2015.

India, which was once a major exporter, has seen its exports dropping by 80%+, after a 30% export duty on the commodity, and as major producing states in the country imposed a ban on exports. Although the Indian government stated this past week that they are not considering reducing the 30% export duty, I believe, a change on their stance going forward can result in a lot of additional supply into the international market.

All the above, I believe, makes the iron ore sector extremely vulnerable, with supply clearly expected to outpace demand. I would be cautious when looking to invest in the sector.