‘Inevitable large surplus’ to crush iron ore price to double digits

Iron ore is down 17.5% since the start of the year as China’s economy and particularly its steel industry enters a period of slowing growth.

While demand is picking up in Europe and elsewhere, iron ore is highly exposed to China which accounts for nearly 75% of global usage, 62% of global trade of roughly 1.3 billion tonnes and around 48% of global steel output.

Iron ore was one of the better performing commodities last year averaging $135 a tonne thanks to record breaking imports by China fueled by mills restocking.

Regulation changes in July facilitated the use of ore as collateral for loans creating fresh demand for the commodity. About 40% of the more than 100m tonnes of iron ore at China’s ports are part of finance deals according to some estimates.

Independent research house Capital Economics in a new study predicts further downside for the iron ore price.

Capital Economics Senior Commodities Economist Caroline Bain was one of the more bullish forecasters, predicting iron ore to retreat to $110 by the end of the year, but has now slashed the end-2014 price to $95 and to $85 the following year.

Apart from Chinese economic woes a number of factors industry-specific factors will results in a decline in the price says Capital Economics:

• The lack of established hedging tools for iron ore within China unlike those that exist for base metals suggests iron ore financing trades may be the first to be unwound as they start to lose money.
• Government efforts to contain carbon emissions will target the steel industry, in particular, given its low capacity utilisation rate at between 70-75% resulting in plant closures and consolidation.
• The prospect of a huge ramp up in global iron ore output, particularly in Australia where BHP Billiton, Fortescue Metals Group and Rio Tinto are targeting an additional 170 million tonnes in 2014, leading to a large market surplus.

Capital Economics says the inevitable slump in the price “begs the question of why the mining companies have maintained their commitment to higher production.”

The answer is that the new supply is generally very low cost with Brazil’s Vale enjoying all in costs of below $50 a tonne while Anglo-Australian giants can produce for as little as $40 – $45 a tonne.

With costs of around $110, smaller producers inside China will find it tough going and will be forced out of the market.

Image of Rio Tinto’s Mount Tom Price mine in the Pilbara from Wikimedia Commons