‘Peaking’ supply surge to lift iron ore price above $100

According to data from the The Steel Index, the import price of 62% iron ore fines at China’s Tianjin port was off slightly to $93.60 per tonne on Friday, down $0.70 on the day.

The iron ore price fell to its lowest level since September 2012 on May 30 and the commodity remains 30% below levels at the start of year.

The weakness in iron ore in 2014 is blamed on expectations of a glut on markets just as demand from China, responsible for two-thirds of the 1.2 billion tonne seaborne trade, cools.

Iron ore has not trade below $100 on a quarterly basis since 2009 and when prices stay below this level for long enough high cost mines, particularly those in China, become unprofitable leading to cuts in supply.

During the September 2012 slump down to $86.70, number two producer Rio Tinto estimated as much as 100 million tonnes output were taken off the table, which pushed prices back up.

A new report from investment bank Citi argues the price won’t go below $90 and is set to re-enter triple digits before the end of the year according to investment blog Barron’s:

The biggest reason for the large decline in iron ore prices this year has undoubtedly been the rapid growth in supply from Australia and other exporting nations. However, we continue to believe that this surge in supply is peaking in Q2 and that the second half of the year should see a leveling off in supply.

In fact, export volumes out of Australia have leveled off in recent weeks after the explosive growth seen in February through May. We expect Q3 exports to remain relatively flat before a seasonal upturn in Q4 (far less pronounced than the surge seen last year). Exports out of Brazil have admittedly increased rapidly over the past month (partly helped by resolution of difficulties at CSN’s port), but such gains should moderate and in the short-term be partially absorbed by stockpiling at Vale’s new Malaysia logistics center.

A complicating factor in 2014 may the popularity in China of using commodities – particularly iron ore and copper – as collateral for trade credit.

Demand driven by financing deals help explain why import of copper and iron ore have been so strong despite the slowdown in the world second largest economy. While iron ore imports slowed to 77.4 million tonnes in May, down 7.2% and copper imports fell 15.6% from a month ago to 380,000 tonnes, year on year imports are still expanding at a rapid rate.

Stockpiles of imported iron ore at Chinese ports are at record highs above 110 million tonnes according to industry consultancy Steelhome, up more than 50% from this time last year.

Some estimates put the portion of iron ore inventories that is used as collateral for short term loans at 40%, but Beijing is cracking down on the practice as it tries to rein in the country’s vast shadow banking system and tackle excessive debts in the economy.

Beijing’s tightening of controls coupled with a weakening yuan – another deliberate move by authorities – are pushing these deals under water and much of that ore could find its way back onto the market creating a vicious circle.

Iron ore deals are also being targeted to reduce chronic overcapacity in China’s steel industry and in the process tackle polluting sintering plants and blast furnaces.

Combined with a probe into multiple pledging of inventories at the Qingdao port could see vast quantities of iron ore and copper dumped onto already soft markets says a report by UBS:

The typical iron ore collateralised loan has a 3-month duration (unlike the usual 6 months for copper). If banks increasingly prevent traders from rolling over collateralised loans in the coming months, the risk of inventory liquidation increases and possibly coinciding with a seasonal slowdown in iron ore demand.