China's gloomy forecast for iron ore miners

China’s key economic planning agency has provided a sobering demand-side perspective on the outlook for the iron ore industry. There is no near-term relief in sight.

With iron prices edging below $US97 a tonne overnight -- its lowest level in 20 months -- China’s National Development and Reform Commission said yesterday that prices were unlikely to rise over the next three months because of a combination of high levels of inventory at ports and increasing supply.

While there are some in the sector who have seen the sharp decline in the price as a temporary response to China’s crackdown on its shadow banking sector and a consequent liquidity squeeze that has impacted commodity-based financing, the NDRC’s views are founded in the industry’s fundamentals.

“As some big miners are running new capacity, iron ore delivery would grow steadily over the next two to three months while port inventories will continue standing at high levels and steel demand is slowing, so iron ore prices will find it difficult to rise,” it said. Inventories at China’s ports are a record 113.3 million tonnes.

The NDRC expects global iron ore production ex-China to increase by about 130m tonnes this year but the growth in China’s demand for iron ore to slow to an annual rate of about 3-4 per cent. Last year China’s demand for iron ore grew by about 10 per cent.

The commission expects the lower prices to impact China’s domestic iron ore producers, whose costs of production range from $US75 to $US145 a tonne against a global average of just under $US55 a tonne. However, the impact of the price reductions -- now 28 per cent since the start of the year -- will obviously be felt in the profitability of the major seaborne iron ore producers.

The flipside of what would be a painful experience for iron ore producers and their home economies, of course, would be a windfall for China’s steel producers. The market-related pricing adopted by seaborne producers during the boom would flow through quickly and positively to their input costs.

While the NDRC’s comments relate to the near-term outlook (Iron ore miners brace for a structural shift, May 21), the continuing expansion of supply occurring in the sector is rapidly pushing the industry into a position of structural surplus, which could be reached as early as the second half of this year. There are some who suspect that point has already been reached.

The ramp-up of production occurring even as the price has fallen is quite dramatic. Brazil’s Vale, which produced just over 300 million tonnes of ore last year, has a planned expansion to 450 million tonnes by 2018.

Rio Tinto produced about 250 million tonnes last year and will hit an annualised rate of about 290 million tonnes by the middle of this year. It is on a trajectory to reach a rate of 360 mtpa by the middle of next year.

BHP Billiton, which is targeting output of 217 mtpa this financial year, is on a pathway to between 260 mtpa to 270 mtpa.

If the NDRC is right and China’s demand growth slows to that 3-4 per cent level, the extent of the surplus in iron ore and the impact of that over-hang of supply could be even more significant and lasting than even the more pessimistic of analysts have forecast.