The big question for smaller iron ore miners is whether the current slump in the price below $US100 a tonne is a re-run of September 2012 or something different and more structural.
In 2012 the iron price plummeted below $US90 a tonne as China’s growth rate slowed and sent the smaller miners, most notably Fortescue, scrambling desperately for stability.
As it transpired, however, the price bounced back quickly and within months had risen above $US150 a tonne. With hindsight, the traders and steel mills were running down their iron ore inventories and were ultimately forced to begin re-stocking.
The price, at $US97.50 overnight, is now down almost 30 per cent from its level at the start of the year (and last year’s average) of about $US135 a tonne. This time it does appear to be different to 2012.
Even as the price has been tumbling, stocks of iron ore at China’s ports have been rising during a period where the cyclone season in the Pilbara and a seasonal lift in China’s steel production ahead of a winter slowdown normally sees inventories reducing and the iron ore price firming.
There could be some exogenous factors. The squeeze on liquidity as China continues to try to control its shadow banking sector has seen commodity-based financing come under severe pressure and some forced offloading of the underlying commodities. It is also apparent that activity in China’s property sector has slowed both because of the liquidity crunch and the Chinese authorities’ attempt to re-orient economic activity.
The critical question, however, is whether the massive and continuing expansion of supply by the major producers has brought forward the point at which the market will shift from a deficit of supply relative to demand to a position of structural surplus.
The more pessimistic analysts had anticipated that point being reached towards the latter part of this year, while the more optimistic/less pessimistic saw the balance swinging into surplus next year and heading north of 200 million tonnes a year over the next couple of years.
While there could be fluctuations in the price as inventory levels move around, that would suggest the price will trend lower of the next couple of years. Many analysts believe it will fall to around $US80 a tonne next year. The process of a structural adjustment to the price may, however, have started a little earlier than anticipated.
The big seaborne iron ore producers can still make significant money at those sorts of price levels, albeit nothing like they have made during the commodities boom. The big increases in their production volumes aren’t sufficient to compensate them for the loss of margin that flows from the lower prices.
A key issue for smaller and higher-cost producers is whether that increased production from the likes of Rio Tinto, BHP Billiton, Vale and Fortescue drives out the really high cost producers and, in particular, the high-cost and low-quality Chinese domestic producers who account for about 30 per cent of its requirements.
In theory they should be displaced first, although China has been shifting its domestic production base to newer, larger and lower-cost mines.
Rio and BHP, however, factor into their analyses a proportion of that higher cost domestic production, which they treat as occupying the lowest position in the cost curve. This approach recognises that because some of the mines are co-located and integrated with steelworks, they won’t be shut down, and that there may be social pressures to maintain sub-economic production.
Over time, the lowest-cost producers in the Pilbara and Brazil ought to prevail. However, it may require the price to drop below $US80 a tonne for a sustained period under the weight of the continuing surge in production that the major producers have in train.
It could, however, be an increasingly nasty and destructive few years for everyone in the sector because the big miners will still be bringing new tonnes -- and a lot of them -- into the market towards the end of this decade.
It is the big and continuing increase in production that has occurred since 2012 and the changes in China's economic policies and settings that suggest that this time, history is unlikely to repeat itself with a quick bounce-back in the price.