Labor's vain hope for an iron ore rescue

Could the rebound in the iron ore price save Wayne Swan's surplus? It's not likely.

Apart from the unhappy reality (for Swan and his colleagues) that it appears his Minerals Resource Rent Tax has yet to raise a dollar more than halfway through the financial year there is a major question mark over the sustainability of the current iron ore price level of more than $US150 a tonne.

While there are some analysts who believe the price could rise even further in the short term even they concede that the current price, and any near term movement, is being driven by short term and temporary factors.

That's a view shared by Fortescue's Nev Power and Rio Tinto's Sam Walsh, who attribute the spike to re-stocking by China's steel mills and anxiety about the impact of the cyclone season on Pilbara production.

If the price level were to be sustained it would be because of a longer term shortfall of supply relative to demand from the steelmakers, which would imply a significant increase in steel production.

If that were the case other steel-making inputs, most notably metallurgical coal, would also be experiencing significant price rises.

That isn't, however, the case. Metallurgical coal is flat-lining around the $US160 a tonne level, less than half the peak levels of around $US330 a tonne experienced at the height of the commodity price boom (and against a backdrop of supply shortfalls created by the Queensland floods) in 2011 and nearly 30 per cent lower that it was six months ago. The iron ore spot price, by comparison, is only about 20 per cent off its 2011 peak and about 18 per cent higher than it was six months ago.

Although, there is a fundamental reason why metallurgical coal prices might not move quite in tandem with iron ore prices.

The US shale gas boom has displaced some US coal demand and forced some US and Canadian coal into export markets, so there has been some increase in supply and prospective supply.

The more obvious explanation for the extent of the discrepancy between movements in the iron ore and met coal prices, however, is that the mills aren't materially increasing production and therefore the spike in iron ore prices is driven by a stock cycle and seasonal factors – the first few months of the year traditionally see a higher price – and is unlikely to be sustained throughout the rest of the year.

As this year progresses production from the Pilbara miners – Rio, BHP Billiton and Fortescue – and from Brazil's Vale is scheduled to increase quite significantly, which will provide steadily intensifying downward pressure on the price.

The bigger miners are working on the premise that the equilibrium price for iron ore which balances supply and demand will drift towards the $US120 a tonne or so at which the marginal Chinese producers break even. At those levels there wouldn't be any MRRT revenues.

Even if China's economic growth and its demand for steel-making materials surprises on the upside over the remainder of this financial year and beyond it would, given the extent of the offsets and credits within the MRRT, probably be the next federal treasurer, which may not be Swan, who would benefit from it.