Markets: BHP's steel reinforcement

BHP Billiton bluntly outlined supply pressures on its market, but between solid demand and increased production things aren’t so bad for the mining giant.

Before anyone points to the favourite scapegoat, China, as the reason BHP Billiton’s full-year report wasn’t what investors were hoping for, it only accounted for 58.8 per cent of BHP’s iron ore sales.

And including all commodities BHP Billiton produces, China only accounted for 29.4 per cent of revenue in the year just gone, down from 29.9 per cent in 2012. China was actually responsible for a greater percentage of revenue this year, than in 2011 when the figure was 28.2 per cent.

Early in BHP’s annual report the miner put the reality facing all commodity producers in black and white – increased supply has exerted downward pressure on commodity markets. The expectation is this trend will continue over the short term. No reprieve is offered.

Morgan Stanley has led the way in estimating future prices for iron ore, tipping it will average $US125 per tonne in the next quarter and $US120 per tonne in the first quarter of next year.

The average price for BHP’s iron ore in the 2013 financial year was $US127.23, a smidge above where Morgan Stanley can see it going.

Despite the average price of iron ore falling just on 22 per cent over the past two financial years, BHP Billiton has been able to offset this to an extent by increasing production of iron ore by over 26 per cent over the same time.

The expectation from BHP is that global growth will be more balanced over the long term as China continues to develop its economy. There is also hope for growth from the US. Beyond two of the world’s super powers, there remains plenty of demand for iron ore. Rest assured, steel is still needed.

According to the World Steel Association, steel production for the month of August was 130 million tonnes, an increase of 5.2 per cent on the same month last year. As a sign of improving conditions in China, the country reported steel production of 66.3 metric tonnes, a 12.8 per cent surge from the month of August last year.

While there are cyclical and structural pressures facing the iron ore industry and commodities in general, BHP Billiton appears to have taken the steps to negate this. The future won’t see commodity prices pushing shares higher, but it will see profits being more closely aligned with volume growth, cost cutting measures and improving margins.

This year has seen a fall in China’s iron ore inventory (green line on the graph below), which has supported the iron ore price (white line) and consequently reignited investor interest in BHP Billiton (yellow line). Despite an honest commentary from BHP, things don’t actually look that miserable for the major miner.