The smile's back on Twiggy's face

The strong iron ore price has restored the Fortescue founder's fortunes, writes Max Mason.

The strong iron ore price has restored the Fortescue founder's fortunes, writes Max Mason.

Standing over his self-made empire in the Pilbara earlier this year, the red earth beneath Andrew Forrest must have felt like it was shrinking at an incredible rate.

In the five months to June, the Fortescue Metals founder watched a 30 per cent fall in the price of his company's most valuable commodity, iron ore, from its 2013 high of $US158 a tonne to $US110 a tonne, with many analysts predicting the slide to continue.

Fortescue's share price had tumbled 45.8 per cent to $2.92, slashing the value of Forrest's 33 per cent stake from more than $5.5 billion to just over $3 billion.

But in the second half of the year, defying expectations, the iron ore price began its resurgence.

From its low at the end of May, iron ore quickly picked up much of the lost ground and is trading around $US136 a tonne. The price has sat in the $US130 to $US140-a-tonne range since mid-August.

Fortescue shares have surged 96.9 per cent, since hitting their low in June, to $5.78 in late trade on Friday. Forrest's stake in Fortescue is now worth close to $6 billion.

China's continuing demand for Australia's raw materials has been the driving factor.

"Iron ore is the most strategic commodity to China," says ANZ head of commodity research Mark Pervan. "It is their highest dependency commodity, they import about 70 per cent of their iron ore requirements."

And that dependency is expected to rise. Communist leaders at the third plenum spelt out that China was keen to have less impact on the market, sending a clear signal that the world's second-largest economy was unlikely to keep propping up unprofitable domestic state-owned operations.

"State-owned enterprises that have high-cost, unprofitable domestic production and are polluting the atmosphere aren't going to be propped up, that's clearly the signal that China is trying to send," Platypus Asset Management senior analyst Anna Kassianos said. "But things in China never happen fast ... [it could take] a couple of years for that to play out."

Australia provides just over 50 per cent of China's iron ore imports, but as expensive state-owned enterprises begin to shutdown that market share is likely to increase.

"In terms of iron ore supply, China will be more reliant on product coming from Australia," Kassianos said. "Australian supply is much cheaper, when you compare it to Brazil, especially on the freight rate differential to China, so therefore Australian ore supply is much better positioned to take advantage of any [increase in] demand."

But not every local iron ore miner will reap the benefits of increased volumes to China.

With infrastructure vital to supply lines locked up between a handful of companies, the success of smaller players will rely on deals struck with the likes of Fortescue, Gina Rinehart's Hancock Prospecting and QR National, to name a few.

"There are others which are constrained because they don't have infrastructure solutions to complement their growth, like Atlas and Brockman. They're stuck because they're reliant on deals, you can't necessarily say deals will get done in the time frame that is required and at the right price," Kassianos says.

Because of these constraints, she says BHP and Fortescue are best placed to benefit from increased output to China, albeit at a lower price. Analysts agree long-term iron ore prices will decline, but they disagree by how much and when.

Pervan says he sees the price coming off a bit, but expects it to hold in the $US120 to $US130-a-tonne range for the next 12 months.

"The issue right now is that steel production [in China] is running at very high levels and this is creating this upside support for iron ore, well above where people thought it was going to be," Pervan says.

He says while that is a little concerning, rebar inventories are at a more than two-year low.

Goldman Sachs commodities analyst Christian Lelong says he expects the iron ore price to hold in the short term and then begin to decline from the second quarter of next year, and then further in 2015.

"This year the market was in balance, but next year supply starts to grow ahead of demand and that means you start to see some mine closures, initially in China, but we think it also means the iron ore price starts to trend lower towards its long-term level, which we estimate at around $US85 a tonne."

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