Iron Ore Slump No Bar to Supply as China Mines Shut: Commodities

Sep 04, 2014 3:52 pm ET

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Sept. 4 (Bloomberg) -- The world’s biggest iron ore producers are targeting record shipments as lower output costs offset plunging prices and less competitive mines in China shut.

Vale SA, Rio Tinto Group, BHP Billiton Ltd. and Fortescue Metals Group Ltd. are still making money even after prices of the steel-making ingredient dropped 37 percent since December to the lowest level since 2009. They’re betting that higher-cost producers will be squeezed out of the market.

Slowing steel demand in China, which buys 67 percent of seaborne iron ore supply, and new production capacity in Australia and Brazil have led to a global surplus that Goldman Sachs Group Inc. forecasts will more than double to 175 million metric tons in 2015. As mines in China close, the four companies will boost their share of the seaborne supply to almost 70 percent, according to CLSA Ltd., a broker and investment group.

“You’ve got the four major producers with very strong, world-class, lowest-cost production,” said Daniel Kang, an analyst at JPMorgan Chase & Co. in Hong Kong. “Even at current prices or lower, the economics of their expansion projects are very compelling.”

Ore with 62 percent iron content delivered to the Chinese port of Qingdao declined to $85.24 a ton today, the lowest since October 2009, according to Metal Bulletin Ltd. Prices are 56 percent below a record $191.70 reached in February 2011.

The slump has a way to go before the biggest producers are in the red. Rio Tinto has the lowest break-even cost at $42, BHP’s is $51 and Vale is at $60 in terms of ore landed in China with 62 percent content, according to UBS AG estimates.

Bigger Cushion

Rio Tinto, the top supplier after Vale, plans to boost output to more than 330 million tons in 2015 after an 11 percent advance to 295 million tons this year, the company says. Vale will raise production by 8.4 percent to 348 million tons in 2015. BHP sees an 8.9 percent increase from its Western Australian mines in the year from July 1, while Fortescue may boost shipments by 25 percent.

Even smaller companies such as Perth, Australia-based Atlas Iron Ltd. are predicting record shipments this year. Atlas, with a break-even cost in the mid-to-lower $80s a ton, predicts an increase of at least 12 percent in exports from its mines in the mineral-rich Pilbara region in the year from July 1, according to 43-year-old Managing Director Ken Brinsden.

While profit margins are being squeezed, higher-cost companies will have to cut output first, he said on a conference call Aug. 28. Atlas will seek to create “more head room” over time by cutting expenditure, Brinsden said.

Chinese Mines

There’s less of a cushion for suppliers in China, where about 80 percent of mines have costs of $80 to $90, according to estimates from Mysteel.com, a Shanghai-based adviser. About 25 percent to 30 percent of coastal mines have shut, said Andrew Hodge, an analyst at Wood Mackenzie Ltd. in Sydney. Output in the country will contract 15 percent to 282 million tons next year, JPMorgan estimates.

“We are very comfortable at these prices, but we do expect to see prices drifting up as the higher-cost production exits the market,” Nev Power, Fortescue’s chief executive officer, said in an Aug. 20 interview on Bloomberg Television. Vale also sees prices rebounding as supply growth slows and mines close, Jose Carlos Martins, the Rio de Janeiro-based company’s head of ferrous and strategy, told reporters on July 31.

While a quarter of global supply is break-even or loss- making at prices now and cuts are happening, high-cost production may be slow to withdraw from the market, Daniel Morgan, a UBS analyst, wrote in a report dated today.

Goldman Bearish

Prices may have further to decline. Goldman Sachs sees iron ore dropping as low as $75 in 2015, 12 percent below levels now, and averaging $80 over the year. The median of 13 bank forecasts compiled by Bloomberg is for $96, down from $105 this year. Commerzbank AG has the highest prediction at $110.

“We’ve been the most bearish for a long time,” said Christian Lelong, a Goldman analyst in Sydney who worked at BHP for seven years. “Seaborne supply is very strong. Consumption of iron ore is not growing as strongly. You have too much iron ore, which means prices drop,” he said in an interview Aug. 19.

Inventories at Chinese ports climbed 28 percent this year and reached a record 113.7 million tons in July, data from Shanghai Steelhome Information Technology Co. show. Global supply excluding mines that haven’t secured financing and require approvals is poised to grow 8.6 percent next year to 1.44 billion tons as producers in Australia and Brazil expand, Bloomberg Intelligence estimates.

Urban Growth

China’s weakening property sector is damping the outlook for steel, Goldman said. Demand will expand 2.7 percent in 2015, down from 3 percent this year and 6.1 percent in 2013, the World Steel Association estimates.

Fortescue’s Power is “firmly confident” in China’s growth as urban development fuels steel use, he said Aug. 20. The world’s second-largest economy predicts that 60 percent of its people will live in urban areas by 2020 from 50 percent in 2010. BHP sees Chinese steel output rising to 1.1 billion tons in the next decade. The country produced 779 million tons last year. Ore exports to China from Australia’s Port Hedland jumped 44 percent to a record in August from a year earlier.

Premier Li Keqiang’s government has brought forward railway spending, reduced reserve requirements for some lenders and cut taxes to protect its economic expansion target of about 7.5 percent. While analysts forecast China is set for 7.2 percent expansion in 2015 and 7 percent in the following year, that would still be the slowest in a quarter century.

Entrants Squeezed

The glut will deepen until at least 2018 as seaborne supply increases 27 percent to 1.69 billion tons from 1.33 billion tons this year, Goldman Sachs estimated in a July 23 report.

Rising output hasn’t stopped the mining companies’ shares from declining along with prices. Vale lost about 22 percent of its market value this year, while Rio Tinto fell 8.9 percent and Fortescue plunged 30 percent. BHP retreated 5.2 percent. Iron ore is the biggest contributor to their revenues.

Vale will have net income of 21.2 billion reais ($9.48 billion) in 2015, little changed from 21.3 billion reais this year, according to the average of at least 17 estimates compiled by Bloomberg. Rio’s profit will increase 13 percent to $10.43 billion, the mean of at least 19 analyst estimates shows.

Spokesmen for Rio Tinto, BHP, Fortescue and Atlas referred to guidance given with earnings last month when asked to comment on plans for production and exports.

The top producers are “squeezing potential new entrants into the market,” said JPMorgan’s Kang. “Their new production is going to be lower-cost and still very profitable.”