Commodities | Dec 23 2009
By Chris Shaw
Since the second quarter of this year global iron ore consumption and steel production have been heading higher, a trend Resource Capital Research (RCR) suggests has been driven by strong Chinese demand, cuts to iron ore production levels and increasing levels of optimism on the part of consumers. The other driver has been fiscal stimulus measures from governments around the world, which have boosted infrastructure construction levels and as a result the iron ore market.
The issue with China being the main support for the market, according to RCR, is that any threats to the health of the Chinese economy pose a potential problem for global commodity markets, with an example being the cheap credit available as a by-product of the fiscal stimulus measures given the potential for it to create something of a credit bubble.
It is this easy availability of credit that has created some overcapacity in the Chinese steel market, and moves to address this by limiting capacity and shutting down smaller producers are likely to meet with limited success in the RCR’s view. The end of Chinese stockpiling is another risk for the iron ore market as this has supported consumption to date, while the end of what has been some easing in global production levels is a further risk, as is increased investment in new mines given it could create oversupply in the medium-term.
On balance, RCR notes iron ore contract prices in 2009 were down around 33% from 2008 levels, while the impact on steel prices has been even more pronounced. For example, steel standard plate prices of US$53.40 per tonne are currently almost 56% below their peak of July 2008.
The weakness in steel prices saw China attempt to secure 40% iron ore price cuts for the year but contract talks were eventually abandoned, leading RCR to suggest the current benchmark pricing system will likely be abandoned in favour of a more flexible, index based system for settling prices.
Based on current market conditions, RCR expects contract iron ore prices could regain lost ground in 2010-2012, which would suggest price rises of anything from 3-34% depending on the type of material. Long-term it sees iron ore prices as being tied to the GDP growth of the main end users in China, the US and Japan, and it forecasts a long-term price of US$40 per tonne at 62% iron for fines and US$48 per tonne for lump ore. (Note that long term price forecasts are always set well below pot prices.)
There are some uncertainties associated with these price forecasts in RCR’s view, including the relative strength of the US dollar, the strength of global aggregate demand and potential price volatility from changes to the structure and pricing of iron ore contracts, especially so given the potential for the current contract system to be abandoned.
As prices change in the iron ore market they will also change in the steel market, but in UBS’s view the changes won’t be uniform as while rising industrial activity will provide a boost it will be a steadier increase in emerging markets, while the more developed economies will lag due to a construction backlog and still limited credit availability.
As with iron ore it will be China that drives the global steel market, UBS pointing out China accounts for around 50% of global steel production and apparent demand at present. This implies that if the rest of the world, apart from China, has scope for a re-stocking, but if China is de-stocking, the bull case is tempered somewhat. However, UBS doesn’t see such an outcome as it expects Chinese demand to remain strong given the level of stimulating activity levels in the economy at present.
What could impact on UBS’s view globally is uncertain levels of demand, especially as some buyers may feel reluctant to place orders given the fragile state of the economy around the world. The other issue on the supply side is excess capacity, particularly in China, and here the government is having only limited success in its attempts to make headway via shutting down smaller producers and through consolidation in the sector.
Demand in China may also weaken into the second half of 2010 as current fiscal stimulus measures wear off and the material intensive period presently being experienced ends, but UBS remains positive on the price outlook, expecting scrap prices could rise by as much a 28%.
Other prices should be similarly strong, UBS forecasting US domestic hot rolled coil (HRC) prices will average US$579 per tonne through 2010 against US$522 per tonne this year, while in China the HRC price should average US$494 per tonne next year against US$441 per tonne this year.
UBS also sees stronger prices for coal and iron ore, forecasting gains of 29% for iron ore through 2010 to a Japanese financial year fines benchmark price of US$117 per tonne and 32% for benchmark coal prices.
