Commodities | Mar 04 2014
-China's pollution policy risk to pricing
-Limited impact seen on steel and ore
-High inventories underpin prices
-Iron ore price falls likely short-lived
By Eva Brocklehurst
Asia's steel industry usually gets a move on after winter and the Chinese New Year and the uptick in trade flows, UBS notes, is usually a reliable indicator and driver of iron ore prices. This year there's a new variable in the mix: a Chinese policy to cut pollution. Steel, cement and power producers are being blamed and the central government appears under pressure to impose the environmental reforms that were considered recently at the Plenary session. Many expect the pollution to be managed via steel production reductions, with the central government scrutinising the industry and, in particular, targeting the capacity in Hebei. UBS believes, while changes will be made, they will have limited impact on the steel and ore trades.
Looking only at Hebei, UBS calculates that a 50mt cut to steel production would mean imported ore demand collapses by 80mt, doubling the analysts' current forecast trade surplus to 170mt. Demand for high grade iron ore such as lump and pellet would lift in this extreme scenario, given recent sintering capacity closures. So yes, the analysts contend a new bearish risk exists, but they have not changed iron ore price forecasts. At this stage, they expected the seasonal lift in steel production will draw on relatively high ore inventories in the first quarter, underpinning prices, which the analysts expect to average around US$126/t CFR this year.
Commonwealth Bank analysts observe the spot iron ore price continues to ease, trading around US$117/t currently, from US$135/t at the start of the year. This is consistent with the sharp lift in port stocks through January and February. So far the fall has been orderly but the analysts contend there is a risk of a downward price gap. The lift in iron ore stocks in January has been attributed to trade financing, where Chinese companies that are unable to obtain credit via conventional means try to obtain such by importing iron ore under letters of credit. This lift may be underpinned by tight credit conditions in China but the analysts do not believe that significant tonnage beyond 5-10mt is involved.
A better read on demand is expected in late March, as construction ramps up after the New Year holidays and the effects of winter. Moreover, any gapping lower in the price is expected to be short lived. Cost curves should support prices of US$110-120/t over the next one to two years. For the market to find a balance at a price below US$100-110/t, CBA analysts would expect global steel demand to fall around 8% in 2014 – an extreme scenario.
In terms of the iron ore price, Morgan Stanley thinks conditions may get worse, before getting better. Chinese crude steel production fell unexpectedly in February after a rebound earlier in the month. This corresponds with lower iron ore pricing over the same period and suggests to the analysts that prices could drift down further if production fails to rebound soon. Elevated inventory at the ports means seaborne purchases of iron ore are likely to be scarce and the analysts concur there's a possibility prices could fall more dramatically. Nonetheless, Morgan Stanley points to the fact there's little evidence for demand weakness.
The analysts are not concerned if the current decline is related to voluntary cuts from pollution controls and poor profitability. Steel mills in Tangshan cut production by 30% after the Chinese government issued a level three air pollution alarm. Should the cut be prolonged, iron ore prices could stay below Morgan Stanley's forecast, but a rebound should follow once the alarm is lifted, because of demand fundamentals. At this point Morgan Stanley sees no evidence there's panic from either buyers or sellers. The analysts are comfortable with a current price forecast profile for an average US$125/t CFR in the first half and US$115/t in the second half.
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