Commodities | Nov 01 2006
By Greg Peel
Overall market sentiment towards the upcoming annual iron ore contract negotiations has made a significant shift over the past few weeks with analysts upgrading their price forecasts for next year from a previously pencilled in price decline to further price rises.
The latest to increase price forecasts are commodity specialists at National Australia Bank. Their revised assessments follow similar revisions at Morgan Stanley and Credit Suisse.
On the demand side, there appears little reason to believe China will not keep steel production growth ticking along despite expected slowing in other regions.
On weight of evidence, the above analysts have now moved to expect higher iron ore prices (fines) in 2007 of 5% (Credit Suisse), 10% (National) or 15% (Morgan Stanley) at the next round of negotiations.
It might sound scary that China supposedly has increased its domestic iron ore production anywhere between 35-45% year-on-year, but it has to be taken in context. Firstly, Morgan Stanley is suspicious of the numbers anyway, noting China has had a propensity to understate its production in the past. Hence year-on-year comparisons may be overblown.
Secondly, all analysts note that the quality of iron ore being produced is a far cry than the highly regarded material coming out of Australia or Brazil. While the latter produce 63% Fe ore the former is more like 15-30% Fe, and CS notes China has to mine about ten times more dirt to achieve the same result.
The reality is that Chinese concentrate production has only risen in line with imports, and while August saw the second highest output level of the year it also saw the highest ever imports. So Chinese domestic production is actually making little difference to the equation.
Morgan Stanley suggests the only reason domestic iron ore has been ramped up (and will continue to grow) is simply to keep China’s many steel mines running to avoid the greater cost of capacity shutdowns.
Investors have also been concerned with moves by the Chinese to invest in iron ore projects elsewhere. This is part of the great Chinese acquisition push, which has seen it snap up resource interests around the globe – oil interests in the US, for example, and uranium interests in Australia.
To that end China is reportedly planning to invest US$3bn in a greenfields project in Gabon, Africa, with target production of 500Mt. This is due to be on-stream by 2010 and is intended to shift bargaining power back to the buyers, CS suggests.
It’s a good idea in theory, but in practise the project is start-from-scratch affair, with no mine, no railway, no processing plants and no port. CS estimates the capex spend required would amount to US$150 per annual tonne of capacity, compared to US$55/t industry average expansion. By 2010 CS expects China to be consuming 770Mt of iron ore, so this project will ultimately represent only 2.5% of requirements.
In the meantime, Chinese steel production hit a new record in August, at 36.7Mt. This takes the year to date back to equivalent 2004 levels, and makes a bit of a mockery of government hopes to keep steel production limited. National expects finished steel production to increase by 10% in 2007 to 413Mt. Growth remains supported by construction, infrastructure developments and the manufacturing sector.
Production growth in other regions is expected to be only a modest 1.5%, with both the US and Europe expecting cutbacks.
The key point to note is that Chinese steel demand should be enough to ensure global steel consumption will not slow dramatically due to expected economic slowdown in the US and elsewhere. However, prices of some products will come under pressure. Hot rolled coil prices in the US are expected to fall by 13% in 2007, but higher grade prices are expected to remain supported, as China is a net importer.
Credit Suisse does not expect any meaningful export supplies of iron ore coming out of India soon either. Production has been largely directed towards the domestic market, and CS actually expects spot supply to dry up within three years, as there isn’t the investment in mines and infrastructure to sustain production. Steel production is also expected to grow in India.
Morgan Stanley is expecting iron ore contract negotiations for Japanese Financial Year 2007-08 will be very tough, particularly considering the lengthy negotiations this year. If you can get a ticket to the final, it would be worth the money.
MS believes the Chinese will be well on the front foot as the dominant consumer, but after 45 years at the top the Japanese are not going to let China take over. It might be in Japan’s interest to let China go first, however, as it will have clout as the largest global consumer.
While Japan might wait to come in and pick up the pieces, consensus is that it will be China who is frustrated once again.
There’s always next year.