Commodities | Mar 27 2007
By Chris Shaw
For Credit Suisse, the recent agreement between Chinese buyers and the major iron ore suppliers of a 9.5% price increase is justification of its view, as it has argued for some time the market would need to revise its estimates up to where it was already sitting.
While the market has caught up with respect to this year’s prices the broker suggests the good news is not over, as it expects further price increases in coming years. These are likely to be more modest, reflecting a market the broker sees as still tight despite a supply side response from major producers such as BHP Billiton (BHP), Rio Tinto (RIO) and Companhia Vale do Rio Doce (CVRD) of Brazil.
The reason prices will go higher according to the broker is twofold, the first being the potential for delays to increased supply. On its estimates utilisation of capacity on the supply side is running at around 98% currently, whereas a more sustainable rate is around 95%. This means any disruptions, such as the likely delays at the Fortescue Mining (FMG) operations following Cyclone George, push out the timetable for increases to total iron ore supply.
Secondly, it notes Chinese steel production continues to expand strongly as that economy continues its strong growth. The Chinese Iron and Steel Association is forecasting steel production to increase by 13% in FY08, an outcome the broker suggests would be enough to drive up the iron ore price in FY08 by as much as 15% against its base case scenario of a 5% increase. This is a simple reflection of the Chinese being forced to import much of their iron ore requirements, as two-thirds of Chinese supply is either uneconomic or marginal in terms of quality.
The broker sees prices as gaining only slightly in FY09 with a 3% increase factored into its estimates, but it doesn’t expect a return to long-term average prices until around 2015 as it expects the market to continue to be in deficit until this time.
National Australia Bank doesn’t agree, suggesting the market could return to a surplus as early as the end of this year and certainly by next year. It expects iron ore supply will increase by as much as 50 million tonnes this year, which would be enough to ease the current tight market and so push down prices.
The bank expects a price fall of around 10%, which would put the price for next year at around US93.9c per dry long tonne, compared to this year’s US104.3c. The bank does agree the risk is to the upside, as the potential for disruptions to the proposed supply increases remain possible, if not likely particularly if the Indian threat of a withdrawal of supply following some tax changes actually eventuate. It also points out while reductions in capacity in the Chinese steel industry are proposed, delays in achieving them are likely to be a positive for the iron ore price.
Deutsche Bank takes something of the middle ground, agreeing with Credit Suisse’s assessment prices in FY08 are likely to increase by around 10% thanks to production disruptions and stronger steel prices. This compares to its previous forecast of a 5% fall. Beyond next year the broker is more in tune with National Australia Bank’s outlook, anticipating prices will fall in FY09 by around 5%, down from a 10% decline previously, while the rate of decline in future years has also decreased.
Aside from BHP and Rio Tinto, Credit Suisse suggests OneSteel (OST) as a good play on the iron ore price outlook as not only will Project Magnet give it a bigger role in the industry but there are further growth options at the company’s disposal. As well, it suggests the current positive price outlook it has for iron ore is not fully factored in to the market’s earnings forecasts for the company.
The broker rates OneSteel as Neutral with a $4.75 price target, while the FNArena database shows it as receiving two Buy and seven Hold recommendations overall with an average price target of $5.10.
OneSteel shares closed yesterday at $5.09, up 1c.