Commodities | May 22 2007
By Chris Shaw
Leading into 2007 iron ore contract price settlements were completed fairly quickly and most in the market had expected this year to prove to be the peak in prices before a return to levels closer to the long-term average.
But as Credit Suisse notes the iron ore market has remained very tight in the first few months of the year, in part due to delays to new projects, poor weather in places such as Australia that has limited output and the introduction of tariffs in India, which is limiting its ability to fill its current role as the swing supplier to the world market.
This has proven a bonus for stocks such as Fortescue Metals (FMG), which has enjoyed a more than 30% increase in the last week alone, this before the new third force in iron ore in Australia has even commenced production. While arguably the stock is over-valued given it has yet to generate any output no-one appears prepared to argue with the notion conditions are very supportive for iron ore prices generally.
Driving this supportive environment is a very tight global market, a situation unlikely to reverse itself anytime soon. The broker points out new projects scheduled to come on stream over the next few years will fall short of meeting the increase in capacity required to keep the market in balance, while expansions of production from existing operations are generally proving to be high cost and not enough to meet demand.
At the same time Indian producers are struggling under the impact of the export tariffs, which were introduced to limit exports and so support the domestic steel industry. The problem as Morgan Stanley notes is a number of India’s iron ore producers operate on very thin margins, so the tariffs have basically put them out of business.
This is being felt in China as it now is turning towards domestic producers, who are higher cost and so require higher iron ore prices to sustain their operations. At the same time other major producing nations have fallen short of the broker’s expectations in terms of supply, Australia and Brazil being prime examples.
Australian shipments had been expected to increase by 12% this year but are now likely to record a fall in the current quarter, while in Brazil shipments were expected to increase by 17% this year but could manage only a 3.2% increase in the first quarter.
With Chinese steel production for the year to date currently up 23% against Credit Suisse’s forecast for a 13% increase, it is clear the risk to demand forecasts lies to the upside at the same time as supply is falling short of expectations. As a result deficits in the supply-demand balance are expected in coming years, Morgan Stanley expecting such a situation to continue through to 2010 at the earliest.
Credit Suisse agrees, estimating if Chinese steel production rose 10% annually through to 2010 a further 260-270 million tonnes per annum of iron ore would be required to balance demand, well in excess of the 190 million tonnes per annum it forecasts will be available in three years time. Given it now expects a 17% increase in steel production this year that number looks conservative.
Both brokers have therefore lifted their forecasts, Credit Suisse now expecting a 10% increase in 2008 compared with its previous estimate of a 5% increase. This suggests a price for the coming year of US$92.32 per tonne, while it has also lifted its long-term forecast to around US$40 per tonne.
Morgan Stanley has made similar changes, the broker’s forecasts for iron ore fines in 2008 now US$58.22 per tonne, up from US$53.17, while for lump iron ore it is now forecasting a price of US$74.33 per tonne, up from US$67.88. It expects a further 5% increase to prices in FY09, which puts its estimates at US$61.13 per tonne and US$78.05 per tonnes respectively. Its long-term forecast has increased to US$45 per tonne, up from US$40 per tonne.