Metal Matters: Steel, Iron Ore and Base Metals

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-Steel pressures iron ore prices
-Oz miners still strong, ready for upgrade
-Price at US$80/t makes mid caps marginal
-Base metals still diverge
 

By Eva Brocklehurst

Standard Bank analysts have paused to explain the sudden drop in iron ore prices, some 16%, to US$133 tonne since February 20 latest spot US$134.60/t). The focus is on China, of course, and the large steel industry capacity that exists. The analysts note China's steel industry association (CISA) forecasts the country has over 960 million tonnes of installed steel capacity compared with an output rate of 716mt last year. This suggests utilisation rates of around 74.5%. The remaining capacity needs to maximise returns from the start of each new year as end-user demand ramps up from the end of March, when the northern construction season emerges out of the winter.

What happened this year was an excess of steel output occurred from January and sent Chinese steel warehouse inventories soaring towards 21m tonnes more recently. For Standard Bank analysts this meant Chinese mills returned from the new year holidays with a need to de-stock at a time when they were expecting rising demand and pricing momentum. Moreover, recent policy prognostications from both the central bank and the government made the steel mills and consumers even more jittery. How much steel should consumers buy and how much should mills produce? The end result, according to the analysts, was steel prices falling around US$20/t for long steel, and as much as US$60/t for flat steel.

So, despite low iron ore inventory levels at the ports and poor availability of fresh ore deliveries, steel mills had to enact a raw materials boycott over the past month. This reminds the analysts of the time last year when iron ore prices plunged from US$135/t to US$87/t. It appears steel versus raw material margins are aligning and steel inventories are starting to clear and the analysts expect iron ore prices will once again rally in the June quarter. Iron ore swaps are forecasting a price of US$129/t for Q213 but the analysts believe this price is a bit low.

For CIMB the iron ore price movement translates to something simple for Australia's miners. Focus on costs. The broker believes the miners are cum-upgrade unless prices continue to decline sharply. In this environment Fortescue Metals ((FMG)) is the more vulnerable, with higher gearing and higher costs. In the broker's view FMG will need to differentiate itself from Mount Gibson ((MGX)) and Atlas Iron ((AGO)) on margins.

Despite some bearish sentiment over the iron ore price, the broker believes the quick recovery from last year's price fall remains at the forefront of the investor mindset. CIMB suspects investors may wait until the June quarter to assess but notes year-to-date prices are averaging US$150/t CFR, signalling earnings updates are likely, given consensus prices are around US$129/t for the first half. This implies prices need only average US$113/t during the June quarter.

CIMB has also taken a closer look at margins for the large and mid cap iron ore producers, setting iron ore fines prices at levels of US$120/t, US$100/t and US$80/t to judge where any difficulties might lie. The majors, BHP Billiton ((BHP)) and Rio Tinto ((RIO)), benefit from having lower cost operations. Their healthy margins are expected to continue even in a lower iron ore price environment. Rio is viewed as having the lowest cash costs of the five iron ore miners reviewed. At US$100/t there's pressure on the more vulnerable, such as FMG. CIMB does note that FMG's cash costs are expected to reduce to around US$40/t over the next year or so.

Taking the lower iron ore fines price of US$80/t, the mid caps – FMG, AGO and MGX are marginal. This shows the importance for these miners of reducing costs and maintaining healthy balance sheets in case of any sustained period of depressed prices. On the other side of the square, the broker estimates Mount Gibson receives the highest selling price across the hematite iron ore miners, given the 64% reserve grade at Koolan Island and 59.5% at Extension Hill, combined with a moisture content level of around 3%. Fortescue and Atlas sell material with a grade in the 57-59% range with moisture levels of 9% and 7.5%, respectively, so they suffer materially on the price received per wet tonne.

Meanwhile, base metal prices have been erratic. BNP Paribas analysts note the rally from mid November 2012 petered out by February. A quarterly price gain for base metals, overall, for the first quarter is still expected, of around 5%. Copper is expected to underperform the others as 2013 takes hold. Copper's supply constraints are expected to ease and, for the analysts, this is significant in a highly priced market. Signs are still encouraging for 2013.

Apart from faster economic growth in emerging countries and cyclical restocking in China, it seems unlikely that European metals demand will fare as badly as it did last year. BNP Paribas analysts expect world base metals demand growth will re-accelerate in 2013 to 5-6%, comprising 8-9% in China and around 3% in the rest of the world.

Differences in performance among the metals should be less marked than in 2012 and aluminium demand is expected to outrun copper. The analysts note demand was distorted last year by Chinese stockpiling, albeit not a once-only occurrence. This affected copper and tin and high imports led to a build in inventory in China. The Chinese overseas buying of refined metal may therefore be modest in 2013. The analysts at BNP Paribas find the supply-side differences amongst the base metals quite pronounced. Reported stocks of aluminium, nickel and zinc are higher than copper, lead and tin. Moreover, the tying up of inventory, both LME and unreported, in financing deals has done more to raise physical premium than to prop up LME prices.

For new supply, at one extreme is tin, where the scope for production to grow in 2013 is very limited. The analysts expect tin production will fall short of demand for the fourth year in a row. Lead may soon fall short as well. Current supply-constrained copper is moving further away from this position. The difficulties of the copper mining industry are far from over, according to the analysts, but a combination of new mines, expansions and improved performance at some operations should finally deliver strong production growth in 2013-15.

The other end of the spectrum is aluminium, where smelter capacity stays strong. Here too lies nickel, where output surged around 30% between 2009-12. Some problems at new plants and Indonesia's changed policy may limit potential for more rapid production growth but the metal is not expected to fall short. The analysts emphasise forecasts are highly sensitive to the world economic trajectory because they assume a sharp pick-up in metals demand growth. Copper would be most exposed to a deterioration in economic and demand prospects and aluminum would be least exposed.
 

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