Material Matters: Iron Ore, Major Miners And Thermal Coal

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-Samarco impact on iron ore price muted
-Are major miner dividends sustainable?
-Upside for thermal coal in Japan limited
 

By Eva Brocklehurst

Iron Ore

The Samarco disaster confronting BHP Billiton ((BHP)), which has a 50% interest in the Brazilian joint venture with Vale, has put the spotlight on iron ore and raised further speculation as to what it might take to prop up prices.

Commonwealth Bank analysts note the bulk of Samarco pellet production is sold into the Atlantic basin where the pellet premium is more than twice that of China. They expect it will likely support pellet premiums, particularly in basin.

Otherwise, the impact in terms of the benchmark iron ore price is expected to be muted. Information remains scarce on when operations will return to production and the analysts suspect the idea that the market will lose 30mt may be premature. The larger issue, in the analysts' view, is if the accident leads to a broader review of mining practices in Brazil and/or the delay of the Vale S11D project, scheduled to come on line in September 2016.

Other catalysts which could drive iron ore prices are China's steel exports, which fell materially in October. If this leads to a greater reduction in steel production, prices could be supported but, equally, if output is resilient, prices may descend further. The analysts note, in any case, statistics suggest the mills are procuring less imported iron ore.

Delays to new projects could also be supportive. Iron ore from Australia and Brazil is likely to be the primary contributor to additional volumes next year. If the additional output is delayed this could support prices but the analysts also believe sticky local supply from China may counteract this.

A reduction in high-cost Chinese iron ore needs to be considered as capacity continues to exit on the back of low prices. Nevertheless, the analysts suspect this could be mitigated or delayed by a lower Chinese currency.

Eventually, Chinese product is expected to fall to around 150m tonnes, from current levels of 200-300mt, which would represent state-owned capacity or production that is integrated with Chinese steel mills.

Broad-based stimulus measures are considered unlikely, such as the Chinese government committed to in 2008, the analysts maintain. This is because of its strategy to broaden the economic base towards consumption and services.

Major Miner Dividends

Further to the iron ore supply story, speculation has also circled the sustainability of the major miners' dividend policies. Goldman Sachs contends that BHP Billiton and Rio Tinto's ((RIO)) policies are sustainable in the short term, out to 2018. Longer term, a re-basing of the level may be required.

The broker's analysis suggests the dividends are sustainable at around 20% of earnings, implying US60c a share for BHP and US$1.40 a share for Rio Tinto. This implies sustainable yields of 3.6% for BHP and 3.8% for Rio Tinto, broadly in line with the long-term average of 2.9%.

BHP is able to cover its dividend as long as oil remains above US$50/bbl and iron ore above US$50/t, the broker estimates, assuming a US$7bn capex bill. For Rio Tinto, the figures are iron ore above US$50/t and aluminium above US72c/lb on the basis of capital expenditure of US$4bn. Goldman estimates that capex could run below these levels over the medium term without significantly affecting production volumes, in order to pay the dividend.

Thermal Coal

Changes to Japan's energy policy have the potential to affect global demand for energy inputs, given Japan as a major economy has lacked the resources necessary and must import commodities to fuel its electricity and industrial sectors.

After the Fukushima disaster the nuclear sector is now re-starting and two reactors are in operation. The Ministry of Economy, Trade and Industry considers nuclear is currently the lowest cost generation technology in Japan. The government's new energy plan for 2030 spreads electricity generation broadly equal across LNG, coal, renewables and nuclear.

National Australia Bank analysts observe the scale of thermal coal demand in Japan is unclear, given differing views about long-term electricity requirements, and the optimistic official view of the nuclear sector. The analysts consider it unlikely any further reactors will be brought back on line soon but Platts analysis suggests between five and seven could re-commence in 2016.

Japan remains the major market for Australian thermal coal exports, accounting for around 40% in the 12 months to August 2015, and the analysts suspect growth prospects are likely to be limited. The Australian Department of Industry forecasts a fall in the volume of Japanese thermal coal imports to 2020.
 

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