Commodities | Mar 06 2018
The iron ore market is unlikely to be affected by US tariffs on imported steel, while the focus remains on the sustainability of low-grade supply.
-ROW should be able to absorb excess supply of steel if US imposes tariffs
-Development expenditure on iron ore in China declines significantly
-Cost inflation creeping back into iron ore market
By Eva Brocklehurst
Will the imposition of US tariffs on imported steel weigh on global steel demand and, by default, iron ore? US president Donald Trump has said he prefers global tariffs on both steel and aluminium imports of 25% and 10% respectively. Macquarie notes, if these were the actual tariffs imposed, they would exceed the most severe option presented by the Commerce Department. The president has until April 11 to decide on steel.
Actually, Commonwealth Bank analysts don't expect the tariffs to be that disruptive to either steel or iron ore markets. US steel prices are expected to increase but the rest of the world should be able to absorb the excess supply of steel, particularly Southeast Asia. If this is the case, iron ore markets can also absorb the tariff changes.
Nevertheless, the analysts point out that stronger US steel output at the expense of production elsewhere would be more negative for iron ore consumption, because US steel is predominantly produced via electric arc furnace and this uses less iron ore than the basic oxygen furnace process. The basic process accounts for around 75% of global steel production and is the primary driver of iron ore consumption.
Global steel production rose just 0.8% for the year to January, with China's output declining -0.9% because of reductions during the winter. This was offset by the rest of the world growing at 2.5%. Meanwhile, Citi notes, the iron ore price has displayed resilience in the mid-to-high US$70/t range.
China
Capital expenditure on iron ore mining in China dropped -23% in 2017, despite a recovery in the iron ore price. Citi points out the absolute peak in iron ore mining expenditure occurred in 2014 in China, and since then the growth rate has slowed to 5% per annum.
The broker also observes that most of the small domestic iron ore mines did not produce proper mine plans during the boom years and development expenditure has declined significantly over the last couple of years. Moreover, credit availability for re-starts is likely to be constrained because of China's fiscal tightening. Hence, it could take some time for iron ore mine operating rates to resume the levels of previous years.
Nevertheless, globally, iron ore supplies are plentiful, and while prices continue to surprise on the upside, incentive pricing is not sustainable, Ord Minnett believes. Major producers have shown discipline when it comes to supply, the broker acknowledges, but the likelihood of marginal supply returning, and the risk of de-stocking, should take away some of the pricing tension.
Ord Minnett maintains a declining price profile for iron ore and expects US$65/t over 2018 for a December quarter target of US$60/t.
Productivity
Macquarie notes cost inflation is slowly creeping back to the iron ore market, although miners are countering this fiercely with productivity measures. Virtually all producers are in the money, the broker adds, as prices are well above the seaborne marginal cost.
With the exception of high-cost magnetite operations in Australia, miners selling lower grade sinter fines are still the marginal suppliers in the seaborne market. Some of these operators have come under pressure, as both Atlas Iron ((AGO)) and the Asia-Pacific division of Cliffs, which account for 20mt of low-grade Australian supply, reported small losses in the December quarter.
Macquarie believes, if low-grade discounts stay at current levels throughout 2018, a benchmark price in the high US$60/t range is required to keep 92mt of low-grade supply in the market.
Meanwhile, widening discounts have now become visible in trade flows and low-grade supply has started to exit the market. The broker suggests this is offsetting the expected growth from the major suppliers. The break-even price for iron ore majors is expected to slip slightly in the March quarter because of lower freight rates, although Macquarie observes the underlying trend is clearly one of rising costs.
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