Downward spiral of the price of iron
28 Aug 2012 8:21 PM GMT
It has been almost a decade now that the iron ore industry across the globe has been experiencing a phase of unprecedented boom. The price of iron ore, which was between $12 to $16 per metric ton in 2001, touched $193 in February 2011. Since 2003, the price of iron ore kept its upward trend almost continuously, except for 2008-2009, when there was a significant fall in prices as a result of global recession which had hit the steel industry in 2008. However, shortly thereafter, the price recovery for iron ore became much faster than what was expected. In 2010, the iron ore miners achieved a very major breakthrough in determining the prices in long term contract by practically converging the long term prices with the spot prices. This meant a huge rise in long term prices which the buyers had to agree to. The quarterly pricing system also provided more opportunity to the miners in a rising market.
A boom is always loaded with a syndrome of anxiety. Since September 2011, there is a distinct trend of decline in prices. For 63.5 Fe content iron ore, the price in the Chinese spot market came down from $186 in September to $151 in April 2012. This by itself should not have been disturbing. But it brought in focus certain factors which are obvious consequences of continuous price rise for a fairly long period. In such a situation, the suppliers tend to increase their supply, initially by increasing production from their existing facilities and later by expanding their capacity. Whenever the existing capacities are expanded and new capacities are created, that involves a lot of capital investment. In order to realise the investments, the miners get prepared to sell the product even at a lower price putting pressure on price. The buyers on the other hand, look for alternate source of supply especially captive supply to reduce dependence on commercial imports. The growth of demand of the buyers also gets contained at some stage to put further pressure on price. All these factors have been active in the iron ore market in varying degree for sometime past. Therefore, there are reasons to be apprehensive about the price trend for iron ore even in the short and medium term.
In order to put the entire issue in proper perspective, it needs to be stated at the outset that the earth is endowed with a large reserve of iron ore. Iron ore is the fourth most abundant component in the earth’s crust and comprises about five per cent of it. Global iron ore reserves exceed 340 billion metric ton. The problem with iron ore is not related to its availability but in respect of the infrastructure required to extract it and transport it. Inadequate evacuation directly affects the production. The capital cost in organising this infrastructure is huge and it takes time to install that. Therefore, the iron ore industry tends to suffer from a mismatch. When the demand is very high, the supply growth is sluggish. When the demand tends to be saturated, new supplies augment the gross supply. We need to examine whether a similar situation is going to emerge in the iron ore industry in the near future.
Incidentally, iron ore is practically a single use commodity. It is required for steel making. About 98 per cent of iron ore consumed across the world is for steel making only. On the other hand, one cannot produce steel without iron ore. Scrap is included in this because it is nothing but processed iron ore. Hence, demand for iron ore is directly related to steel production. Global steel production has gone up from around 1050 million ton in 2004 to 1527 million ton in 2011. During this period, the Chinese steel production increased from about 250 million ton to 695 million ton. Thus almost the entire rise in global production came from China. Practically, China is the engine of growth for the steel industry of the world. China’s steel industry could beat the recession in 2008 by creating the domestic demand by preponing the infrastructure development which were to be carried out later. But then, even thereafter, the spree of expansion had continued because of the impressive GDP growth China achieved. Even in 2011, China’s steel production increased by 8.9 per cent over the previous year. In absolute term, this meant an increase of 58.8 million ton production in one year. Now China alone produces 45.5 per cent of the global production. In 2011, there were some good news for the steel industry, as production increased by 16.2 per cent in South Korea, by 7.1 per cent in the USA and by 6.8 per cent in Brazil. However, in absolute terms, the figures are not that impressive because of the low base. In fact, compared to 2004, global steel production in the world, except China, grew by just about 50 million tons. Therefore, growth in world steel production has been China centric for almost a decade by now.
The question remains how long China will keep increasing its steel production? It is well known that many Chinese steel mills are operating on thin margin. Will not the credit squeeze in China affect further expansion in steel industry? In any case, can there be infinite elasticity in growth even if it is China? The fact today is that China’s rate of growth in steel production has come down from about 20 per cent in 2004, 30 per cent in 2005 and about 19 per cent in 2006 to about 8.9 per cent in 2011. In the first quarter of 2012, the growth in steel production in China has been just one per cent more than the corresponding period of the previous year. Incidentally, during this period, global output fell by 0.2 per cent. In March and April 2012, Chinese monthly production exceeded 60 million tons which indicates more of stability than growth. The expectation that by 2017 China’s steel production would grow beyond 800 and may reach 850 million may not be impractical but that would mean a very low rate of cumulative growth.
On the other hand, the response of supply to the growing demand for China has started coming to the market. The existing suppliers in Australia have already taken ambitious plans to increase ore production. Rio Tinto expects to increase its production from a level of 220 million ton to 353 million in 2020. BHP Billiton is going to improve its production from 180 million to 356 million. FMG’s production till 2020 is going to increase to 155 million from the current level of 55 million. Australia as a whole is going to produce about one billion metric ton of ore as against 470 million ton produced now. Currently, about $60 billion is planned to be invested on mines and another $22 billion on infrastructure. The ports at Dampier and Cape Lambert by Rio and Hedland by BHP and FMG are being expanded further. These additional productions will try to find its destination to China. Brazil is also likely to increase its production by about 200 million by 2017 in order to increase its exports from 313 million ton in 2011 to 489 million ton in 2017. China, the largest consumer of iron ore has also in the meantime increased its own production of iron ore. Last year it has produced 1.33 billion metric ton of low grade ore which can be converted into about 400 million of standard grade ore. It constituted just about 40 per cent of China’s total requirement of iron ore. China is also aggressively making its presence known in Africa which has estimated reserves of 34.9 billion tons of hematite and 17.3 billion tons of magnetite ore. [Australia’s estimated reserves are 37 billion tons of hematite and 10.4 billion tons of magnetite iron ore]. During the next 5 years, China is expected to invest about $52–54 million in the iron ore rich states in Africa to secure captive source of iron ore for its steel plants. Chinese projects are in various African states like Congo, Guinea, Liberia and Sierra Leone. These countries in West and Central Africa have the potential to add about 480 million ton to world iron ore export capacity by 2018. Recently, Luke Hurst of Crawford School of Public Policy of the Australian National University has made an in-depth analysis on the subject and concluded that even if all medium and low risk projects are executed, Africa will increase the export capacity by about 166 million ton by 2018, resulting in export overcapacity of 10.6 per cent and reduction of price to AS $65 in 2018. As per the estimates made by Australian Govt’s Bureau of Resources and Energy Economics [BREE], the contract price of iron ore will be around AS $140 in 2013 and $107 in 2017. Meanwhile, between January and May 2012, 20 reputed investment banks of the world came out with iron ore price projections till 2016. The average of their projections has been that by 2016 iron ore price [CFR China, Fe 62 per cent] will go down between $100 to $111 in spot and between $85 to $88 in long term contracts.
Let us now make a brief analysis of these projections. In the near future in 2012 and 2013, the supply side is likely to be affected by a sharp decline in iron ore exports from India due to imposition of 30 per cent export duty on iron ore exports. Together with high railway freight, this has made most of iron ore exports uneconomic and Indian export may fall to 45 million ton in 2012 as projected. Despite this, due to sluggish demand for iron ore on the part of Chinese steel industry, price of iron ore may fall below the level estimated by BREE in 2013. In fact, already in August 2012 CFR price for Fe 62 per cent ore has touched a figure of $118 in China. However, with fall in prices, an important impact will be seen in China’s own iron ore production. Due to high cost of production and transportation, any price of less than $120 will make most of the mines in China unviable and increase China’s dependence on import. Therefore, price reduction below $120 is likely to happen only when China’s own source of supply from Africa replaces its own domestic production. In that case, if substantial production is generated from Africa and is available to China at lower than the prevailing price, there will be twin pressure on prices, oversupply and lower price of ore from Africa and the price may go below $100 per ton. Even otherwise, price may go below $100 per ton if interplay of oversupply from Australia and Brazil and stagnant Chinese demand pulls down prices to such an extent that imports become profitable and Chinese do not mind closure of their mines.
These trends are likely to start from 2014 and may mature by 2017. The bright side of the entire analysis is that even thereafter, the iron ore miners will make reasonable profit. Lower cost of iron ore will help steel industry to expand. Steel and iron ore industry together will generate more investment, employment and income and that will be a more preferable situation to emerge. For India, there are some lessons. First, there is no harm if iron ore export is encouraged now, as it will fetch better price now than later when iron ore can even be imported at much lower price. And second, no permanent policy to extract more revenue from the miners should be taken on the basis of present profitability, because the profits in any case will go down and any permanent scheme to share the profits may affect the health of the industry and possible expansion of steel capacity in the country.
Rana Som is a former chairman and MD, NMDC limited.
A boom is always loaded with a syndrome of anxiety. Since September 2011, there is a distinct trend of decline in prices. For 63.5 Fe content iron ore, the price in the Chinese spot market came down from $186 in September to $151 in April 2012. This by itself should not have been disturbing. But it brought in focus certain factors which are obvious consequences of continuous price rise for a fairly long period. In such a situation, the suppliers tend to increase their supply, initially by increasing production from their existing facilities and later by expanding their capacity. Whenever the existing capacities are expanded and new capacities are created, that involves a lot of capital investment. In order to realise the investments, the miners get prepared to sell the product even at a lower price putting pressure on price. The buyers on the other hand, look for alternate source of supply especially captive supply to reduce dependence on commercial imports. The growth of demand of the buyers also gets contained at some stage to put further pressure on price. All these factors have been active in the iron ore market in varying degree for sometime past. Therefore, there are reasons to be apprehensive about the price trend for iron ore even in the short and medium term.
In order to put the entire issue in proper perspective, it needs to be stated at the outset that the earth is endowed with a large reserve of iron ore. Iron ore is the fourth most abundant component in the earth’s crust and comprises about five per cent of it. Global iron ore reserves exceed 340 billion metric ton. The problem with iron ore is not related to its availability but in respect of the infrastructure required to extract it and transport it. Inadequate evacuation directly affects the production. The capital cost in organising this infrastructure is huge and it takes time to install that. Therefore, the iron ore industry tends to suffer from a mismatch. When the demand is very high, the supply growth is sluggish. When the demand tends to be saturated, new supplies augment the gross supply. We need to examine whether a similar situation is going to emerge in the iron ore industry in the near future.
Incidentally, iron ore is practically a single use commodity. It is required for steel making. About 98 per cent of iron ore consumed across the world is for steel making only. On the other hand, one cannot produce steel without iron ore. Scrap is included in this because it is nothing but processed iron ore. Hence, demand for iron ore is directly related to steel production. Global steel production has gone up from around 1050 million ton in 2004 to 1527 million ton in 2011. During this period, the Chinese steel production increased from about 250 million ton to 695 million ton. Thus almost the entire rise in global production came from China. Practically, China is the engine of growth for the steel industry of the world. China’s steel industry could beat the recession in 2008 by creating the domestic demand by preponing the infrastructure development which were to be carried out later. But then, even thereafter, the spree of expansion had continued because of the impressive GDP growth China achieved. Even in 2011, China’s steel production increased by 8.9 per cent over the previous year. In absolute term, this meant an increase of 58.8 million ton production in one year. Now China alone produces 45.5 per cent of the global production. In 2011, there were some good news for the steel industry, as production increased by 16.2 per cent in South Korea, by 7.1 per cent in the USA and by 6.8 per cent in Brazil. However, in absolute terms, the figures are not that impressive because of the low base. In fact, compared to 2004, global steel production in the world, except China, grew by just about 50 million tons. Therefore, growth in world steel production has been China centric for almost a decade by now.
The question remains how long China will keep increasing its steel production? It is well known that many Chinese steel mills are operating on thin margin. Will not the credit squeeze in China affect further expansion in steel industry? In any case, can there be infinite elasticity in growth even if it is China? The fact today is that China’s rate of growth in steel production has come down from about 20 per cent in 2004, 30 per cent in 2005 and about 19 per cent in 2006 to about 8.9 per cent in 2011. In the first quarter of 2012, the growth in steel production in China has been just one per cent more than the corresponding period of the previous year. Incidentally, during this period, global output fell by 0.2 per cent. In March and April 2012, Chinese monthly production exceeded 60 million tons which indicates more of stability than growth. The expectation that by 2017 China’s steel production would grow beyond 800 and may reach 850 million may not be impractical but that would mean a very low rate of cumulative growth.
On the other hand, the response of supply to the growing demand for China has started coming to the market. The existing suppliers in Australia have already taken ambitious plans to increase ore production. Rio Tinto expects to increase its production from a level of 220 million ton to 353 million in 2020. BHP Billiton is going to improve its production from 180 million to 356 million. FMG’s production till 2020 is going to increase to 155 million from the current level of 55 million. Australia as a whole is going to produce about one billion metric ton of ore as against 470 million ton produced now. Currently, about $60 billion is planned to be invested on mines and another $22 billion on infrastructure. The ports at Dampier and Cape Lambert by Rio and Hedland by BHP and FMG are being expanded further. These additional productions will try to find its destination to China. Brazil is also likely to increase its production by about 200 million by 2017 in order to increase its exports from 313 million ton in 2011 to 489 million ton in 2017. China, the largest consumer of iron ore has also in the meantime increased its own production of iron ore. Last year it has produced 1.33 billion metric ton of low grade ore which can be converted into about 400 million of standard grade ore. It constituted just about 40 per cent of China’s total requirement of iron ore. China is also aggressively making its presence known in Africa which has estimated reserves of 34.9 billion tons of hematite and 17.3 billion tons of magnetite ore. [Australia’s estimated reserves are 37 billion tons of hematite and 10.4 billion tons of magnetite iron ore]. During the next 5 years, China is expected to invest about $52–54 million in the iron ore rich states in Africa to secure captive source of iron ore for its steel plants. Chinese projects are in various African states like Congo, Guinea, Liberia and Sierra Leone. These countries in West and Central Africa have the potential to add about 480 million ton to world iron ore export capacity by 2018. Recently, Luke Hurst of Crawford School of Public Policy of the Australian National University has made an in-depth analysis on the subject and concluded that even if all medium and low risk projects are executed, Africa will increase the export capacity by about 166 million ton by 2018, resulting in export overcapacity of 10.6 per cent and reduction of price to AS $65 in 2018. As per the estimates made by Australian Govt’s Bureau of Resources and Energy Economics [BREE], the contract price of iron ore will be around AS $140 in 2013 and $107 in 2017. Meanwhile, between January and May 2012, 20 reputed investment banks of the world came out with iron ore price projections till 2016. The average of their projections has been that by 2016 iron ore price [CFR China, Fe 62 per cent] will go down between $100 to $111 in spot and between $85 to $88 in long term contracts.
Let us now make a brief analysis of these projections. In the near future in 2012 and 2013, the supply side is likely to be affected by a sharp decline in iron ore exports from India due to imposition of 30 per cent export duty on iron ore exports. Together with high railway freight, this has made most of iron ore exports uneconomic and Indian export may fall to 45 million ton in 2012 as projected. Despite this, due to sluggish demand for iron ore on the part of Chinese steel industry, price of iron ore may fall below the level estimated by BREE in 2013. In fact, already in August 2012 CFR price for Fe 62 per cent ore has touched a figure of $118 in China. However, with fall in prices, an important impact will be seen in China’s own iron ore production. Due to high cost of production and transportation, any price of less than $120 will make most of the mines in China unviable and increase China’s dependence on import. Therefore, price reduction below $120 is likely to happen only when China’s own source of supply from Africa replaces its own domestic production. In that case, if substantial production is generated from Africa and is available to China at lower than the prevailing price, there will be twin pressure on prices, oversupply and lower price of ore from Africa and the price may go below $100 per ton. Even otherwise, price may go below $100 per ton if interplay of oversupply from Australia and Brazil and stagnant Chinese demand pulls down prices to such an extent that imports become profitable and Chinese do not mind closure of their mines.
These trends are likely to start from 2014 and may mature by 2017. The bright side of the entire analysis is that even thereafter, the iron ore miners will make reasonable profit. Lower cost of iron ore will help steel industry to expand. Steel and iron ore industry together will generate more investment, employment and income and that will be a more preferable situation to emerge. For India, there are some lessons. First, there is no harm if iron ore export is encouraged now, as it will fetch better price now than later when iron ore can even be imported at much lower price. And second, no permanent policy to extract more revenue from the miners should be taken on the basis of present profitability, because the profits in any case will go down and any permanent scheme to share the profits may affect the health of the industry and possible expansion of steel capacity in the country.
Rana Som is a former chairman and MD, NMDC limited.
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