Commodities | Oct 07 2008
By Chris Shaw
Even as base metal prices weakened over the past few months and as oil joined in more recently by sliding from almost US$150 per barrel to below US$100 per barrel, the prices of the bulk commodities of coal and iron ore still looked more likely to go higher thanks to the combination of still tight markets and not much of a supply response.
This picture now appears to be changing with respect to the iron ore market, with the tightness of the market now coming into question given a recent boycott by the Chinese Iron and Steel Association of iron ore from Brazil following attempts by major producer Vale to push through price increases of 12-13%.
As broker UBS notes, the boycott suggests the iron ore market is now weakening as the move shows either steelmakers in China especially are confident of being able to secure alternative supplies, or demand itself is falling from previous levels.
In the broker’s view the latter is more likely, as there is some evidence of a build up in inventory levels at Chinese ports and mills, with current inventory of around 75 million tonnes well above the 40 million tonne level from September last year.
While the build up is not a great surprise in the broker’s view, given the poor state of the global economy at present, it does introduce some downside risk to prices going forward. Similarly there is evidence of this already occurring, as spot prices in the iron ore market are now below US$120 per tonne and this is a sharp decline from levels of around US$190 per tonne back in August.
As Citi notes, this puts spot prices at parity with Australian delivered prices, the change reflecting what it classes as an accumulation of negative data such as weaker Chinese steel production and the impact of freight rates. For any turnaround, the broker suggests there needs to be a reduction in Chinese inventory levels back to around 30 million tonnes, as well as greater clarity on the underlying level of Chinese steel demand post the Olympics.
With respect to the price outlook, Citi estimates the marginal cost of production is around US$90 per tonne, while it sees a cycle trough target price of closer to US$70 per tonne. Such a price is not expected in the shorter-term though, as the broker continues to factor in a further lift in contract prices for 2009/10.
On its numbers the most likely outcome is a further 10% increase for the coming year, though with the supply response continuing to ramp up, it sees conditions as more challenging beyond that. To reflect this outlook the broker is forecasting a 20% fall in prices in 2010/11.
In contrast UBS is not as confident contract prices will again go higher in 2009/10, suggesting while it is too early to make a definitive call on prices, the backdrop has certainly taken a turn for the worse, meaning consensus estimates of a 10% increase in the coming year may not be attained.
Last week Merrill Lynch dropped its 2009 price increase forecast from 15% to 10%, while Macquarie is now factoring in only a “roll over”, meaning no change from the 2008 price.
