Commodities | Oct 27 2017
As China's winter looms, restrictions on iron ore and steel production have been imposed earlier than expected. Brokers review the outlook for the next six months.
-Suspension of iron ore production in China over winter likely to be positive for iron ore prices
-Restrictions on coke production a signal for increased use of high-grade iron ore
-Ex-China steel output at highest level since 2014
By Eva Brocklehurst
China is lowering steel output by -50% in north east cities to reduce air pollution over the winter and Tanshan has ordered its reductions to commence one month ahead of the formal start in mid November.
UBS expects this first round of reductions to global iron ore demand from Chinese lower steel output will be large, but the full impact over winter will be offset by higher steel output in these northern cities, as well as the rest of the world. This will be exacerbated by a slower ramp-up of Indian iron ore exports post the monsoon and lower Chinese iron ore supply.
Even if iron ore demand falls modestly through the northern winter the broker still suspects strong high-quality price premiums, and a higher and steeper cost curve, will mean the price should average US$60/t through the December and March quarters.
Deutsche Bank notes, according to Mysteel, the suspension of iron ore production will possibly last until March 2018 and this should be positive for high-grade iron ore prices. Earlier this month, because of environmental concerns, governments have informed the majority of iron ore mines in Hebei province that supply of explosives will be halted and associated iron ore dressing plant production will be suspended.
Deutsche Bank calculates this to potentially affect around 10.2mt of iron ore production until March. Hence, steel mills might need to externally procure raw materials to relieve the pressure. The actual duration of the suspension remains to be seen, but the broker understands these actions are in addition to the recent environmental inspections which may affect 100-150mt of run-of-mine Chinese domestic iron ore production.
Morgan Stanley agrees pollution controls mean lower demand for iron ore, particularly low-grade material. The broker expects iron ore prices to converge through the December quarter, as metallurgical coal supply is normalised and China's steel mills turn to lower grades to reduce yield during the winter reductions.
While the availability of both high-grade iron ore and seaborne metallurgical coal has improved, China's restrictions on coke production have added to the pressure on steel mills to boost yields and minimise coke usage. This can be achieved by the use of higher grade ore.
Hence, large discounts for low-grade ore appear likely to persist as long as China maintains an anti-pollution policy. In turn, this puts pressure and seaborne supplies of low-grade, that now face prices that are below the cost of production. Morgan Stanley expects the production reductions and restrictions over the winter in China will affect 9% of iron ore seaborne trade and maintain pressure on prices for all grades.
China's Port Stocks
Macquarie observes Chinese iron ore port stocks are one of the most widely watched and poorly understood price indicators in the iron ore market. The broker believes current port levels are far from excessive. Higher inventories are a natural consequence of weaker domestic production and increased blending activity at Chinese ports by Vale. The broker finds port stocks a weak indicator as the relationship with prices changes over time, depending on whether supply or demand is a driver.
Despite the sharp fall in prices recently, ANZ analysts believe the outlook for iron ore is robust in the short term. Demand for steel is also positive. Yet the analysts believe growth in exports of iron ore will ease coming months. Over the past decade, Australian exports of iron ore have fallen by an average of -5% in November.
If underlying demand from China continues to beat expectations the analysts argue that prices will need to be slightly higher. At US$60/t over half of the Chinese domestic iron ore industry is uneconomical. Hence, the analysts expect prices to stabilise at current levels before slowly pushing back towards US$70/t by the end of the year.
Output of steel, ex-China, is at the highest level since June 2014. Macquarie observes crude steel output in the "often forgotten half of the world" is up 4.8% and on track to post the best growth rate since 2005. Underpinning this is strong manufacturing activity in the developed world amid falling exports of steel from China.
Two main beneficiaries of the retreat of Chinese steel from world markets are South Korea and Europe, where production is growing faster than domestic demand. South Korea appears to be the only major economy where steel consumption is contracting, as rising tensions with North Korea hurt confidence and investment.
The broker notes world steel data also reveals that electric arc furnaces have gained market share this year. Macquarie believes this increase in competitiveness is a natural result of more volatile iron ore and metallurgical coal prices in 2017. However, the trend is expected to revert in the December quarter, given the fall in raw material prices and increase in graphite electrode prices.
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