Commodities | May 27 2019
Global supply of iron ore has fallen over 2019 and China's port stocks are dwindling. So, how high can prices go?
-Iron ore markets currently facing a supply disruption of around -6%
-The physical squeeze on stocks may be passed as China's steel production should seasonally slow
-If India has to import more iron ore prices may linger above US$80/t, CBA analysts suggest
By Eva Brocklehurst
Supply and demand for iron ore have aligned and prices have risen above US$100/t, benefiting major Australian miners amid significant supply disruptions from their Brazilian counterpart, Vale, the world's largest supplier.
Sentiment regarding supply, after an acute tailings dam failure in Brazil this year, has weakened. Vale has recently indicated it expects another tailings dam, Gongo Soco (currently not producing), to fail if seismic activity at a nearby mine continues.
However, Australia has not been without its setbacks, as both BHP Group ((BHP)) and Rio Tinto ((RIO)) reduced 2019 shipment guidance after Cyclone Veronica cut a swathe through the north west in March.
Commonwealth Bank analysts believed a breach of US$100/t for iron ore was always a chance following the supply disruptions that have affected the market, including the fatal dam failure at Vale's Feijao mine in January, which triggered a series of mine closures across Brazil.
Vale has guided to reduced sales of iron ore, down -50-75mt this year, and its iron ore production is -93mtpa below levels before the dam disaster. Iron ore markets, the analysts calculate, are currently facing a supply disruption of around -6% of the seaborne market. Accounting for an increase in China's iron ore output, in response to higher prices, this is only slightly better, at -5.5%.
The CBA analysts upgrade estimates for iron ore prices by 7% to US$92/t in 2019 and by 3.5% to US$74/t in 2020 on the back of further downside to China's iron ore port stockpiles. UBS has lifted forecast prices for 2019 and 2020 by 8% and 4% to US$90/dmt and US$80/dmt, respectively.
The broker expects earnings for major iron ore miners will be lifted by up to 17% in 2019 and, in Australia, Rio Tinto will be the largest beneficiary. China accounts for 70% of the world seaborne imports and, more specifically, iron ore prices are primarily driven by physical changes to supply and demand.
Significantly, cost curves are steep at these prices such that that any change in supply conditions can cause iron ore prices to move wildly, in either direction, the CBA analysts assert. Warnings have been sounded that volatility will be extreme if China's iron ore port stocks fall below 100mt. As seaborne markets are missing around -90mt of production right now there is a risk this will occur.
The lag between the drop in China's port stockpiles and the dam disaster reflects the timing of shipments from Brazil to China, and the efforts by Vale to deplete any existing stockpiles. The CBA analysts note, in the past, port stocks in China been overlooked because of a higher proportion of low-grade ore. Not only has this proportion moderated but low grades are becoming more attractive following the surge in prices.
Iron ore port stocks may be a two-year lows but do not look particularly low versus recent history, in Macquarie's view. The broker suggests it is better to look at stocks relative to some estimates of demand. While demand continues to outpace supply for now, and stocks may drop for another week or so, Macquarie believes the physical squeeze is past and steel production should seasonally slow.
Also, Australian supply is running above its average and more Brazilian cargo should arrive in China by early June. The CBA analysts point out that around 40mt of production from Vale that is off-line is largely because of Brazilian regulator intervention. The 30mt Brucutu mine has received most of the scrutiny, in that this could return to production quickly if approval is obtained.
Since the mine was first ordered shut in on February 5 there have been two occasions when approval was granted and then withdrawn. Vale's production is expected to be normalised over three years and Brucutu, which does not use the same type of dam at that which collapsed at Feijao earlier, is expected to come back on line over the next 6-12 months.
Australian iron ore majors have shipped volumes at above-average levels in the last few weeks, yet Macquarie notes Rio Tinto is currently running well short of guidance following a weak first quarter. Sustaining very recent levels of shipments may prove difficult and the broker expects a reversion to the average. Fortescue Metals ((FMG)) and BHP Group are shipping in line with guidance.
While tonnage has been variously lost from Vale, Rio Tinto and BHP Group, UBS observes growth in Anglo-American's Minas Rio mine and notes Australia's Roy Hill is at capacity. All up, the broker forecasts 2019 seaborne demand to lift by around 30mt and supply to shrink by -40mt. The latter is based on known outages and prior to any lift in production from countries which previously used to export iron ore at higher prices.
Macquarie's latest survey of Chinese steel shows sentiment on the 3M steel market has become a little less positive. End-user demand remains driven by general construction activity and demand for flat steel has declined sequentially in April.
Steel margins, which reflect the ability of mills to absorb higher iron ore prices, have been supported by rising steel prices. China's crude steel output rose to a record high in April and China's policymakers still plan to increase expenditure on infrastructure.
Meanwhile, India is expected to face an iron ore shortfall next year and, if it has to import more iron ore as a result of its bureaucratic processes, the CBA analysts suspect iron ore prices may linger in the US$80 region, or even the US$90, next year.
See also, Material Matters: Iron Ore, Met Coal & Copper on May 21, 2019.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
FNArena is proud about its track record and past achievements: Ten Years On