Will The Spike In Iron Ore Prices Hold?

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Iron ore prices are likely to remain at elevated levels for the near term as the market assesses the reliability of supply in the wake of the Vale tailings dam failure.

-Supply likely to tighten, iron ore prices stay elevated for the near term
-Vale to alter iron ore production mix, less pellet and more lower-quality fines likely
-A review of tailings dam construction may have long-term implications for prices
 

By Eva Brocklehurst

The catastrophic collapse of a tailings dam at Vale's Feijao mine, the second such failure in Brazil in three years, has triggered a spike in iron ore prices. Brokers suspect, while the impact on Brazillian iron ore operations is assessed, prices will remain at elevated levels.

Mysteel reports traders are concerned about Vale's other vast operations, which may be curtailed for safety checks. Vale is the world's largest iron ore miner. ANZ analysts expect the market should tighten because of the closure of the mine, noting 7.3mtpa of supply from the Feijao mine has already been lost in the current quarter.

While the company intends to increase production elsewhere, the analysts estimate a total loss of around -13mt net in 2019, which should, on their forecasts, push the iron ore market back into deficit. As a consequence short term forecasts are raised and spot prices are expected to breach US$80/t in the current quarter. Further upside is likely if the losses in Brazil are more than expected.

As its base case accounts for a 40mt global surplus in 2019, Morgan Stanley believes a -15mt cut to production by Vale would still leave the market in surplus, while a forecast surplus for iron ore continues to feature in Deutsche Bank's estimates too, although this has been lowered to 29mt for 2019 and 36mt in 2020.

Deutsche Bank retains its bearish view on prices, nonetheless, expecting an average of US$68/t in 2019, as declines accelerate over the rest of the year. The main driver of this bearish view is minimal steel production growth in China, while the risk lies with the reliability of supply.

Credit Suisse agrees Vale's plans add risk to the market. A pre-condition for iron ore prices to decline in the June quarter, as the broker forecasts, is China's port traders rebuilding inventory levels by the end of March.

Having assessed no significant rebuild occurred in January from the 2018 depletion, Credit Suisse believes a rebuild of at least 10mt may be needed from current levels by the end of the March quarter, in order for prices to ease in the June quarter.

The broker's base case assumes that Chinese steel demand will slow down because of weakening housing construction and, consequently, demand for iron ore should slacken off. China's imports of iron ore are likely to return to growth in 2019, the ANZ analysts assert, as domestic production falls and there is move to use higher grades.

Seaborne Mix Changes

Credit Suisse believes the mix of production from seaborne iron ore should change, with pellet capacity likely replaced with fines to the tune of 11mtpa. Vale has indicated that its mix of iron ore will be different, given mine suspensions. This replacement iron ore is likely to have higher silica and alumina levels, as it will come from lower-quality mines.

Morgan Stanley suspects the iron ore pellet premium will be affected for longer than is generally believed, as offsetting pellet production will be harder for Vale. Deutsche Bank also expects, given the current disruption, that pellet premiums will rise and this should benefit specific players such as Rio Tinto ((RIO)) and the remainder of Vale's pellet portfolio that is unaffected by the recent disaster.

The broker assesses BHP Group ((BHP)) has little scope to further boost its volumes above the rate already needed to achieve FY19 guidance. Furthermore, the lower-grade discount versus benchmark should fade as an issue for Fortescue Metals ((FMG)). High expectations are factored into the stock and long-term prices would need to be 15% higher to justify the current share price, in Deutsche Bank's view.

Credit Suisse agrees BHP does not have additional capacity, nor Rio Tinto for that matter, to compensate for the reduction in Vale's capacity and doubts Fortescue Metals will increase output. Hence, there may be no constraints to upside for prices if steel demand remains strong.

Meanwhile, the ANZ analysts expect India to become a permanent net importer of iron ore as constraints on production and exports are likely to continue. India has historically been a net exporter, having a relatively small albeit growing domestic steel market. However mining bans in India have hampered supply and, as a result, mills are topping up iron ore from the seaborne market.

Brazil

The disaster in Brazil, which Credit Suisse suspects stems from unforgiving topography and rainfall, has highlighted the fact that risky dams apparently exhibit little outward signs of a problem.

Credit Suisse expects wet tailings dam capital expenditure costs will rise as more robust designs are used, while many new operation will offer dry tailings stacking, despite the higher expenditure. This may have long-term implications for iron ore prices.

Deutsche Bank expects production reductions in Brazil will take place over many months, as decommissioning plans are reviewed. Meanwhile, the Brazilian government has decided not to punish Vale while it deals with the aftermath of the disaster and investigations begin. However, a response may be forthcoming, which brokers acknowledge could affect output.

Vale estimates the suspension of certain mines will result in production from its southern system falling by -40mt, to allow the decommissioning and removal of 10 tailings dams that were constructed using the upstream method.

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