IRON ORE May 2017
Production at Risk

The iron ore price has begun to fall during the second quarter of 2017 and is expected to remain subdued for the medium term. With the continued ramp up of Roy Hill and S11D and the probable return of Samarco; a surplus is likely to exist in the short term. Given the expectations of a surplus and lower prices we have examined which type of operations are most at risk and culling of production is most likely to occur.

Chinese Producers

As shown in the cost charts below there is a major concentration of Chinese mines in fourth quartile of the cost curve. While, the vast majority were operating at positive cash margins in the first quarter of 2017, this will shift to very low and negative margins in the short term. Mines in China are the highest cost producers due predominantly to the low-quality magnetite resources that are mined and the smaller scale of production. Production of iron ore in China has fallen from around 350Mt in 2012 to 140Mt in 2016. Despite the high cost, Chinese domestic production is thought to be nearing a floor, at the level of domestic pellet production capacity. For this reason, further significant falls in production are not expected despite a low medium term price forecast.

 

 

United States Producers

Iron ore production in the United States is sourced from taconite mines in the Lake Superior region. These mines reside in the fourth quartile of the cost curve and have a high cost due to their low grade and the costly process of finely regrinding the ore to liberate the magnetite. Even though the mines are high on the cost curve they are protected geographically from the threat of seaborne supply. Seaborne supply has a significant additional transport expense to access the steel mills around the Great Lakes region. The domestic steel industry and iron ore supply is also considered of importance to national security in the US. Production is further presently supported by the current administration rhetoric on increased infrastructure spending and support of increased steel production in the US and subsequent increase in iron ore production.

Indian Producers

Iron ore production in India recovered significantly in 2016 after government mandated closures in 2014-2015 resulted in India needing to import Iron ore to feed the steel plants in 2015. While iron ore demand is expected to grow significantly in India, production of lower quality exported iron ore from Goa will be at risk in a low price environment. India is also unlikely to improve the internal and costly freight issues it has in the next three years to be able to economically move iron ore from the western states to the eastern where the major steel plants are located.

Major Producers

The major producers of Vale, Rio Tinto and BHB Billiton have previously stated their intentions to manage supply and support prices. As a result, AME expects that within the forecast lower price market they will limit more marginal production and will not run operations at their full capacity. We expect this will result in a delay of the projects and expansions like Koodaideri with a slower ramp up from 2021-2024 before reaching 35Mtpa and Jimblebar not commencing further expansion till 2021 and taking four years to reach 60Mtpa.

Concentrate Producers

The third party concentrate market is relatively small. The majority of exporting sites will further upgrade a concentrate by pelletising first to produce pellets suitable for either blast furnaces or for direct reduction. Mines that produce a concentrate for export are generally at the upper end of the cost curve due to the increased processing costs they incur to upgrade the iron ore to marketable product. Additionally, those that choose to export concentrates are also likely to be geographically located in high energy cost market, making the pelletising process uneconomic. With a high cost structure and lower revenue from weaker prices these operations will be at increased risk of closure.

Lower Quality Fe Producers

Since 2011 the 58% Fe fines price has normally (85% of days) been within a 10% discount range of 6%-16% of the 62% Fe fines price. During April, this discount has greatly increased and at the end of April the 90-day average discount has increased to 19%. Discount levels of this size have not occurred in the last 5 years. The current high price for premium hard coking coal is thought to be increasing downward pressure on the 58% Fe fines price as steel producers favour high grade and low impurities iron ore products to reduce their coke needs. The leads to a fall in demand for low grade iron ore and has significantly impacted the 58% Fe iron ore price. While coking coal prices are expected to subside from their current level in the second half of 2017,AME expects prices to maintain at high levels in the June Quarter. This, coupled with increasing low grade exports from Goa will likely see an increased 58% Fe discount be maintained. On top of that, with the expectation of a price correction for iron ore, this will place exporting producers of lower quality iron ore at increasing risk of margin pressure and possibly lead to exits in the market.

 

 

Supply at Greatest Risk

In conclusion, based on our assessment, we expect to see production possibly curbed in three ways: supply control by the majors; a reduction in supply from operations producing lower quality product and; a reduction in seaborne traded magnetite concentrate.