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Will the strong rise in iron ore prices continue in H2, 2019?


  • Iron ore price records strong performance due to supply cut in Brazil and Australia
  • Major miners cut guidance on yearly production; commodity might see deficit during the year
  • Slower steel demand, subdued economic cues may weigh against strong performance going forward

 

Iron ore, the raw material used for making steel, steered higher during the first few months of 2019, with the price as tracked on spot markets in China, SGX AsiaClear iron ore futures (62% Fe grade) and Chinese Fine and Lump prices of 58% to 62% grade, rising anywhere between ~20 to 50 percent since the start of this year. According to the latest reading for the week ending April 19th, iron ore at SGX for 62% Fe content was hovering near $90 per MT level, while China iron ore spot prices stood (average grade) near ~95 per MT mark. Moreover, for the other major Chinese iron ore contract traded at the Dalian Commodity Exchange, its most active September contract stepped up to ~635 Yuan per MT (USD 94) during April, gaining 32% YTD. Almost all major contracts for the commodity across the globe have touched or are moving towards the highest levels since mid-2014, following the mining accident in Brazil in January and the latest weather-related issues in Australia.

On 25th January, one of the tailings dams of Vale near Brumadinho, Brazil broke away driving mud, sludge and waste in open. Hundreds died due to the disaster forcing the government and other policymakers to take stern action against the company. Other than the humanitarian loss, the accident is expected to hit the Brazilian economy as a whole, alongside the global iron ore markets heavily. Vale is among the biggest companies in Brazil, while it is also the largest iron ore producer in the world. The accident prompted the Brazilian government to ban new ‘upstream mining dams’ that were being built on a similar technique, whereas it ordered decommissioning of all such dams in different mining regions of the country by 2021. The upstream tailings dams which hold mining by-products are cheaper to build, though they present a high-security risk as these require less solid material and ground for their construction. Vale has since announced that it would decommission almost a score of its dams built using a similar methodology. The company, through separate statements in the last two and a half months, has continuously raised concerns on the expected loss of mining from the region. According to different reports, Vale is expected to witness a production cut of around 90 Mn MT of iron ore including ~11 Mn MT of pellet production this year. Positively, the company is expected to utilise inventories and would also try to manage additional supplies from other stable mining areas, still, the overall cut from Vale is anticipated in the tune of 50-75 Mn MT. Televisory feel that the total supply from Vale in 2019 may vary between 325-350 Mn MT, which will be significantly lower than its targeted ~400 Mn MT supplies for 2019, as proposed earlier, though is still better-off than the initial estimates going around at present. The above numbers may see a further upward reduction on how fast the company is able to roll-back production from some of the temporary closures like the Brucutu mine, which has an annual capacity of around 30 Mn MT and was earlier closed due to the nearby dam closure.

If the above issues were not enough, iron ore supply is seen to be additionally inflicted by supply cut from the major Australian producers namely Rio Tinto and BHP, which through separate statements announced a reduction of their guidance for the total supplies by 5-7 Mn MT and 6-8 Mn MT, respectively, amid the damage caused by cyclone Veronica. Fortescue, the 4th largest supplier of the steel-making ingredient in the world also said that a marginal cut against its earlier estimates is possible, though the quantum is limited to the tune of 1.5-2 Mn MT.

The global markets are expected to see a deficit of the commodity, which will range from 30-60 Mn MT for the year, with a probability of a further reduction in the deficit. The number is seen lower than the actual cuts announced lately as Vale might come-off better than what the current estimates suggest in terms of the production cut from the player, while a number of small miners within Brazil, China, Australia and India would look to enhance the output to catch the high price scenario and indirectly stem the deficit incited due to supply issues. The strong price performance in the commodity during the initial months of 2019 is backed by an anticipated deficit against expectations of a balanced market during the start of the year. On a subdued note, there are still areas which the broader market is not focusing at the moment, mainly a scenario, wherein policy tightens from governments across the globe and especially Brazil and Australia post the January incident. Brazil mining agency’s ban on fresh upstream tailing dams can have concurrent effects on iron ore producers in other countries, particularly Australia, the largest producer and exporter of iron ore. Australia has over 100 dams which are constructed using the upstream methodology out of a near total of 800 tailings dams in the country used for different types of mining waste. A low priority now, however, in case, the Australian regulators weigh tight regulations on these set-ups, it has the capacity to aggravate the mood for iron ore supply in the global markets and can foster a positive impact on prices.

Looking at the broader picture, the steel consumption growth seems to be decelerating amid a moderately subdued economic environment across the major emerging and developing economies globally. Chinese economic growth has been consistently revised lower, year after year, while fresh issues are erupting out of the EU region, with Germany just managing to shy away from a recession and Italy falling for the same. The US is also expected to see a modest cut in its GDP performance for 2019 as effects of the US-China trade spat and the weakening outlook in other economies take a toll on the world’s largest economy. Further, as per the latest report from the World Steel Association, the demand for the commodity, which fuels consumption for iron ore might grow by a meagre 1.3% (2019) to 1735 Mn MT as the demand from the world’s largest consumer China, flattens, while it may see a contraction in 2020. Addedly, any increase in the steel demand is expected only if there is a fresh round of stimulus from Chinese and other major governments, whereas an amicable solution to the trade issue is arrived upon sooner rather than later. Slow growth in consumption is seen to be hitting the production as steel-makers might look at trimming their internal forecasts based on the overall demand scenario. Additionally, high raw material prices, especially for iron ore in the past few months might add to the worries as extended gains in iron ore could deter the margin growth, which most corporates were witnessing throughout the world during the past few years (backed by higher steel prices).

As for the steelmaking commodity (iron ore), the high price momentum is expected to continue in the short-term. This is a supply side story, wherein aspects regarding iron ore demand do not look too optimistic if we examine the steel consumption-production trend and the future forecasts alongside the state of the economic developments around the major economies globally, particularly China. There has not been much movement in terms of the demand from China if we track monthly iron ore imports for Feb. and March month, whereas inventories also stayed largely stable. While extended effects of iron ore production cuts cannot be ruled out and the same is already getting reflected in prices of the commodity, things might ease during the second half of the year. Supply aspects would also provide a higher clarity with respect to the actual output from Vale and other key players by that time. On the pricing side, stability after the recent rise would work best for the industry as raw material suppliers gain significantly due to unexpected and sudden gains at least on their spot sales and contracts which had variability price clause. Any further rise from here though can lead to re-starting of closed iron ore mines in Australia, parts of China, whereas countries like India which have additional capacity can also start adding to world markets. One can say, we are nearing a peak on the current upside cycle for the commodity. While prices are seen averaging, better than the rates seen during much of 2018, though acutely lower than premiums which are attached to the iron ore spot and future contracts currently. Any strong and sustainable up-move from here can only come in if we see very solid stimulus measures, regulatory action by the major governments following the accident earlier this year or a fresh round of supply issues due to unforeseen circumstances.

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