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Iron ore prices struck with persistent supply glut

  • Industry hit by stubborn supply glut
  • Chinese stockpiles at their peak
  • Top industry players persistence on increasing the production

 

Iron ore, which is the key raw material for steel was one of the most sought-after commodities in 2016 as it saw a reversal against its incessantly plunging prices. Iron ore prices soared by a whopping 68% (2016), the year began at ~41 USD/MT and closed at ~69 USD/MT. This jump was driven by a combination of consumption increase from China (world’s largest consumer of the commodity) and expected demand from the United States under President Donald Trump’s government (strongly advocating infrastructure led growth).

The upsurge during 2016 continued in Q1 2017 as well. However, correction set in thereafter, when prices dipped by 19%, 12% and 6% in the April, May and June, respectively. Consequently, closing Q2 2017 at 58 USD/MT. According to the latest figures, these stand near 60 USD/MT. Undoubtedly, 2017 has largely been a year of volatility for the raw material as prices ranged from as high as ~89 USD/MT (February) to as low as ~58 USD/MT (June). 

Moreover, this affected the actual demand-supply since the price boom in 2016 lured the players to produce more in order to encash on higher realizations. The global iron ore production saw a continuous increase in 2017 at ~5%, on a YOY basis (Q1 2017). However, this loomed on an addition to supply and triggered a price fall in April 2017, which was sustained through the 2nd quarter of the present year. Hence, the global production rose on one hand and mounted Chinese stockpiles on the other hand (as depicted in the chart below), this pushed prices to fall. The volatility continued as prices increased by 15% (July), 13% (August) and fell by ~7% (September) as Chinese government enforced stringent cuts in steel production capacity to reduce pollution levels in the nation. A low steel production indirectly weighed on low demand for iron ore and hence, saw a fall.

Furthermore, amid the price volatility, the main iron ore producers continuously increased their output during the first 3 quarters of 2017 and aim to further accelerate their FY 2017 production numbers (as announced in their guidance). The increase in the global prices and hence, realization coupled with a jump in production and sales volumes increased the revenue of top players, particularly in the quarter ending December 2016 and most of 2017. This, in turn, led to significant improvement in profitability. The EBITDA margins for Rio Tinto enhanced from 54% (quarter ending March 2016) to 64% (March 2017) and for BHP Billiton, this increased from 53% to 65% during the same period. Similarly, EBITDA margins for Vale improved from 46% (March 2016 quarter) to 61% (March 2017 quarter). However, this declined to 44% (quarter June 2017) primarily due to higher freight spot prices.

     

     

Hence, the industry was in a way traumatized by a persistent supply glut, the ideal reaction from the top players should have been a cut in the production levels. However, the response was opposite and the production increased continuously, thereby, putting more pressure on prices. The top players are low-cost producers (cost per MT ranging from USD 12 to 15) and could still afford to survive even with prices collapsing further. However, this will force the high-cost miners to eventually exit the market (players like Anglo-American, Atlas Iron and Cliff Natural Resources have already closed few of their iron ore operations in past 2 to 3 years).

On a positive note, the demand is expected to see buoyancy for the commodity. In 2017 and 2018, the global steel consumption is anticipated to grow and will be driven by the demand from China, the United States and the developing countries, especially, Brazil, Russia and India. Traditionally, (as depicted in the chart below) iron ore demand grew in line with the growth in the global steel production. Thus, a higher steel demand (as mentioned above) will lead to a rise in steel production, this, in turn, is anticipated to improve iron ore demand.

But, even this increase in demand may not provide a necessary boon to the industry as it is already flooded with added supply. In addition, the production is expected to surge in the next 6 to 12 months as the top 4 players have announced higher production numbers in their guidance. In an interesting development, ramp up of Vale’s S11D deposit (Australia) is setting new production records every quarter with 91.8 million MT (Q2 2017) and 95.11 million MT (Q3 2017). Hence, the global iron ore production seems to be growing at a brisk pace, this will rather offset the positive effects of enhanced demand.

Presently, the Chinese inventory is at its peak. The stockpiles were 125 million MT as of Q1 2017, the highest since 2015. The same trend can be witnessed in Chinese inventory to consumption ratio in the past few quarters, where the ratio touched a massive 43% (Q1 2017). 

Therefore, in nutshell, the supply-side has remained a problem over the last few years and still remains a serious concern for the industry. Hence, given a surplus, consistent increase in production and relatively slow demand growth, the glut is expected to stay in the industry for a longer period. Further, in near term (6 to 12 months), the growth in production is anticipated to nullify the impact of an increase in demand, thus, resulting in fall in prices from the current levels and is projected to hover around $50-$55 per MT (early 2016 levels, pre-boom period). 

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