Iron ore, one of the largest traded dry commodities in the world, has taken a big hit over the past few years. It fell by ~24% (CAGR) from ~$150 per MT to ~$57 per MT between January 2013 to July 2016. In an ideal situation, the decline in the price calls for a slowdown in production, however, for iron ore, the story is somewhat different. The iron ore production increased by ~3% despite a continuous decline in its prices, with the major contribution from the top 3 players in the industry, namely Vale, Rio Tinto and BHP Billiton. These three iron ore producers together account for ~30% of the global production of the mineral. While the global production increased by ~3%, the surge in production by Vale, Rio Tinto and BHP Billiton was ~4%, ~10% and ~13% respectively from 2013 to 2015.
This reverse trend, that was deliberately pursued by major players is an attempt to monopolise the iron ore market. Thus, by consistently increasing production, these players are flooding the market with the product and putting further pressure on iron ore prices. The downward pressure on prices, in turn, is pushing the high-cost players out of the market. The companies like Anglo American, Atlas Iron and Cliff Natural Resources have already closed (either partially or completely) their iron ore operations in last 2 years.
Therefore, the behemoths have exploited their power in the market and directed the iron ore price movement. This was made possible by their exceptionally low cost of operations, large economies of scale and relatively strong balance sheet. Further, with iron ore prices hovering around $45-$55 per tonne and the average cost being $32 per tonne for these major players, they enjoyed some cushioning vis-à-vis their counterparts who operate at a cost above $50-60 per tonne.
However, the three giants have been revising their capital expenditure (capex) guidance since late 2015. For example, Vale revised its capex guidance, down to $6.2bn from $8.2bn in December 2015 and to $5.5bn in April 2016.
The outcome of this diminishing capex will not be known in the near future as these companies have already invested in huge projects and will shortly start yielding their output. For instance, Vale’s, Serra Sul (S11D) is one of the largest iron ore mining project which is expected to start production by the end of 2016 and will add 90MT to its capacity. Hence, this revised guidance does not imply a reduction in production rather just the slowdown in future capex.
Nevertheless, the iron ore price has changed its trajectory since the beginning of 2016 and has jumped significantly by ~43% from $40 per MT in January 2016 to $57 per MT in July 2016. The recent signs of improvement in the Chinese economy brought this surprise in the iron ore market. The YTD figures indicate that the Chinese steel output has increased by ~1.1% to 559.9 million tonnes. This increase in steel output is, in turn, driven by government impetus to sustain growth at ~6-7% in Q2 2016. The recent rally in prices was driven by China as it is the biggest producer and consumer of steel.
Lately, improvement in Chinese economy coupled with an on-hold production by several high-cost producers has led to the upswing in prices. Further, announcements regarding capex cut by these behemoths also influenced the iron ore prices, but this was driven mainly by sentiments and was not a reflection of the demand-supply balance. If the improvement in prices continues, these high-cost producers could resume their production. This together with production influx by the big firms could again add some pressure on the prices. Though, Televisory believes that the iron ore prices have already bottomed out, at least for now, this new demand-supply game is expected to cap the prices in the range of $45-$65 per tonne over the next few quarters.
Also Read:- Gold mining, movement in gold prices and operating performance of gold players
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