In Commodity News 10/04/2015
The iron ore casualties are piling up as the price plumbs ever new depths.
The price of benchmark 62 percent ore as assessed by The Steel Index (TSI) is now trading below $50 per tonne, which is the lowest level since TSI started compiling spot market prices in 2008.
Few, if any, expect a sustainable recovery any time soon. The consensus is for a long war of price attrition as an over-supplied market rebalances by forcing out higher-cost production.
That process is now accelerating.
Just in the last week Canada’s Labrador Iron Mines has initiated a court-supervised restructuring and Australia’s Atlas Iron, an established producer, has requested a suspension of its shares while it considers its survival strategy.
Such companies are just the publicly-traded face of producer pain. Across the world, many others are quietly failing.
Not entirely surprisingly, governments are starting to worry about the longer-term costs.
The state of Western Australia has said it will defer royalty payments for smaller producers. “Not a hand-out”, stressed the state’s mining minister Bill Marmion, just a “temporary relief”.
And now China is getting in on the act, the Shanghai Securities News reporting that the government is drawing up unspecified plans to subsidise parts of its iron ore sector.
China has most to lose from the current market dynamic.
Not just because its iron ore producers are among the highest-cost in the world. But also because it is starting to dawn on policymakers that from the current Darwinian battle of survival is likely to emerge the old supply oligopoly against which Beijing railed for so long.
Government subsidies, however, are only going to make the whole displacement cycle that much messier and more protracted.
WHEN THE COST CURVE DOESN’T WORK
Such has been the speed and severity of the collapse in iron ore prices that even cost-curve economics are no longer sufficient to ensure survival.
The true metric, as recently spelt out by Rio Tinto’s iron ore chief Andrew Harding, is balance sheet strength.
That means even Fortescue Metals, the new kid on the Pilbara block boasting cash costs of around $30 per tonne, is having to soothe investor fears about its debt repayment programme.
But at times of low commodity pricing, governments are incentivised to provide some balance sheet “relief” to keep their mines operating.
This is particularly true if mines are ultimately state-owned, which is often the case in China.
There have been no details of what form iron ore subsidies might take but a sector such as aluminium smelting provides plenty of evidence of what can be achieved if the political will is there.
China’s aluminium smelters are among the highest-cost in the world and many should, in theory, have closed years ago in the face of protracted low prices.
But most of them haven’t thanks to a range of “temporary relief” measures from both central and local governments, often in the form of reduced power charges and zero-interest loans.
The result is a chronically over-supplied Chinese aluminium market with surplus seeping out to the detriment of aluminium producers everywhere else.
Neither cost-curve nor balance-sheet economics work in aluminium because such subsidies have effectively overridden both.
It’s possible that China is about to do something similar with its iron ore mines.
BACK TO THE FUTURE?
Indeed, given the history of the iron ore market, it would be surprising if China doesn’t try to intervene in the iron wars.
The chart below shows the split of China’s iron ore imports by origin country, specifically Australia, Brazil and everywhere else.
The key take-away is that even as total import volumes have risen, so too has the share of Australian and Brazilian ore.
Imports from other countries have fallen from around 30 percent of the total in January 2013 to just 18 percent in January 2015.
This, of course, is what is supposed to happen with cheaper iron ore from the biggest producers displacing higher-cost iron ore from opportunistic suppliers who were drawn into the market when prices were high.
From a Chinese perspective, however, it looks very much like a return to the bad old days, when iron ore supply was essentially controlled by the “Big Three” producers, Rio, BHP Billiton and Brazil’s Vale – particularly when the changing import ratios are viewed in tandem with mass closures of domestic production capacity.
The logical conclusion for Beijing is that unless China itself acts to protect its domestic industry, it will face a future which bears uncomfortable resemblance to the past days of foreign oligopoly.
They were far from happy days for either side.
China’s Iron and Steel Association would regularly lambast what it alleged were monopolistic tendencies by its big suppliers.
It was more than just verbal sparring. In 2009 the Chinese authorities arrested Hu Stern, an iron ore negotiator for Rio Tinto, on charges of bribery and industrial espionage. He is still serving a 10-year sentence.
It might even be suggested that BHP Billiton’s careful nurturing of a spot iron ore market was a way of displacing an increasingly acrimonious pricing relationship with its main buyer, China.
It’s ironic that the spot market is now working in favour of a return to the bad old days of iron ore pricing.
SURVIVAL OF THE FITTEST?
Chinese subsidies, however predictable, are only going to make an already ugly market that much uglier.
Because it will mean high-cost supply, or certainly a tranche of it deemed sufficiently strategically important, will not exit whatever the price.
With no signs of the big producers backing down from their expansion plans and with every sign that China is already close to “peak steel” production and therefore peak iron ore consumption, the prospect is for a prolonged period of super-low prices – a lengthy battle from which only the fittest will emerge.
The likes of Rio, BHP Billiton and Vale are confident they will be among the survivors, given their low production costs and balance sheet strength.
But if this really is going to come down to balance sheet strength, none of them is as strong as the Chinese government.
