Commodity Focus: Iron Ore
If Australia once rode on the sheep’s back, today a strong case could be made that it is Australia’s ability to satiate China’s insatiable appetite for iron ore which drives the economy.
IN 2003, the appetite for iron ore crystallised in the ‘ once in a century’ resources boom that lasted for nearly a decade and a half – an economic windfall not seen since the gold rush of the mid 1850’s.
The boom’s serendipitous timing kept the Australian economy out of the Global Financial Crisis, the worst recession since the great depression.
But in 2012, iron ore prices had begun tapering off, bottoming out at about US$40/t in 2016.
In 2018, Australia still held the lion’s share of global exports at 53pc, equating to about $64b of exports in 2018, 81pc of which was sold to China.
Since 2016, iron ore prices ebbed and flowed, but they did not come close to the US$187/t highs of 2011 – until a mix of tragedy and circumstance early in 2019 began driving iron ore up to boom-time prices again.
The tailings dam collapse at Vale’s Brumadinho mine in Brazil that killed more than 200 people also shut down the world’s second largest iron ore exporter, leaving a massive 90mt hole in the supply chain.
Vale confirmed that it will take two to three years to return to the pre-rupture target of 400mt.
In Australia, Cyclone Veronica caused the Pilbara’s three big players FMG, RIO and BHP to all significantly lower their iron ore guidance which further tightened the seaborne supply.
And as the Sino-US trade wars have continued to escalate, prices have continued to rise.
To combat US imposed tariffs, the Chinese government rolled out economic stimulus in the form of tax cuts, increased lending to smaller companies, and increased investment in infrastructure and construction projects which has kicked its steel making mega-machine into overdrive at precisely the time when Chinese iron ore stockpiles were at their lowest in recent times, down by 17pc year-on-year for May.
This caused prices to rally by more than 70pc, to over US$120, and has generated billions of dollars in revenue for mining companies and state and federal governments alike.
Experts and commentators have speculated that the iron ore windfall which filled the government’s coffers was one of the deciding factors in Federal Labours shock defeat in the 2019 election.
Fortescue Metals Group chairman Andrew Forrest paid himself close to $1b in dividends, Rio Tinto said that every $10 price rise per tonne for iron ore generated about $1b in profit, and BHP looks set to de-throne Rio Tinto and take the crown as lowest-cost producer of iron ore in the Pilbara.
BHP has also been given the green light by the WA state government for its 50-100 year plan in the Pilbara which would see more than 12 new potential mines in the region and cut down environmental approvals times by up to 50pc, and South Flank is expected to reach 80mtpa by 2021.
Rio Tinto’s Koodaideri will come online late in 2021 with an expected nameplate capacity of 43mt.
FMG will see its Elwina mine reach production in December 2020, and Iron Bridge will reach production by 2022.
FMG chief executive Elizabeth Gains told the Australian Mining Review that the wide product offering from the two mines would position the company to meet a range of segments from low to high iron content.
“Against a backdrop of an iron price of above US$120/t – which none of us would have predicted six months ago – China’s steel industry continues to outperform expectations with growth in crude steel production in the first half of 2019 supporting predictions that annual steel production could reach 1bt this year,” she said.
“The strength in the iron ore price is in part attributable to seaborne iron ore demand outpacing supply following the impact of the tragic event in Brazil earlier this year, as well as more recent weather-related events in the Pilbara.”
Mr Forrest has also entered into talks with the ruling family of Dubai aimed at resuscitating a railway line linking Guinea to the Liberian port, Buchanan.
The re-establishment of the railway would pave the way for the possible reassessment of Guinea’s Nzerekore region, long considered the world’s next iron ore province, which hosts a series of very large and very high-grade iron ore deposits.
While the soaring price has been an unexpected windfall for Australian miners, understandably not everyone is happy.
Eight steel firms representing 30pc of China’s steel output gathered at the China Iron and Steel Association (CISA) on June 27 to discuss strategies to cope with the crippling price of iron ore as the 69pc increase continued to frustrate the booming steel-making industry.
According to documents obtained by Reuters, in the meeting’s minutes, the companies blamed poorly designed methodologies by price reporting agencies, speculators on the futures market, and poor trading mechanisms in the spot market.
“There are some non-market factors behind the price rally.
“Especially in recent months,” the note said.
In another meeting, one attendee who wished not to be named told Reuters that “Government officials said they support industrial participants’ assertion of their own rights and will resolutely sustain market order”.
The June Resources and Energy Quarterly predicts that the price will return to an average of US$57/t by 2021 as Vale begins producing at full capacity and the Chinese government eases up on steel-reliant infrastructure spending.
The outlook to 2021 is quite positive, with prices expected to continue benefitting from the shortfall in global seaborne supply, however there are some factors that should be taken into consideration.
Firstly, China’s iron ore imports declined by 4.9pc year-on-year in the last half of FY19, despite the record high steel production.
This can be attributed not only to the supply disruption from Brazil and Australia, but also to the increased domestic iron ore production and the rising use of scrap material that has displaced some of the need for iron ore.
Chinese steel makers are attempting to use lower-grade iron ore and more scrap metal to offset the high prices, which will reduce their reliance on imports and affect the price difference between high and low-grade iron ore.
Secondly, with a short-term demand increase from a single economy comes the increased risk of production oversupply once the demand dies down.
Iron ore is famously common.
It is everywhere.
But getting it out of the ground is expensive.
The infrastructure required to mine and process it is a massive investment.
FMG gained its foothold as a major player in the industry only after the extended boom period afforded it the profit margins needed to establish itself.
While Australia can expect its export volumes to increase by 3.9pc with FMG’s Elwina and Iron Bridge, Rio Tinto’s Koodaideri and BHP’s South Flank all expected to come online before 2022, they cannot fill the gap left by Brazil.
Should iron ore continue to command high prices for an extended period of time, the door could open for new players in Guinea, the Democratic Republic of Congo, and Canada to find a foothold which could lead to oversupply and affect price stability once Vale returns to nameplate capacity.