PEAK PRICING
ý This time last year, alarm bells were going off as iron ore prices inched towards $100 a ton.
The price, warned pundits and mine bosses alike, was simply unsustainable.
By December, at
$120/t, the alarms had begun to screech.
A huge correction was overdue, people said.
But the iron ore price has defied logic and has already breezed through $190/t this month, a price last seen a decade ago.
You’d expect the laws of gravity and the market to kick in at some point — but when, and why? And who will call the peak?
After all, just about everyone got the iron ore price trajectory spectacularly wrong.
“Iron ore is shredding the handbook on pricing,” says John Meyer, partner and head of research at SP Angel. “Futures markets have lifted prices far beyond the cost of marginal production and well over production costs.”
For example, he says, Rio Tinto’s unit cash cost was $15.4/t last year at its Pilbara operations in Western Australia. BHP’s cash costs, excluding royalties, were $11.82/t in 2020.
While the price may be shredding conventional wisdom, analysts are now enthusiastically embracing the madness.
But, says independent mining analyst Franco Lorenzani, “where have these analysts all been? Now they’re all upping their commodity prices but they’re behind the curve. I don’t need someone to tell me now that the target price is $200/t, when the price is $180 or $190.”
René Hochreiter, consulting mining analyst at Noah Capital Markets and Sieberana Research, says everyone missed the iron ore price story because they have been fixated with the short term. “The younger analysts don’t think further than the next quarterly results and most analysts have totally underestimated demand.” As usual, China is playing a major role. Supported by the government’s new infrastructure plan and underpinned by a hefty stimulus package, Chinese steel demand has risen past 1-billion tons a year.
“Demand for iron ore and particularly higher-grade iron ore imports continues to rise in China, drawn in by new stimulus projects and the need to reduce excessive pollution in urban areas around steel mills,” says Meyer.
But it’s more than that, says Lorenzani. “We are in this unique moment where the whole world shut down and everything stopped. [Then] the vaccines, the opening of trade, all kind of happened at once. Now you’ve got China rocking and rolling — and it has probably got a sixmonth lead on everybody.”
What’s more, “you’ve got the US now throwing cash left, right and centre. So we’re faced with this unique, upward explosion of demand where supply clearly is being found out.”
He says the prices reflect not just demand but also the many bottlenecks, from trucking to shipping. For example, the Baltic dry index, the benchmark for the price of moving major raw materials by sea, has hit 11-year highs.
The big question is whether investors in companies exposed to iron ore — like BHP Billiton, Kumba or Anglo American — have missed
Iron ore price US $/dry metric ton – monthly the boat and whether a correction is imminent.
Kumba, for example, has seen its shares rally 89% over one year, while BHP is up 52%. Vale stock has gained 151% over the same period.
“If you look five years out, demand will still be much higher than now,” says Hochreiter. “Even the suppliers — who believed the analysts’ price forecasts and therefore have not
Demand, particularly for higher-grade iron ore imports, continues to rise in China, drawn in by new stimulus projects and the need to reduce pollution in urban areas around steel mills
John Meyer
expanded production — are playing catch-up with the surging demand.”
But Lorenzani says history dictates that the supply deficit will correct.
“Initially, when there is some cash in the business, miners listen to shareholders … and don’t expand any further. So you have a supply shock almost, and then you only wake up to demand when it’s almost too late so then of course the prices shoot up. [Then] they all sort of turn on the taps and overpay for assets — Anglo American’s Minas-Rio acquisition is a good example – and the whole thing starts again.”
In 2015, when oversupply caused an industry bloodbath, former Fortescue Metals Group chair Gordon Toll was scathing about iron ore producers that had shown “appalling ignorance of major economic market structures”.
“The iron ore business is an oligopoly. In any well-managed oligopoly you manage for margins not for volume. Managing the volume is a surefire recipe [for disaster],” he told The Sydney Morning Herald.
This time, producers do appear to be moving more cautiously.
In a recent quarterly earnings call, Eduardo Bartolomeo, CEO of Vale, the world’s secondlargest iron ore producer, assured shareholders that there is no major spending or transformation or M&A activity on the company’s radar.
Rio Tinto, the world’s largest iron ore producer, is struggling to meet its 340Mt guidance for this year due to Cyclone Seroja and the challenge of bringing 90Mt a year of replacement mine capacity on line, says Meyer.
But if the supply side of the equation doesn’t bring prices down to earth, there is something else that might — a Chinese government worried about high steel prices.
Already, Meyer says China’s tolerance of such high iron ore prices is puzzling, given how important steel is to the Chinese economy.
“Either some influential princelings are making a packet out of iron ore pricing or the government is simply not willing to tackle the mechanisms which have enabled iron ore prices to rise to these levels,” he says
Meyer notes that even the China Iron & Steel Association has asked the government to play a bigger role when the market “malfunctions” and to improve policies for the futures market amid sky-high iron ore prices.
China may not be happy with the prices but may tolerate the situation as it helps maintain high-cost iron ore production in that country, albeit at the expense of higher steel prices, says Meyer. “If it does act, it is more likely to act against speculation on its futures exchanges before it changes plans relating to economic development.”