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Think again if you believe high-cost iron-ore producers in China are shutting up shop in reaction to price falls, paving the way for a price rally and relief for marginal producers in the west.
In an interview with Mining Journal, Bart Jaworski, a senior analyst at Davy, Ireland’s largest stockbroker, said: “Everyone expected high-cost Chinese iron-ore production [predominantly in the private sector] to come out of the market. Our intelligence says otherwise.
“The authorities are telling those producers to hang in there. They are determined no more than 70% of Chinese demand be met by seaborne imports. To help meet that goal, they are offering producers incentives such as tax breaks, energy subsidies and other enticements.”
Davy said its information came from exclusively Chinese sources, including steel and iron ore traders, and steel industry managers.
All were respondents to a China-focused survey on industry prospects published by the Dublin-based broker earlier this month.
Said Jaworski: “The Chinese are telling producers to “bide your time for the two years, let the Aussies and Brazilians grow supply, but that growth will slow down … eventually.”
Another critical factor for the market, said Jaworski, was that although a few private iron-ore producers in China were being forced out of business, “that was being offset by larger, government-owned mines, which are ramping up production in order to drop unit costs”.
He foresaw a weaker iron ore price for longer than anticipated because “Chinese output is not going to fall as much as people thought”.
Asked if he thought the price would go lower than the current US$72 per tonne (the lowest in five years), he replied: “There is downside risk from here.”
But at some point Jaworski believed non-traditional iron ore production in Kazakhstan and Iran, as well as some of the higher cost material in Canada and the US, “might be coming off, and indeed some of it is.
“[But] the new supply coming on from Australia and Brazil is so large it offsets these small reductions.”
On the other hand, “the Chinese [producers, of course, not Chinese steel consumers] would really start to panic below US$70/t”, he said.
So, how does Jaworski think the bear market will end?
“Over the short term, the main thing that would make the situation more bullish would be a fiscal stimulus in China, or if Rio Tinto, BHP or Vale behaved more rationally… and cut production [viewed as very unlikely].”
In the near term, Davy sees the price between US$75/t and US$85/t.
“Over the longer term, I expect steel demand growth will eventually digest the iron ore glut and prices will recover somewhat,” he said.
As reported in Mining Journal on 26 September (‘Reality bites’ p18) former BHP executive Alberto Calderon gave a particularly stark picture of the challenges confronting existing producers when he said 350-400Mt/y of high-cost Chinese output was unlikely to disappear from the market and this would contribute to a blowout in the supply overhang from the current 100Mt/y to as much as 340Mt in 2016.
“The conventional wisdom was that the production tonnes that would be displaced through mines closing would be in China; this is probably not true,” Calderon said.
His view was that “China’s iron ore production will remain around 400Mt. Maybe it will drop to about 360Mt, but it should orbit at around those levels during the next few years. Yes there will be closures but new and more efficient mines are being built. China will repeat what it has done already in aluminium and thermal coal: create an oversupply of iron ore that will benefit them as a consumer country”.
“The bulk of the reduction in iron ore supply will not come from China. A significant part of the excess tonnes may come from Australia. What we can guess with some certainty is that prices will revert to marginal cost, even under-shooting into the low US$70s (per tonne) for some years, ”he said.
Separately, Davy has initiated coverage of Rio with an ‘underperform’ rating and a price target of £25.75, implying downside of circa 15% from current levels.
The note said: “Oversupply in the iron ore market is well understood by the market. However, our research shows that Rio’s valuation is still implying US$90-95/t iron ore prices – levels we think are too lofty.
“Our recent Davy on China Steel survey shows that 100% and 60% respectively of Chinese iron ore traders and steel mills expect prices to fall from current levels over the next year. This view is corroborated by our modelling, which suggests new supply will not be absorbed by new demand.”
Iron ore represents 51% of Rio’s revenues, according to Davy.(Written by Miningjournal Staff)