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High-grade ore demand drives up prices

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Much has been written about the impact that the Chinese government’s recent restriction on heavy manufacturing might have on the country’s economy. Not only has China put its annual winter shutdown in place, there has also been a clampdown on illegal steelmaking as the country looks to improve its air quality.

The introduction of restrictions in China in the latter part of last year have actually caused iron ore prices to rise continually. High-grade material (Metal Bulletin iron ore concentrate index (66% Fe) cfr Qingdao) reached $100.83 per tonne on January 12. Medium-grade (62% Fe) delivered to China (normalized to Qingdao) reached a four-month high of $79.08 per tonne on January 11.

Georgi Slavov, head of research at Marex Spectron, explains that there were three reasons for this impact of China’s governmental policy. First, the supply of EAF steel was reduced which, on stable demand, increased the demand for steel produced via the blast furnace route: “Naturally, iron ore demand goes up in this case.”

Secondly, the crackdown on illegal and semi-legal steel production, which coincided with implementing the new anti-pollution policies. Responding to those policies, steelmakers turned to higher grades of iron ore, which require lower coking coal consumption and hence reduces pollution.

Thirdly, “coking coal prices shot up [by 300% between 1H 2016 and the end of 1H 2017]which made the economics of using higher-grade iron ore [and a lower quantity of coking coal] even more compelling.”

He reminds that those factors, in particular the demand for higher-grade ore, have been responsible for the price spread between lower and higher-grade iron ore blends widening.

Casper Burgering, senior sector economist at Group Economics of ABN AMRO, suggests that demand for higher-grade iron ore has not only been driven by China, since there was also a stronger increase signaled outside the country over the last couple of months. “Nonetheless, the volumes of iron ore demand are high and shifts in demand have a huge impact on market dynamics.”

Burgering notes that the current increased demand, and the resultant high price, is the consequence of two factors – recovery from recent relatively weak demand and Chinese pollution restrictions driving consumption of higher grades. But he is cautious about concluding how Chinese governmental policies will affect the country’s imports of ore. “The steel mills in the environmentally sensitive areas in China are under closer inspection and will be forced to shut down inefficient capacity. This will have a negative effect on iron ore demand from China on both lower- and higher-grades of iron ore,” he says.

In addition to its influence over imports and ore grades, China’s changing pattern of steelmaking industry is affecting the country’s levels of domestic ore production. “Chinese domestic iron ore output has fallen in 2015, 2016 and 2017,” says Slavov. “This is a decline in nominal (not Fe content adjusted) value. When adjusted for Fe content, the decline of production is even longer.”

Brazilian ore
The international miners who dominate the seaborne iron ore export to China are taking advantage of the country’s increased demand for higher-grade ore. In its production report for the third-quarter of 2017, Vale stated: “Vale iron ore production achieved a quarterly record of 95.1 million tonnes in 3Q17, 3.3 million tonnes higher than in 2Q17.”

Its report continued: “The Northern System, which comprises Carajás, Serra Leste and S11D, achieved a quarterly record of 45.0 million tonnes in 3Q17, 8.5% and 16.4% higher than in 2Q17 and 3Q16, respectively, mainly due to the ramp-up of S11D, which is advancing according to plan, plus better operational performance in the mine and plant at Carajás and the weather-related seasonality.”

Vale also confirmed that its long-term base-case target of 400 million tonnes of total production per year remains.
Senior executives at the company have stated that, if necessary, it will use its capacity to control prices. During Vale’s Investor Day in December 2017, chief executive officer Fabio Schvartsman said: “We have 50 million tonnes of excess capacity. It’s there for a reason. We don’t think that much higher prices are good for the industry. It’s certainly not good for Vale.” He then added: “Certainly if the prices get [out of alignment] and go up too much, we are going to use this excess capacity to balance the market.”

Burgering cautions on how Brazilian iron ore production increases may affect the market. “Brazil’s iron ore exports grew by 3% in 2017 and are expected to grow further in 2018. More than 50% of those exports were to China,” he explains, “but soon demand for iron ore from China will drift lower and, with freight rates increasing, further export from Brazil to China will be hit. Demand growth outside China will be insufficient to absorb the abundant supply situation in Brazil and softer iron ore prices will result.”

Australian output
In the face of increased Brazilian production and the implied impacts that could have on prices, iron ore producers in other countries are looking at ways to reduce their operating costs to better withstand price fluctuations.

Rio Tinto’s expansion of its fleet of autonomous haul trucks at its iron ore operations in Pilbara, Western Australia, is one example. The project at the Brockman 4 operation is due for completion by mid-2019, allowing the mine to run entirely in Autonomous Haulage System (AHS) mode once fully deployed.

Rio Tinto iron ore chief executive Chris Salisbury said: “We are studying future additions to our autonomous fleet in the Pilbara, based on value, to help deliver our share of $5 billion of additional free cash flow for the company by 2021.”

Production cost reductions such as those planned by Rio Tinto will be needed in Australia if the country’s governmental forecast for iron ore prices prove to be correct. In Resources and Energy Quarterly, December 2017, the Australian Department of Industry, Innovation and Science forecasts domestic-mined iron ore averaging $53 per tonne in 2018. The longer-term outlook is even less positive, with the Department forecasting a decline to “$49 per tonne in 2019, due to growing low-cost supply from Australia and Brazil and moderating demand from China.”

That low forecast is not universally shared among market participants however. “I think the average 2018 price will be $63 per tonne for 62% Fe grades,” says Burgering. “Demand from China is expected to weaken during 2018 due to the capacity cuts, while supply of iron ore is still sufficient. The combination of these market dynamics will result in softer prices. But I don’t think this will materialize during Q1. Poor weather conditions in Australia are already triggering supply disruptions and with the upcoming wet season in Australia, shipments from there are expected to come under pressure. This will keep iron ore prices stable at current levels for the time being.”

Despite the Australian government’s predictions on price, BHP stated in its  Annual Report 2017 (published September 2017) that “iron ore production is expected to increase to between 239 and 243 million tonnes in FY2018.” The increase was predicted on an actual production in 2017 of 231 million tonnes. In order to achieve a balance between lower prices and increased output, BHP stated in the report that “Western Australian iron ore unit cash costs are expected to decline further to below $14 per tonne in FY2018.”

Indian iron ore
Alongside Western Australia and Brazil, a third producer in the seaborne iron ore market is India. Prior to restrictions put in place by the country’s government in 2011, to reduce illegal mining activities, it was one of the world’s largest exporters of iron ore. With those restrictions now being eased production is increasing. The Government of India Ministry of Mines’ Monthly Statistics of Mineral Production showed that iron ore production in the country between April 2017 and July 2017 was 64.8 million tonnes, an increase of 8.65% year-on-year.

The forecast for exports of iron ore in 2017 by India, published in Australia’s Resources and Energy Quarterly, December 2017, is 28 million tonnes, an increase of 30% year-on-year. However, the report then goes on to forecast a 57.5% decline in iron ore exports from India for 2018.

Much of India’s current iron ore production is, like China’s, for domestic use. The state-owned steelmaker Steel Authority of India Limited, for example, has its own iron ore mines at Kiriburu, Mehgahatuburu, Gua and Chiria in Jharkhand. The Indian steel industry, with encouragement from the government, is also looking to greatly increase production which would justify the predicted large reduction in exports as domestic iron ore consumption increases significantly.

Aside from greater local use, Slavov is doubtful about how increased Indian iron ore production will impact prices. “India exports predominantly low-grade iron ore,” he says. “The trading environment in 2018 is unlikely to incentivize stronger offtake of low-grade material, so we are neutral to marginally bearish on Indian iron ore export flows.”

Slavov’s viewpoint is shared by Burgering, who says: “India is exporting mostly lower- and medium-grade iron ore. While during 2018 an easing of an Indian iron ore export policy is on the agenda, the fact that demand for higher grades is most likely to grow further, an increase of India iron ore export will have a relatively low impact on global iron ore market developments.”

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