A look into the future: Iron Ore

By Robert Carry

Iron ore export earnings in the December quarter were down $440 million (5 per cent) to $9.1 billion, according to Australian Bureau of Agricultural and Resource Economics (ABARE) data. The depreciation of the Australian dollar has buffered the market thus far meaning the worst may be yet to come for the construction-sensitive commodity.
Australian producers have announced production cuts, totalling up to 260 million tonnes of iron ore this year, and a further 320 million tonnes next year, according to Citi. The financial services and research group has suggested that further production cuts are needed to avoid oversupply, forecasting a 6.7 per cent increase in iron ore exports this year and total seabourne demand for iron ore dropping by 7.5 per cent.
Rio Tinto's first-quarter 2009 iron ore production announcement on March 15th showed a 15 per cent fall to 31.6m tonnes compared with the same period last year.
Much of the export traffic in the last three months has been destined for China. Macquarie Research asserted in a recent report that combined iron ore exports from Australia, Brazil and India to China could jump as much as 32 per cent year-on-year in the first quarter of 2009.
It said exports outside of China are expected to fall 53 per cent to 35Mt, while global exports would total 177Mt, a 3.1 per cent fall.
Iron ore exports from Western Australia rose in March, with statistics from the Port Hedland Port Authority showing total shipments up 7 per cent on the previous month.
The statistics revealed that iron ore shipments from Port Hedland increased from 12.2 million tonnes in February to 13.1Mt in March, while exports to China jumped from 8.2Mt in February to 9.1Mt in March.
All eyes are now fixed on the tortuous price negotiation outcomes between iron ore producers and the pivotal Chinese buyers.
Dr Eric Lilford, head of the Deloitte Mining Industry Group and partner of Deloitte Corporate Finance, said, “In an increasing demand environment, producers can dictate higher prices since China cannot readily increase its internal production rates - this scenario played out last year. However, the current market plays into China’s hands from a contract pricing standpoint - it has the demand but also holds the purse strings.”
This is a view shared by Fat Prophets analyst Gavin Wendt: “It’s inevitable that contract prices will fall (the first decline in seven years) – just a question of how much. My guess is a 30 per cent price cut, although the Chinese are pushing for 40 per cent.”
Stockpiles of iron ore have been steadily building at Chinese ports, but it is unclear as to whether this is as a result of oversupply or an attempt of behalf of the Chinese to strengthen their negotiating hand. Wendt believes it is a case of the latter: “I think the stockpiles are part of the games the Chinese are playing. You want stocks building up just as you are trying to negotiate prices as it paints a more dire picture of the supply-demand situation. I think you just might see those stockpiles dwindle quite rapidly once the price negotiations are completed.”
Regardless of what price is agreed upon when negotiations wind up, Dr Lilford believes the importance of the Chinese market to Australian iron ore producers cannot be overstated: “Nearly all iron ore mined in Australia is shipped to China for processing and ultimate consumption.” Dr Lilford continues, “China has got capital to invest and Australia has got good quality assets and projects to develop. It’s a perfect match.”
ABARE’s Australian Commodities report for the March quarter 2009 detailed the Chinese Government’s recently announced fiscal stimulus package of 4 trillion Yuan. According to the report, “the fiscal stimulus will significantly increase Government spending on infrastructure and other public sector investment projects” which is, of course, good news for the Australian iron ore producers who will supply a significant proportion of this development.
China has of late begun to assert itself in the Australian commodity industry in other ways, with Chinalco’s bid for Rio Tinto interests drawing significant media and shareholder interest.
“It’s pretty universally agreed that the Chinalco/Rio deal is significant from an actual and a perception standpoint,” said Dr Lilford.
“‘Actual’ because Chinalco will gain greater equity participation of an international, diversified commodity producer, which will give it more say on marketing the products. ‘Perceptual’ because China, through Chinalco, is gauging to what extent it can secure resources assets outside its borders, and this is a significant test case.”
Wendt believes the deal has drawn some unfair criticism and that the involvement Australian iron ore and other mineral producers have had with the Chinese has been overwhelmingly positive:
“Many of the deal’s critics have not properly looked at the specifics of the arrangement, hence their frenzied responses. The conspiracy theorists continue to have a field day, claiming Rio is selling off the farm in Australia and virtually giving its assets away to the Chinese marauding hordes. Nothing could be further from the truth and upon close inspection of the deal these fears are proven to be groundless.”
So what are the major challenges facing the iron ore industry in the coming 12 months?
“Firstly, access to capital (equity and debt) for expansions, new developments or for debt rollover relief,” Dr Lilford points out. “Secondly, infrastructure availability continues to constrain Australia’s supply of bulk commodities, with no immediate relief visible.”
Additionally, he said, the need for sustainable development, blending of ores is critically important and this is not easily attained, especially for emerging and smaller producers.
“This may require establishing relationships amongst companies in order to optimise production,” said Dr Lilford.
Wendt meanwhile, is predicting strong demand and comparatively healthy pricing:
“I am expecting iron ore prices to perform better than a lot of people expect. There are indications that Chinese demand will pick up and that steel production will slowly recover. Having said that, for the rest of the steel-producing world, things look pretty tough for 2009.”