Iron ore market to stay firm in 2009: forecasts

The Iron Ore Trust Fund of Geneva-based UNCTAD (United Nations Conference on Trade and Development) has published its annual iron ore market review: The Iron Ore Market 2007-2009, in cooperation with Stockholm-based Raw Materials Group. The review, published in June, concludes that the iron ore boom continues, even accelerating in early 2008. The price increases agreed to so far vary between 65-97% and are the highest ever.

After the publication of the UNCTAD review, BHP Billiton (BHP-N, BLT-L) has announced that it has reached agreement with China’s Baosteel to sell fine iron ore at about US$145 per tonne, up 80%, and lump iron ore at about US$202 per tonne, up 97%.

There are several reasons for the high price increases. Firstly, demand has grown faster than expected. Next, production has not come on stream fast enough because of lack of infrastructure, equipment delivery delays, and a shortage of skilled labour. Another reason is the small number of major iron ore producers, putting them at an advantage when negotiating with the fragmented steel industry. Finally, iron ore producers are aware that steel producers have raised prices, so they can handle higher raw material costs.

Vale (RIO-N) signed the first agreement for 2008 with Nippon Steel and with Korean company POSCO, so the Chinese lost the lead in price negotiations. One contentious issue is the premium for Australian producers to reflect the difference in freight costs between Australia and Brazil for deliveries to China.

The three largest iron ore companies, Vale, Rio Tinto (RTP-N, RIO-L), and BHP Billiton, together control 35% of the market. Should BHP succeed in taking over Rio Tinto, it would lead to further industry concentration. The concentration in seaborne iron ore is even higher: Vale alone controls 36% of the total world market for seaborne iron ore, and the three largest companies control 69%. In order to limit their pricing power, there is a trend on the part of steel producers to create a network of captive coal and iron ore mines, or to have holdings in these mining sectors.

World use of finished steel products increased by 6.6% in 2007 to 1.2 billion tonnes, while world crude steel production increased by 7.5% to 1.34 billion tonnes. Growth continues at a high rate into 2008. Steel demand in China grew by 13% in 2007, and, remarkably, by almost the same percentage in the Middle East.

Steel production in China increased by 16%, and it now accounts for a little more than a third of world production. China, which became a net steel exporter only in 2005, accounted for 21% of world steel exports in 2007.

World production of iron ore grew by 9% in 2007 (vs. 12% in 2006) to 1.6 billion tonnes. Output increased mainly in the four major producing countries: Brazil, China, Australia and India. Mine production in China grew at a faster-than-expected 20%. With a production rate of 332 million tonnes of iron ore, which is 20% of world production, China strengthened its position as the world’s second largest producer, just behind Brazil and well ahead of Australia.

World iron ore exports increased by 8.1% (vs. 6.1% in 2006) to 822 million tonnes. Brazil is now the leading exporter at 269 million tonnes, overtaking Australia. Indian exports grew for the seventh consecutive year, and at 94 million tonnes the country is the third most important exporter, well ahead of South Africa, Canada and Russia, each with exports in the 25-30 million tonne range. China, which imported 383 million tonnes of iron ore in 2007, or 46% of world iron ore imports, continues to be the most important importing country, followed by Japan, Germany and Korea. Europe excluding the CIS accounts for 21% of world imports.

Seaborne iron ore trade has increased by 9% to 799 million tonnes. World production of pellets reached 326 million tonnes, up 1.5%. World exports of pellets were 137 million tonnes, an increase of 3.9%. The share of pellets in total iron production fell sharply to 20% in 2007, but there are signs that the share will rise.

Freight rates increased even faster in 2007 than they had done in 2006 and reached record levels at the end of 2007. The increases continued in 2008.

Nearly 130 million tonnes of new iron ore mining capacity was brought into production in 2007, considerably more than in 2006. The focus for new developments is changing to Brazil and West Africa from Australia. In total, over 600 million tonnes of new capacity is planned to come on stream in the three-year period 2008-2010, compared to demand growth of 340 million tonnes over the same period, based on projections by the International Iron and Steel Institute (IISI). However, of the 600 million tonne figure, around 336 million tonnes are in the “certain” category, while between 77 million tonnes and 167 million tonnes are in the “probable” category, and 196 million tonnes are in the “possible” category.

So it would appear that the projects in the “certain” category would satisfy the demand growth completely, while any further projects would create an over-supply in 2010 or 2011 at the latest. This outcome is far from certain because of the many obstacles and bottlenecks standing in the way of new projects. However, in view of the size of the potential surplus, an over-supply could happen, especially if demand is lower than anticipated. The outcome depends heavily on the ability of Chinese producers to expand production. If freight rates remain high, these producers will continue to enjoy a competitive advantage.

UNCTAD concludes that the iron ore market will most likely continue to be tight until 2010, or perhaps even 2011. There are several indications that prices will increase further in 2009 but the outcome for the following years is more uncertain. At the same time, it appears likely that trade in iron ore will become more diverse and will use a wider range of pricing methods, with shorter-term arrangements and flexible pricing systems playing a larger role. The benchmark negotiating system seems to be doomed.

In a research note from late June, Citigroup analyst Alexander Hacking says that China is attempting to de-stock iron ore, causing spot prices to decline to US$185 per tonne from US$205. Meanwhile, demand from Chinese pig iron production has risen by 9% since January. Citigroup believes that in the short term, Chinese de-stocking will continue, resulting in reduced imports and continued spot price weakness.

However, in the long-term, high-quality iron ore remains under-supplied. Supply disruptions have more than offset softer consumption in 2008, and Hacking forecasts that strong Chinese demand, coupled with continued supply issues, will produce another tight market in 2009. The research note says that India has introduced a 15% export duty on iron ore, a symptom of supply problems. And in a sign that steelmakers are buying raw material suppliers, ArcelorMittal (MT-N), the world’s largest steel company, bought Mid Vol Coal Group, a small U.S. miner.

For 2010, Citigroup forecasts Asia prices for iron ore at US$262 per tonne for lump iron ore (Brockman) and US$188 for fine iron ore (Yandi or Brockman). Long-term projections are US$115 per tonne for lump iron ore (Brockman), US$90 for fine iron ore (Brockman), and about US$85 for fine iron ore (Yandi).

Deutche Bank, in its Commodities Quarterly at the end of June, says that it expects the iron ore market to remain tight until 2011, when it is projected to swing into surplus. The bank projects Australian export lump iron ore reaching about US$206 per tonne in 2009, and then gradually declining to about US$82 in 2013. Australian export fine iron ore is projected to reach about US$162 per tonne in 2009, gradually declining to US$64 in 2013.