Iron ore prices likely to rise further with robust China demand

China’s insatiable appetite for iron ore has been a major factor behind the recent enormous price increases and profits in the global iron-ore industry.

In the last three years, Companhia Vale do Rio Doce, BHP Billiton and Rio Tinto have increased iron-ore prices by, successively, 71.5%, 19%, and 9.5%. This year some analysts expect prices to rise again.

These three companies really dominate the trade and I have a feeling that they are going to ask for another very big increase in the coming year and theyre not going to be too held back by Chinas objections, says Patricia Mohr, vice president economics and commodity market specialist at The Scotiabank Group in Toronto. The price may very well go up another 25% in 2008.

Iron ore prices, set in annual negotiations between miners and steelmakers, are typically based on the Japanese fiscal year, which begins in April. The price in the current Japanese fiscal year that ends in April 2008 is 80.42 US cents Dmtu, or dry metric tonne unit.

Mohr adds that the prospects of a tie-up between Rio Tinto and BHP would probably not affect iron ore prices. It would give them market power but I actually think they have considerable market powers just as things currently stand because those three companies dominate the trade, she says. Unless steel consumption falters in places like China they will probably continue to have a big impact on the market.

Without China’s voracious need for iron ore, such huge price increases would have been impossible. Although China has some iron-ore reserves, it is a net importer of iron ore for its steel industry.

The countrys rapid industrialization and urbanization has driven Chinese steel consumption to almost double in the last four years. And strong growth in steel consumption over the medium term will increase demand for iron ore.

Iron ore is the raw material used to make pig iron, which is one of the main raw materials to make steel. About 98% of the worlds mined iron is used to make steel.

But not everyone expects iron ore prices to rise so dramatically. The Australian Bureau of Agricultural and Reserve Economics, a government economic research agency that conducts independent research and analysis, estimates that negotiated iron ore contract prices will remain stable in 2008-09 before declining by 5% in 2009-2010 and a further 9% in the following year.

But even with such declines, iron ore prices will be relatively high over the outlook period, ABARE writes in a recent research on the outlook for commodity prices to the year 2011-2012.

Either way, Chinas imports of iron ore are expected to continue to grow significantly. Canberra-based ABARE estimates that Chinas imports of iron ore will grow from 326 million tonnes in 2006 to an estimated 367 million tonnes in 2007, 425 million tonnes in 2008 and 477 million tonnes in 2009.

By 2012, the group notes, Chinas iron ore imports will likely reach 615 million tonnes. Indeed China will account for about 90% of the growth in global iron ore imports between 2006 and 2012, the research agency notes.

Wang Anjian, director of the Chinese Academy of Geological Sciences, speaking at the recent China Mining Conference in Beijing, November 13-15, predicts Chinas demand for iron ore will reach 700 million tonnes in 2008 and between now and 2020 will reach a total of 7,000 million tonnes.

World production of iron ore, meanwhile, is projected to grow by around 5.2% a year to reach 2 billion tonnes in 2012, according to ABARE.

The majority of this increase is expected to come from new iron ore mines and expansions in Australia and Brazil that are scheduled to come into production during the 2006-2012 period, ABARE notes. Substantial iron ore production growth is also expected in India and China in response to strong demand from their growing steel industries.

ABARE predicts that the supply capacity of the worlds three largest iron ore producers will increase by about 20% to 100 million tonnes by late 2008.

This substantial increase in the availability of iron ore, particularly from low-cost suppliers, is projected to contribute to an easing of prices over the medium term, ABARE states.

China has ramped up its domestic production of iron ore. Last year primary iron ore production reached 588 million tonnes, up from 468 million tonnes in 2005.

Over the outlook period, Chinas production of iron ore is projected to increase from 263 million tonnes in 2006 to 345 million tonnes in 2012 (for average annual growth of 4.6%).

Underpinning this increase is investment in greenfield iron ore projects by Chinese steel makers as they attempt to offset increases in contract prices of imports of iron ore, says ABARE.

The research agency notes that the anticipated expansion in iron ore production in China is well below the requirements of its steel mills, adding that Chinese iron ore is generally of lower quality and more costly than ores sourced from the worlds three main producers.

Wang of the Chinese Academy of Social Sciences noted that higher iron ore prices are a double-edged sword. The high prices will force Chinese authorities to bring greater amounts of the country’s domestic low-grade iron ore into production. Higher prices will also force China to restrict its steel and iron production capacity and exports and reduce iron ore imports, he said.