##{"id":59035,"date":"2011-10-24T11:52:34","date_gmt":"2011-10-24T00:52:34","guid":{"rendered":"http:\/\/www.fnarena.com\/index.php\/2011\/10\/24\/iron-ore-prices-under-pressure\/"},"modified":"2011-10-24T11:52:34","modified_gmt":"2011-10-24T00:52:34","slug":"iron-ore-prices-under-pressure","status":"publish","type":"post","link":"https:\/\/staging.fnarena.com\/index.php\/2011\/10\/24\/iron-ore-prices-under-pressure\/","title":{"rendered":"Iron Ore Prices Under Pressure"},"content":{"rendered":"

\n\t– Iron ore prices under pressure
\n\t– Prices now impacting on higher cost Chinese producers
\n\t– Weaker prices increasing pressure for move to spot pricing
\n\t– Short-term rally in iron ore appears unlikely<\/strong><\/p>\n

\n\t
\n\tBy Chris Shaw<\/p>\n

\n\tTaking a simplistic view, Deutsche Bank suggests iron ore prices are falling because supply is currently exceeding demand at the Chinese ports where spot prices are set. The decline has pushed spot prices to around US$155 per tonne<\/span>, which is well below the calculated quarterly contract price of around US$175 per tonne<\/span>.<\/p>\n

\n\tWith steel prices also easing Deutsche suggests the appetite for steel mills to pay above the spot price is again being tested. The likely outcome is a move to shorter time frame contracts of one month, which Deutsche notes is what industry heavyweight BHP<\/span> Billiton<\/span> ((BHP<\/span>)) has been targeting for some time.<\/p>\n

\n\tA big driver of the current price weakness in the view of Deutsche is increased supply in the Asian region, as Australian producers are ramping-up their share of supply at the same time as Brazilian producers are diverting ships from Europe where demand is weaker to Asia where demand is stronger.<\/p>\n

\n\tWhile spot prices have been resilient until recent weeks, Deutsche suggests received prices have been declining for some time as mills have been achieving lower premiums for premium product. Weaker spot prices suggest the premiums must now be at very low levels.<\/p>\n

\n\tAssuming the pricing mechanism changes and there is a shift to shorter contracts, Deutsche expects seaborne suppliers will continue to compete for tonnes<\/span> by producing more ore. Low cost bases for major producers make such a decision more likely. <\/p>\n

\n\tThis should drive prices down further. This is already happening according to Citi<\/span>, the broker noting Vale has lowered prices to get tonnes<\/span> away for the December quarter. Citi<\/span> agrees with Deutsche the price moves are a step closer to spot pricing, the broker suggesting this is the case rather than being a price cut as such. This implies some recovery in prices in the first half of 2012.<\/p>\n

\n\tAs prices come under pressure Deutsche expects the high cost producers in China are increasingly likely to stop production. In Deutsche's view this process could continue to a price level of US$120-$130 per tonne<\/span>, which appears to offer a point of resistance for prices relative to costs of production.<\/p>\n

\n\tThis is below Citi's<\/span> estimate of the high cost marginal producer in China of around US$150 per tonne<\/span>. On Citi's<\/span> numbers, half of Chinese supply is estimated to have an average cost of production of US$135-$150 per tonne<\/span>.<\/p>\n

\n\tIn the view of Citi<\/span>, if Chinese steel production was to fall by 15%, iron ore prices would need to fall to around US$120 per tonne<\/span> to spark a supply-side response. Taking a worst case view, Citi<\/span> suggests if European steel consumption was to fall by 50%, Japanese consumption by 20% and Chinese consumption by 20%, iron ore price support doesn't emerge until prices hit US$90 per tonne<\/span>. <\/p>\n

\n\tThese scenarios are unlikely in Citi's<\/span> view given underlying Chinese demand remains robust. As well, further price falls in iron ore may not elicit a rapid supply response from Chinese producers given high fixed costs. This means these producers may elect to operate at short-term losses if the expectation is weak demand will be short-lived. <\/p>\n

\n\tGiven the spot price for iron ore is now only about 15% above levels suggestive of GFC-like<\/span> demand destruction, the recent sell-off appears to have been overdone in Citi's<\/span> view. But as Chinese buyers are likely to pullback on any unnecessary purchases of iron ore while prices are falling, Citi<\/span> suggesting this could take at least a quarter to wash through the market. This suggests a short-term rally of any strength is unlikely, Citi<\/span> arguing a sustainable bounce won't occur prior to the macroeconomic environment stabilising<\/span>. <\/p>\n

\n\tLooking at the global market, Macquarie notes the latest Brazilian iron ore export data showed September was a relatively stable month, though exports again recorded a decline in year-on-year terms.<\/p>\n

\n\tThis lack of growth in Brazilian exports puts pressure on high-cost Chinese domestic ore to balance the iron ore market in Macquarie's view. This is because even allowing for stronger Australian output in the September quarter, overall shipments to China from major suppliers are only on par with 2010 levels at present.<\/p>\n

\n\tWith respect to freight rates, Barclays Capital suggests the recent softening in iron ore prices is a positive for seaborne trade. Volumes bound for China in particular are likely to pick up, as the differential between seaborne and domestic iron ore prices is attractive at present.<\/p>\n

\n\tKey suppliers are believed to be now offering Chinese steel mills the chance to buy iron ore at spot prices rather than the usual practice of an average price for the past three months. Barclays expects this will tempt steel mills into preferring imported iron ore given margins are currently being squeezed due the fall in steel prices.<\/p>\n

\n\tBut Barclays also suggests the actual requirement for iron ore is also likely to come under pressure near-term given moderating demand from downstream steel consumers. Any significant short-term pick-up in steel sector activity in China is unlikely given an uncertain outlook at present.<\/p>\n

\n\tFor Barclays this suggests while freight rates on routes carrying iron ore to China should stay buoyant for a few more weeks, negative catalysts should then kick in and drive rates lower by the end of the year.<\/p>\n

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