Iron Ore’s War of Attrition

Hong Kong’s “Mines and Money” conference attracts over 2,000 mining industry movers and shakers from around the world every year. Timed near the start of the Rugby Sevens, bankers, brokers, fund managers and miners can mingle in one of Asia’s major financial centers before letting their hair down at the three-day rugby event known for its raucous behaviour.

This year though the mood was somewhat subdued, even for the Asia-Pacific’s richest woman, Gina Rinehart. Accepting the “Asian Lifetime Achievement Award” at the conference on March 26, the mining multi-billionaire urged governments to slash red tape in response to weak commodity prices.

“If only we could do something about that falling iron ore price – well we can’t,” Rinehart said. “[Australian governments] need to recognize that they need to come to the party and recognize falling commodity prices, and cut the horrific expense of their regulations and compliance burdens.”

According to Rinehart, the permitting process for her company’s new Roy Hill mine in Western Australia’s Pilbara region has involved more than 4,000 approvals, including for the railway, mine, port and various environmental reports.

Rinehart and her partners have invested A$10 billion ($7.75 billion) in the project, which will produce 55 million tons a year of iron ore at full production. In September, the company announced it had secured long-term sales contracts with steel mill customers in China, Japan, South Korea and Taiwan accounting for more than 45 million tons of production.

However, with the benchmark iron ore price falling to a six-year low of around $55 a ton on weak Chinese demand, Roy Hill will add to a supply glut sparked by aggressive expansions by iron ore majors BHP Billiton, Rio Tinto and Vale.

Nevertheless, Rinehart remains committed to the project, telling the conference that it was on schedule for first shipments by September.

“All the naysayers are having a field day, but leaving that aside, Roy Hill is an important project for Australia,” Rinehart said.

Amid calls by Fortescue Metals chairman Andrew Forrest for Australian iron ore producers to cap production to support prices, Rinehart said other countries would simply fill the gap.

“If someone else doesn’t sell iron ore from Australia, the market will get it from elsewhere,” she was quoted saying by The Australian.

Price Slump

From record prices of around $190 a ton in 2011, a wave of new production, principally from Australia, has sent prices tumbling. According to ANZ Research, the two-year supply lag took effect in 2013, when Australia’s BHP Billiton, Fortescue Metals and Rio Tinto added 100 million tons to Australian iron ore exports, three times the amount added each year over the previous decade.

Despite slowing demand growth in China and tumbling prices, the large expansions have sunk much of the capital expenditure, giving producers little incentive to reduce activity. BHP and Rio Tinto have slashed expenditure, targeting a production cost of under $20 a ton, resulting in a squeeze on margins at higher-cost producers such as Fortescue and others.

According to analysts at Australia’s CBA, Fortescue’s stock is virtually “worthless” at current prices, with Goldman Sachs analyst Christian Lelong warning of a “long war of attrition” that could last well into 2017 as unprofitable miners slowly exit the industry.

After averaging $88 a ton in 2014, iron ore prices are seen headed downwards at least for the next two years. Lelong predicted a price of around $60 a ton through to 2018, below an estimated “all-in” marginal cost of $70, while ANZ expects prices to average $58 a ton this year and $60 in 2016. In its latest resources quarterly, the Australian government’s Department of Industry cut its forecasts to $60 a ton in 2015 and $56 the following year, although tipping a rebound to $73 by 2020.

The price slump has battered Australia’s fiscal coffers, removing an estimated A$10 billion or more from forecast federal government revenues, while also causing the demise of some marginal producers. According to one analysis, at $70 a ton, smaller producers Atlas, Arrium, BC Iron, Fortescue and Gindalbie are operating “underwater.”

Yet amid the gloom, other analysts have pointed to a potential upturn, along with growth in specific market sectors.

Westpac senior economist Justin Smirk has forecast that an upturn could be in sight by 2016, based on stronger global growth, while CRU Consulting’s Allan Trench has pointed to the continued urbanization of western and central China. According to the World Bank, Asia’s urbanization is only just beginning, with more decades of urban growth set to spur rising incomes and increased demand for commodities, particularly in India and Southeast Asia.

Should the global population reach its expected 9 billion to 9.5 billion in the next 50 years, global steel use would expand to more than 1,900 million tons per annum (mpta), up more than 400 mpta from current levels.

"Market balance will be restored over time by higher cost producers exiting the market and through gradual demand growth, with analysts expecting this to occur by around 2018," said Quentin Hill, managing director of Carpentaria Exploration.

“However a bright spot in the market exists for higher grade pellet feed suppliers, as

China transitions to less polluting, more efficient steelmaking which requires higher grade ores. We expect high-grade pellets to secure a greater proportion of the market, displacing fines ore from lower grade mines.

“The pellet premium is currently around $38 a ton above the iron fines benchmark price, reflecting limited supply and solid demand. Analysts see global pellet demand increasing by 90 million tons per annum by 2020 and another 200 to 400 mtpa by 2030, giving plenty of scope for new sources of supply, such as from our Hawsons Iron Project near Broken Hill.”

In the meantime though, it is all systems go for Rinehart and other major iron ore producers, while the rest of the industry adjusts to the new environment. Rather than champagne, tap water might be the drink of choice at Hong Kong’s “Mines and Money,” at least until the cycle turns again.