Feeling the shock and ore

Iron ore prices have had a rollercoaster ride so far in 2016, as China’s economy continues to recalibrate, and world markets look to accommodate and gain from the shifts afoot in the Asian economic powerhouse. At the end of last year, gloom pervaded the market, amid oversupply and falling demand, which was followed by a rally in prices that jumped some 70% and then started to dip in May. The volatility has surprised the market in recent months, with prices rising to above US$60/t.
 
Reductions in supply, improved demand from China and a growing speculative market have powered the surge. Iron ore prices soared as Chinese steel mills increased output to feed the steel price rebound, while supply disruption in Australia spurred prices. However, few expect a prolonged rally. In April, Sam Walsh, mining giant Rio Tinto’s CEO, said prices are likely to fall in the second half of 2016 as supply ramps up. Analysts at US bank Citigroup do not expect weak Australian exports and stronger Chinese steel production to last.
Macquarie, the Australian investment bank, believes the surge is short-term and resembles the mini booms of September 2012 and July 2013. Sluggish global growth and a stronger US dollar on a Federal Reserve rate rise could halt  the rally, according to Macquarie. The Sydney-based bank expects prices will drop to US$48/t in the fourth quarter and US$45/t next year, and reach US$60/t by 2021 (compared with US$180/t in 2011). US investment giants Citigroup and Citibank also expect the rally to fade in the second half of 2016.
China’s march
China continues to shape the iron ore market, as it does the global economy. Beijing is ramping up spending to stimulate growth, which has fuelled a property boom and boosted steel demand. Increased steel prices have stimulated production and prevented the closure of loss-making mills. However, with hundreds of millions of tonnes of excess capacity in China, analysts expect that supply will swamp demand and start to push down steel prices. Discontentamong global steel producers and governments over cheap Chinese exports could also put the brakes on output.
In May, iron ore prices started to slide, however, and China’s port inventories began to pile up. Rio Tinto has stated that the surge in iron ore prices is not sustainable, while fellow Anglo-Australian miner BHP Billiton has warned that the industry should prepare for “lower for longer”. US investment bank Goldman Sachs has remained unconvinced, although supply disruptions at mines and ports have lifted prices. Goldman says prices will continue to drop through 2016 to US$40/t in the fourth quarter. Goldman has forecast US$35/t for 2017 and 2018. 
 
With the supply of iron ore set to increase, analysts are concerned that the revival in prices could spell trouble. If steel output tapers off, the increase in ore production will rapidly result in excess supply. 
 
New projects could also flood the market. Brazilian miner Vale’s huge S11D project, the world’s largest iron  ore development, could go into production this year, as could the next phase of Australian group Gina Rinehart’s Roy Hill mine expansion. Vale and BHP Billiton’s Samarco joint venture is also poised to resume production.
But much of the price volatility stems from speculation in iron ore futures. The Dalian Commodity Exchange has created an iron ore market the size of gold futures in New York, according to Citigroup. Despite an expected glut of iron ore in 2016, Dalian iron ore futures have climbed by almost 50% this year. Chinese regulators now fear a bubble. “The volumes that are traded are so high that they swamp the physical market,” says Neville Power, CEO of Australia’s Fortescue Metals. “The negative side is the volatility we have seen.” 
 
Until 2010, the iron ore market was dominated by the large global producers, including BHP Billiton and Rio  Tinto, which annually negotiated sales directly with steel mills on one-year contracts. However, when Chinese demand  outstripped even the largest producers’ inventories, the market shifted from physical cargoes to spot prices, which paved the way for the rapid development of an iron ore futures market. An investor rush into China’s commodity  markets has raised fears of a repeat of the volatility that racked the Shanghai and Shenzhen stock exchanges last year.
Iron ore price spikes this year have been a direct result of Dalian futures speculation. In early May, the daily price of iron ore rose 20%. While demand and supply in the 1.4 Btpa seaborne iron ore market was in balance last year, US investment bank Morgan Stanley warns that increased mining will mean it will be oversupplied by roughly 60 Mt this year and 90 Mt in 2017. In the meantime, producers of the steelmaking metal will enjoy the increased prices – and more iron ore will be handled at China’s bulk terminals. 
However, China has raised concerns over an iron ore joint venture between Fortescue and Vale, while Australian regulators investigate the agreement, announced in March. The world’s second and fourth largest iron ore exporters want closer alignment, and to blend a portion of their ores to create a new product for sale into China. Vale and Fortescue are looking to start to blend at Chinese ports this year, and deliver 80-100 Mt to its steel mills. The move also gives the Brazilian miner entry into the Australian market. 
 
Beijing is concerned over the loss of an independent source of supply if Vale proceeds with the blending deal and takes a 15% stake in the Pilbara producer. The China Iron and Steel Association says regulators may oppose the tie-up. However, Fortescue’s Power is confident that the move will not reduce competition. “If anything, it improves the competitiveness of supply to the Chinese steel industry,” says Power. “This is about maintaining volumes, and simply combining a proportion of our production, and theirs, into a blended product.”
But Chinese authorities view the seaborne iron ore trade as of vital strategic importance for the country’s steel industry and wider economy. The seaborne iron ore market is already highly consolidated, with the top four producers behind more than three-quarters of all cargo. A Vale-Fortescue tie-up would control a third of the world’s iron ore shipments. Vale is behind 21% of estimated seaborne iron ore supply in 2016, while Fortescue accounts for around 12%. (Rio has a 24% share of the trade and BHP Billiton 20%).
Oz exports
Australia’s miners have ramped up exports, to take advantage of higher prices and the recent stimulus to the Chinese economy. Port Hedland, the country’s largest bulk port, handled record volumes in March of 39.5 Mt, up from 36.6 Mt in February. Exports to China amounted to 32.6 Mt, compared with 29.1 Mt a month earlier. Port Hedland serves Western Australia’s iron ore-rich region of Pilbara. Gina Rinehart’s Roy Hill Project in Pilbara dispatched its first cargo to China’s port of Caofeidian in March. Two berths in Hedland are under construction to handle 55 Mtpa for Roy Hill. 
West Australia’s government is looking to sell the Port Hedland bulk handling facility and Kwinana Bulk Terminal. Utah Point has revenues of A$132M a year, mainly from iron ore, while Kwinana generates A$53M a year from bulk cargo, including iron ore. Utah Point was designed to serve small iron ore producers, who are the hardest hit when iron ore prices fall. The government need to pass a bill to sell any part of the Pilbara Port Authority to pay state debts. But the legislative rigmarole has slowed the sale. 
 
Meanwhile, Western Australia’s miners are coming to  blows over the proposed sale of the Utah Point facility. Mid-tier miners using Utah Point believe that the majors, such as BHP Billiton, Fortescue and Gina Rinehart, will exclude new players from Pilbara’s new mining projects. Smaller miners fear that a new port owner could threaten their businesses. Australia’s Association of Mining and Exploration Companies has warned that the state will want to command higher prices, if it allowed big miners to use Hedland, raise fees, and lock out juniors.
Big spenders
Despite the opportunities this year, producers looking beyond 2016 have started to scale-back output forecasts. Although its Q1 shipments of 80.8 Mt were up 11.4 %, Rio Tinto has cut its 2017 production forecast to 330-340 Mt(from 350 Mt), and it aims to ship 335 Mt from Pilbara during 2016. However, Deutsche Bank believes Rio will hit its  Pilbara target of 360 Mt by the end of 2017, and is offering conservative guidance against risks. One of these risks is the implementation of its AutoHaul automated heavy-haul railway project, which will feature driverless trains. 
 
BHP Billiton cut its forecast for the year to June by 10 Mt to 229 Mt, following a cyclone earlier this year in Western Australia. BHP previously lowered its forecast by 10 Mt, due to the loss of output after a dam disaster from its jointventure Samarco mine with Vale in Brazil. The AngloAustralian miner is also looking to ramp up additional capacity at its Jimblebar mining hub. However, BHP also has a rail renewal programme that is scheduled to take two years which is expected to disrupt production and international shipments. 
 
Vale expects iron ore output this year to be at the lower end of its 340-350 Mt target, although the new S11D, or Serra Sul, mine will boost production to 380-400 Mt in 2017. Vale’s flagship S11D project in the Carajás mining area of the Amazon has an annual capacity of 90 Mt, and is already four-fifths complete. The US$17B project has required expansion of the Carajás railroad by 504 km, and upgrading 226 km of existing lines to the port of São Luis. Vale is expected to start shipping this year from the 230 Mtpa port. 
 
 
Anglo American 
 
Market conditions are proving tough beyond the mining super majors too. In February, South Africa’s Anglo American announced the sale of US$3B of assets, to tackle debt, and an exit from iron ore. Anglo had increased output in the face of plunging prices, after accruing debt to expand into iron ore and capitalise on China’s steel boom. The move spells the sale of Kumba Iron Ore, Africa’s top producer, and Minas Rio, one of the world’s largest mining projects, in Brazil, which Anglo spent US$14B developing. 
 
But the iron ore trade continues to expand. According to Morgan Stanley, around 1.36 Bt of iron ore was shipped around the world last year, which represents a 76% increase on volumes in 2007. The AngloAustralian giants, BHP Billiton and Rio Tinto, largely by dint of size and economies of scale have been able to withstand the fall in the price of iron ore. Although prices have slumped from US$192/t in 2011, iron ore production costs below US$30/t meanthat major profits are still generated from the sector. 
The iron ore majors have continued to increase iron ore production from their vast operations in Pilbara, despite demand from China slowing. This, in turn, has placed pressure on smaller and higher-cost producers. 
 
The iron ore mining sector is now mired in debt, particularly those who pursued low-quality, high-volume strategies for a larger slice of the commodities super-cycle. An iron ore glut could start to get bigger, as 266 Mt in new production will be added over the next three years, before supply is curbed from 2019, according to analysis from Bloomberg.