Ironing out demand

The perfect mix of market conditions has led to iron ore reaching record highs well above $US200 per tonne this year, but how long can the metal stay at these all-time levels?

Chinese steel consumption has set the stage for iron ore producers to thrive in current market conditions.

Following the initial economic impacts of COVID-19 on China, the country responded with a ramp up of infrastructure projects that has driven iron ore demand.

Such demand has seen prices maintain levels above $US200 ($270) per tonne as mine production also grows.

Iron ore giant BHP produced a record 252 million tonnes of iron ore at its Western Australia Iron Ore operations in the 2020-21 financial year as it brought the massive South Flank project online.

According to Ausbil, the global market for iron ore sits at 1.5 billion tonnes. But with production capacities stressed, some miners are struggling to overcome internal issues, including Vale and Rio Tinto, impacting ideal levels of output. 

Vale, for example, slashed its production guidance for the 2020-21 financial year from 375 million tonnes to 315-335 million tonnes due to tailings dam issues and problems restarting its suspended capacity.

Ausbil Global Resources Fund co-portfolio managers James Stewart and Luke Smith say this has left a supply gap in the market. 

“Vale are targeting a 400 million tonne per annum run-rate by year-end 2022, however, this likely only implies reaching that run-rate in the final quarter,” Stewart and Smith say.

“The wet season and continued issues with restarts are likely to impact output leading into those run rates, and as a result we currently estimate they will produce 355 million tonnes in 2022 overall.”

Rio Tinto has seen a 9 per cent fall in iron ore production in the June 2021 quarter due to rainfall issues and COVID-19 travel restrictions, adding to the skills shortages facing mining in Australia.

“Heightened COVID-19 constraints, which resulted in numerous travel restrictions, added further pressure on the business and limited our ability to access additional people, particularly in Western Australia and Mongolia, in order to deliver operational improvements or maintenance initiatives and accelerate projects,” Rio Tinto chief executive officer Jakob Stausholm says. 

Australian iron ore exports have smashed records in 2021.

According to UBS, Rio Tinto will need to lift its iron ore shipments by around 25 million tonnes to reach the middle of its 2021 guidance.

Ausbil anticipates that increased demand and limited supply will continue but will ease in the coming years.

This will be due to softening Chinese demand following a decline in construction activity and a recovery of supply.

“Our expectations for demand strength and supply weakness continue and have been exceeded during this period, with COVID only exacerbating market tightness, through Chinese construction-related stimulus and COVID-related supply issues in Brazil,” Stewart and Smith say. 

“We expect Chinese domestic iron ore supply will remain the marginal source of supply. The key question for us is how large, and how quickly, the Simandou project in Guinea will be brought online over the medium term.

“While we expect the Simandou project to come online faster and larger than market expectations – similar to what we have seen with China’s investment in bauxite in Guinea, and supporting China’s aim to diversify away from Australian supply – ultimately Chinese domestic iron ore supply is likely to remain the marginal tonne.”

Australia exports around 70 per cent of its iron ore to China, according to a UBS report, demonstrating how vital the Asian country is for the nation’s economy and its mining industry. 

In the near term, UBS anticipates that China’s steel mills are being told to halt production in the second half of 2021.

While this may be bullish for steel, it will mean a bearish market for iron ore, resulting in around 75 million tonnes lower demand for iron ore in the second half of the year.

“Press reports suggest China is imposing more restrictive measures on steel production in (the second half of 2021) to ensure output is lower year over year and to meet carbon emissions goals,” UBS states.

“The extent of the policy is not yet clear as six other producers indicate they have not received the order to cut production; we note this policy would also be at odds with the government’s aim to deflate steel prices (albeit it could result in lower iron ore prices).”

Wood Mackenzie is expecting Brazilian iron ore supply to grow in the second quarter of 2021, with its iron ore price forecast for the September quarter higher against a previous estimate as a result.

“We have raised our third quarter price forecast to $US185 per tonne (cost and freight) versus an estimated $US200 per tonne in the second quarter,” Wood Mackenzie head of iron ore research Rohan Kendall says.

“We still think the second quarter was the high point for Fe grade premiums (and discounts), and we expect both to contract slightly in the third quarter – smaller premiums and smaller discounts – as mills adjust to much lower margins than were achieved in the second quarter.

“We still believe prices will be lower in (the second half of 2021) than (first half of 2021) as Chinese credit tightening cools down construction-related demand and Brazilian mine production accelerates.

“But neither is a safe bet and the balance of risk leans towards demand overperformance and supply under-performance.”

Kendall echoes a similar sentiment to Ausbil with Chinese construction activity met with supply issues in Brazil. 

“On the demand side, Chinese construction and manufacturing hold the key,” Kendall says.

“Tighter credit availability should take some of the heat out of the property market, but manufacturing activity remains red hot as recent demand-led power shortages in Guangdong and Yunnan provinces demonstrate. On the supply side it’s still all about Brazil, as the country’s iron ore industry strives to regain its position in key markets after two dreadful years (in volume not value terms). 

“Progress is slow going for Vale on its ‘pathway to 400 million tonnes per year’ with supply of high-grade (Carajas) fines and pellets still running well below target.”

Australia’s iron ore production has taken the helm from Brazil. According to the Australian Bureau of Statistics, metalliferous ore exports achieved a record high of $20.49 billion in June 2021.

Iron ore was up by 6 per cent in the same month, delivering $17.55 billion worth of metalliferous ore exports.

With Australia breaking all-time highs for iron ore supply and demand, mining companies and government bodies will need to carefully navigate the market for future impacts derived from China and production ramp ups in Brazil. 

This story also appears in the August issue of Australian Resources & Investment.