China reforms to leave iron ore miners exposed to price falls
SMH reported that from building scores of new towns to constructing state of the art rail networks, China's demand for steel to feed its modern day industrial revolution has driven a spectacular rally in the price of the raw material iron ore.
The meteoric rise of iron ore in the past decade, a basic commodity with no added value once it is unearthed is starkly revealed when compared with the high end technology sector.
A sustained slide in iron ore prices would hurt a legion of miners which have rushed in to meet the demand and could also trim billions of dollars of revenue for countries such as Australia, where iron ore is the biggest single export.
In 2005, a shipload of iron ore sailing to China was worth the equivalent of 2200 flat screen televisions. Five years later, after a three fold rise in iron ore prices and a fall in the cost of a TV, it was worth 22,000 TV screens.
Mark ups on iron ore for global miners BHP Billiton and Rio Tinto are now at a staggering 160% with profit margins at 62% nearly double that of the world's most valuable tech company, Apple Inc as of June 30th 2013.
Understandably, miners have massively ramped up production. But China's hunger for iron ore, the key ingredient for steelmaking has started to wane as its maturing economy seeks to slim down its industrial capacity.
China currently imports about two thirds of the world's iron ore and has an estimated excess steel capacity that would be enough to build about 3500 of New York's Empire State Building. But with no other country coming close to being able to absorb the slack left by China, iron ore prices risk years of decline as a major oversupply swamps demand, with some forecasting prices to be cut in half by 2015.
Mr Jeremy Platt market analyst at UK steel consultancy MEPS said that "The boom years for iron ore have probably come to an end in line with the boom years for China. A sustained slide in iron ore prices would hurt a legion of miners which have rushed in to meet the demand and could also trim billions of dollars of revenue for countries such as Australia where iron ore is the biggest single export.”
Iron ore prices jumped ten fold in the decade to 2011 led by Chinese demand to become the biggest money spinner for miners Vale, Rio Tinto and BHP Billiton driving them to go all out on expansion plans. But by the end of 2013, the three, along with Australia's Fortescue Metals Group, could be producing nearly 1 billion tonnes of iron ore about 200 million tonnes more than China would buy if imports grew at the same pace as last year.
Iron ore is heavily reliant on China's growth but in a slower economy its uses are more limited. Other metals also rely on Chinese demand but for example, copper has wider uses in anything from power transmission to computer chips.
Mr Dominic Bryant an economist at BNP Paribas said that “If China's GDP grows 7.5% this year as officially forecast which would be the slowest pace in 23 years its iron ore consumption intensity will slip to 118 kilograms per USD 1000 of GDP and crude steel usage to 78.8 kilograms.”
Mr Bryant said that and economic growth may ease further to 5% to 6% by 2020 cutting iron ore and steel consumption further. At 5% GDP growth, steel consumption intensity would drop to 76.8 kilograms per USD 1000 of GDP while iron ore use will decline to 115.4 kilograms.
He said that “If China's new leadership manages to refocus the economy towards consumption, the share of investment in GDP could drop to 30 per cent this decade from about 45%. The amount of steel per unit of GDP will also fall so your GDP becomes less steel intensive predicting steel consumption will flatten in 2015 and drop in the years to 2020.”
Mr Li Xinchuang deputy secretary general of the China Iron and Steel Association said that “In 2012, China's iron ore shipments rose 8.4% to a record 743.5 million tonnes and similar growth would lift imports to just over 800 million tonnes this year. China's imports could peak at between 800 and 850 million tonnes.
BHP and Rio expect China's steel demand to peak at around 1 billion tonnes only towards 2030. But last year, China's implied steel consumption already stood at 910 million tonnes, according to calculations based on Reuters data on output, imports and exports. Meanwhile, seaborne iron ore supply is only getting bigger.
Iron ore rose from less than USD 20 per tonne in 2000 to a record in 2011 near USD 200, before levelling off. In comparison, oil, the only traded commodity market larger than iron ore, rose only half as quickly when it hit an all time high above USD 147 a barrel in 2008 from about USD 30 in 2000.
Iron ore fell to a three year low of USD 86.70 last September as the Chinese economy lost momentum. They have since recovered to around USD 130, but could average USD 126 in 2013, a 4 year low. With production costs at between $US30-$US50 a tonne, big miners like Brazil's Vale, as well as Australian producers Rio and BHP will still remain profitable even with far lower margins and it makes sense for them to produce more for less.
Source - SMH.com