Commodity Bulletin - Iron ore Q2, 2016 - Q3, 2016 | KPMG | BE

Commodity Insights Bulletin - Iron ore Q2, 2016 - Q3, 2016

Commodity Bulletin - Iron ore Q2, 2016 - Q3, 2016

As a result of rising Chinese steel prices and supply disruption in Australia and Brasil, the price of iron ore has increased by more than 25% from Q4 2015 to Q3 2016. However, there is no real expectation that this price hike is sustainable and the expectation is for a slow decrease throughout 2017.

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Overview

Longer term, the expectation is that low-cost supply will continue marginally higher than demand as low cost iron ore expansion projects, principally in Australia and Brazil, are finalized and production ramped up. Higher cost producers will continue to shut down operations but this will not cause a significant reduction in the supply of iron ore. Although there should be less volatility in iron ore prices, there is no real expectation of a significant price increase.

Price outlook

Iron ore prices for 62 percent fines Fe (CFR Tianjin port) witnessed a 6 percent increase over Q3 2015–Q3 2016 to US$57.9/t. In Q2 2016, q-o-q prices increased 16 percent to US$55.3/t, supported by the strong demand from China’s steel sector, driven by the apparently short term recovery of the construction sector over the period.

Prices are, however, forecast to decline to reach about US$52/t by end of 2016, while the forecast of US$48/t at the end 2017 remains unchanged.

The speculative activity on the Dalian Commodities Exchange, which contributed to high volumes been traded and high spot price volatility in H1 2016,has tapered off as a result of measures to reduce speculative trading. As a result of this reduced speculative activity, the iron ore price going forward will likely better reflect market fundamentals of slow consumption growth, and further growth of low cost production volumes.

Price outlook remains sensitive to the level of loss that higher cost producers in the market may tolerate and the risks are moderate. Additionally, there remains the potential for producers to further cut costs, enabling them to operate profitably at lower market prices.

Spot prices of China’s iron ore imports (Q2 2015–Q3 2016)

Source: IMF Primary Commodity Prices, International Monetary Fund, accessed October 2016.

Prices of iron ore (2014–2020E)

Source: Consensus prices from Capital IQ, accessed October 2016.

Supply and demand

Supply

  • During 2016–2020, the global supply of iron ore is projected to increase gradually, owing to the continued substitution of China’s domestic production of iron ore with imports, particularly from Australia and Brazil. The seaborne market is expected to remain well-supplied, with several large, low-cost operations in Australia and Brazil ramping up production through 2017.
  • By 2017, Australia and Brazil are forecast to increase their share of global seaborne trade to 58 percent and 27 percent, respectively, driven by the production at new, low-cost mines and expansion of existing operations. The export growth from Australia and Brazil is also expected to be supported by a growing preference from China's steel mills for higher grade ore to reduce emissions, as operations face more stringent environmental regulations.
  • In Australia, production is expected to increase largely by operational improvements and ramp-ups. Rio Tinto’s Nammuldi Incremental Tons project is expected to start production by the end of 2016, doubling capacity to 10 million tons. In addition, improved utilization rates and installation of a new crusher at BHP Billiton’s Jimblebar hub is expected to increase production. Australia’s largest single mine iron ore producer Roy Hill, owned by Gina Rinehart is expected to ramp up production by 55 million tons (mt) per year, starting early 2017. BHP Billiton’s South Flank mine is expected to produce as much as 80mt per year, once approved. Currently, Western Australia’s Nationals party has proposed a production-rental cost on producing iron ore in Australia that directly impacts the project operation.
  • Brazil production growth is expected to be largely due to Vale’s S11D expansion project — which is in its final stages of development. S11D is expected to produce about 75 million tons of high-quality iron ore per year, with more than half of the production planned to be exported to Asia.
  • The pace of closures of China’s iron ore mines is subject to government policy and could occur faster than expected. However, the small-scale iron ore mines in China are able to restart operations relatively quickly in response to any price recovery and, thus, overall reductions are unlikely to be significant.
  • India’s iron ore production has increased by 43 percent y-o-y in Q2 2016, owing to the lifting of some mining restrictions. However, production caps in the states of Odisha and Goa continue to constrain growth. It is projected to grow further through 2017, as the domestic steel industry has been supported by ambitious infrastructure projects and policies to expand the manufacturing sector, along with protection from international competition through import duties.

Global supply of iron ore (2014–2020E)

Source: JP Morgan, Iron Ore – Supply & demand check, 02 October 2016, accessed October 2016.

Demand

  • China’s iron ore imports are expected to grow marginally in 2016, to reach 1,210mt. The import growth has been revised upward since June, to reflect the unexpected resurgence of domestic steel production, which drove import growth of 11 percent y-o-y in Q2 2016.
  • Iron ore imports in China are forecast to grow slightly in 2017 reaching about 1,227mt, replacing domestic production. According to Reserve Bank of Australia, China’s continued urbanization, its public spending to close gaps in national infrastructure and motor vehicle use will ensure that there continues to be a relatively high level of steel production and consumption in China, which will drive the demand for iron ore.
  • Iron ore demand is expected to grow at CAGR 1 percent over 2015–20, driven by increased imports from key countries such as China and India. Globally, steel demand growth has been sluggish. According to the World Steel Association global demand will grow 0.2 and 0.5 percent y-o-y, respectively, during 2016 and 2017. But, in spite of sluggish demand and historically low iron-ore prices, the big three producers — BHP Billiton, Rio Tinto and Vale — are expected to drive increased production.
  • In India, increased domestic production has resulted in 67 percent y-o-y decline of iron ore imports, during the first five months of 2016. Over the same period, there was a substantially large growth in exports, mainly to China. However, the export growth is from a low base and relatively small, high-cost mines. Going forward, as a result of the growing domestic consumption, India is not expected to become a major exporter of iron ore.

Global demand of iron ore (2014–2020E)

Source: JP Morgan, Iron Ore – Supply & demand check, 02 October 2016, accessed October 2016.

Key developments

Ownership changes

The total value of the nine M&A deals announced in Q2 2016 was US$0.6 billion compared to the nine deals in Q3 2016, valued at US$1.1 billion.

Angang Group Mining, a unit of the Chinese state-owned Anshan Iron & Steel Group Corp, agreed to acquire the entire share capital of Anqian Mining, an Anshan-based iron ore mine operator, from Pangang Group Vanadium Titanium & Resources, for about US$633.7 million.

Please note that the total number of M&A deals include all the announced deals, even those with undisclosed value. Of the 18 deals during Q2–Q3 2016, seven were undisclosed.

Value of major deals announced in iron ore industry

References

Price outlook (1) - “Resources and Energy Quarterly”, Bureau of Resources & Energy Economics (BREE), Australian Government, September quarter 2016, accessed October 2016

Price outlook (2) - JP Morgan, Iron Ore – Supply & demand check, 02 October 2016, accessed October 2016

Supply and demand (1) - "Resources and Energy Quarterly", Bureau of Resources & Energy Economics (BREE), Australian Government, September quarter 2016; BHP Says Australian Mining Tax May Risk Major Iron Ore Project, Bloomberg,14 September 2016; accessed October 2016

Supply and demand (2) - JP Morgan, Iron Ore – Supply & demand check, 02 October 2016, accessed October 2016

Demand (1) - "Resources and Energy Quarterly", Bureau of Resources & Energy Economics (BREE), Australian Government, September quarter 2016, accessed October 2016

Demand (2) - JP Morgan, Iron Ore – Supply & demand check, 02 October 2016, accessed October 2016

Ownership changes - MergerMarket and Thomson One; accessed October 2016

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