Sino Iron’s $10 billion mine on Clive Palmer’s leases in the Pilbara has got its production costs below $US100 a tonne for the first time in the past few months, but they are still double the prevailing iron ore price.
Consulting firm AME lists Sino Iron as the world’s highest- cost operation supplying the Chinese market in seaborne trade. The firm counts only the mine’s variable costs such as wages, processing and transport. Adding in the capital charges could easily double its costs.
If Atlas Iron with production costs of around $US60 a tonne is in trouble, Sino Iron should be mothballed. There is no obvious economic justification for keeping it going. The mine’s continued operation says much about what is wrong with the iron ore market and also flashes danger signals for the outlook for the Chinese economy.
Until the second half of last year, the prevailing wisdom in iron ore markets was that the price would not go below $US90 a tonne or, if it did, it would not stay there.
In theory, the price of any commodity is dictated by the highest-cost production for which there is market demand. There was simply not enough iron ore production in the world to supply China’s steel mills with costs less than $US90 a tonne.
AME compiles “cost curve” charts of the world’s mineral producers, estimating the production costs of each mine. It calculates that of the world’s 1.5 billion tonnes a year of iron ore output, around 200 million tonnes has production costs of $US90 or more.
This production is all Chinese, with running costs (though not capital costs) matching those of Sino Iron. China’s iron ore is mostly very poor quality. The worst Australian iron ore has a 50 per cent iron content, while China’s is just 20 per cent. Chinese ore has to be baked three times before it is usable by a blast furnace, whereas most Australian ore can be fed directly.
The theory says that to get iron ore prices to settle below $US90 a tonne, you would have to take out 200 million tonnes a year of the highest-cost Chinese production, and analysts say that would leave the steel industry short of supply.
Some Chinese iron ore production has been closed since prices started sliding last year — perhaps 40 million tonnes out of the 400 million tonnes that China produces. This production has been replaced by imports, with Australia taking all the increase. But like so much of China’s heavy industry, most of its iron ore mines keep churning out product, regardless of whether there is profitable demand or not.
Many mines are integrated with steel mills, so their losses get swallowed in the larger enterprise. Steel mills may be pressured to pay more than market price for their ore while local and provincial governments will keep businesses rolling with subsidies or by pressing banks to support them. Last week, the Chinese authorities halved taxes on the iron ore industry to help keep it going.
The “stickiness” of production — the readiness to keep operations going at a loss — is not a uniquely Chinese phenomenon. Large tracts of Australia’s coal mining industry are unprofitable at current prices but keep on going because take-or-pay contracts with rail companies would result in even bigger losses if production stopped.
But the scale of the support for China’s heavy industry reveals the partial nature of its transformation into a market economy. State plans, supports and controls rub uneasily alongside the unbridled capitalism of its small- business sectors.
Property development — the seat of many of China’s current economic difficulties — reflects the distortions that occur when Chinese entrepreneurs, state-owned banks and government officials deal with each other.
Chinese business people love the English phrase “win-win” and for much of the past decade, it has seemed as if there was enough surplus in any transaction for everyone to get a slice.
The one policy change of the current Chinese government that has had a real impact is the crackdown on corruption, which is stifling the deal-making business culture across state and private sectors that drove China’s growth.
Chinese Premier Li Keqiang has repeatedly promised pro-market reforms that would include putting state-owned enterprises on a more commercial footing, however little has been seen to date.
Many remain confident Chinese authorities have the fiscal and monetary ammunition to achieve their target growth rates, however they are pushing against an economy weighed down by an increasingly inefficient industrial structure.
In tandem with the iron ore industry, China’s steel industry has also kept going in the face of weak demand. Production last year was essentially flat despite the downturn in the property sector. Mills made up for the domestic shortfall by exporting about 90 million tonnes of steel. Most of that went to Korea, Japan and India, all of which have their own industries and are pushing back against the Chinese incursions into their markets. It will be hard for the mills to avoid production falls this year, and the latest figures show March production levels were down.
Australian iron ore exports are still growing, with BHP-Billiton and Rio Tinto still bringing expansion projects onstream and Gina Rinehart’s Roy Hill cranking up output. Ever-increasing supplies cannot enter a contracting market without something giving way.
With Chinese production continuing, the pressure for mines to close moves lower down the cost curve to the array of smaller producing nations.
Although Australia and Brazil dominate the seaborne iron ore trade, there is about 160 million tonnes a year going to China from mines in South Africa, Iran, Chile, Peru and Ukraine that have production costs in the $US50-$US80 range.
Miners in these countries have fewer political supports than in China so are expected to start cutting back production as the price slump continues.
In the short term, commodity markets pay little heed to the “cost curve”. Prices overshoot both at the peaks and the troughs. Since the end of the annual contract pricing for iron ore in 2010, the market has become much more volatile, with greater speculative involvement.
An odd feature of the iron ore price slide, which began in October 2013, is that other than in the first three or four months, there has been no obvious build-up of inventory.
Chinese port stocks doubled from 50 million tonnes to 100 million tonnes by early last year, but have remained around that level since.
October 2013 also marked the introduction of futures trading in iron ore on China’s Dalian Futures Exchange. A futures market needs to be backed by an inventory of physical material.
Some wonder whether the run-up in port stocks in late 2013 and perhaps the extent of the price slide might reflect the influence of that market.
source: The Australian
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