Iron ore's imminent freefall through the $US55-a-tonne threshold begs two simple questions: how low can the price go from here, and when might this long retreat start to stem the oversupply that is the central cause of a now national budget-denting calamity?
This week the resources team at HSBC, like others before it, cut its suite of iron ore price forecasts and justified the move with a set of numbers that describe in gruesome detail the wave of iron ore that has yet to hit an already swamped marketplace.
HSBC expects global iron ore supply to grow by 143 million tonnes (mt) over the next three years, with the four majors adding 213mt, while another 70mt is squeezed out of the global system.
Nearly 30mt of the disappeared tonnes will come from the Australian juniors' output, which HSBC predicts will fall quickly from a peak of 62mt last year to 35mt this year. Beyond that, Gina Rinehart's 55mt giant at Roy Hill will come on-stream, lifting the Aussie juniors' contribution to 80mtpa by 2018.
On the supply side of the story, once again Western Australia's blunderbuss of a Premier, Colin Barnett, has sheeted blame for this current and future glut to strategies that see BHP Billiton and Rio Tinto deciding to make the most cost-efficient use of the capacity they have spent $US50 billion ($64.7 billion) or so building.
According to the Premier, this is the "one of the dumbest corporate plays" he has ever seen.
No question, Rio and BHP are in a contested sprint to the bottom of the cost curve and some of their competitors will be left dangerously exposed by their every success in enhancing margins through productivity rather than worrying about the impact of the resulting supply surplus on iron ore's price.
It is worth noting that, since January 2011, the Pilbara producers have added some 248mt of iron ore to the seaborne market and just shy of half of that has been delivered by Fortescue, with the targets of Barnett's ire speaking for about half each of the balance.
And, when we look ahead, it is Vale that is going to be making the biggest contribution to growth. It plans to add more than 100mt to the system by 2018 – more than the combined additions we can expect from Rio and BHP.
Whoever is to blame, the hard reality is that the steel world is only going to be able to eat about half of the volume increases that are planned. The result is that by 2017, HSBC believes the market could have a baked-in surplus of 140mt, with supply running ahead of demand by at least 30mtpa. It sees that situation only getting worse in 2018, when Vale completes its post-boom build-up in capacity.
The firm reckons we should be looking for the price to range between $US55 and $US65 a tonne over the medium term and that the supply-demand outlook implies a long-term price of $US58 a tonne. Like others, HSBC also wonders whether the iron ore sector's stranding narrative on Chinese steel industry growth can be sustained.
Of more immediate importance, though, is that HSBC is banking on the idea that $US50 a tonne is the "pinch point" in the market; the price at which even some of the bigger players will have to start to review their investment plans and their production models.
"We think that even low-cost producers will find little economic incentive to expand production at an iron ore price below USD50 [a tonne] and that Vale and Fortescue risk hitting a roadblock at such levels given ore quality factors prevent both from realising the full benchmark price," HSBC said.
So does that mean $US50 might mark the low point of the cycle?
Maybe. But there are some bears out there (iron ore miners among them) who say basic market theory dictates that those who see average prices sustaining rises any time soon are being very optimistic indeed.
Late last year, in assessing where the market was headed, BHP's iron ore boss warned analysts and media alike that, while the market remained in deep surplus, we needed to look to the major with the highest costs to assess how low prices might go.
Naturally, there is some healthy debate about who that might be. But basically it is a race between Fortescue and Brazil's Vale. And the Pilbara's third force offered us a bit of a guide to the state of that race on Wednesday in explaining why it had decided to pull a $US2.5 billion note issue that would have seen it refinance or extend the vast bulk of its $US8.8 billion debt portfolio.
Fortescue noted, en passant, that is was now landing iron ore in China at $US41 a tonne, which means it has already hit second-half targets confirmed in February. Management is rightfully proud of its "cost journey".Through the December half, it landed ore in China at an average of $US45 a tonne, and just two years ago that cost sat at $US85 a tonne.
But the betting is that all of this effort has left it, at best, with a marginally lower landed cost than the giant Vale. Mind you, Vale's all-up cost might be just a little higher, but a good portion of its tonnes would be a better quality than Fortescue's and thus be generating a better price.
Greenfield gains secure
The coal unions have failed to block registration of a new workplace agreement that locks in progress BHP Billiton secured back in 2010 at a next-gen metcoal mine called Daunia.
Despite being opposed by the three coal unions and twice rejected at ballots, the new agreement was voted up by the Daunia workforce in October last year. But challenges to that successful ballot by the CFMEU and the CEPU meant that the Fair Work Commission did not finally sign off on the arrangement until Wednesday.
The guts of the union position was that the enterprise agreement had not been "genuinely" approved because workers had been coerced by management misinformation and the targeted removal from the mine of two union "activists".
This proposition and others were rejected by the commission.
Outside of BHP's successful defence of its agreement, this case is interesting because it stands as confirmation of one of the underlying strategies of the design of the Daunia operation. It was the first mine in the Bowen Basin to have an exclusively fly-in/fly-out workforce. And management always held great hopes that, along with its nearby cousin in FIFO, Caval Ridge, the new-age operation represented a shape shift in the demographics of Queensland's coal industry.
One effect of this shift is that the vast majority of the men and women who were originally employed at Daunia were not by necessity members of coal unions. And that independence appears to be enduring.
Evidence offered by the CFMEU suggests it does not have an established presence at the mine and is still in the process of trying to recruit new members. The union has not yet managed to open a lodge for the mine (lodges are the core mechanic of coal union power) and admitted that other structures of authority, like the formal election of delegates, are not in place either.
Source: Financial Review
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