A bloodbath in iron-ore prices could get much uglier before things turn around. And it’s not all China’s fault, either.
While Chinese demand, a major force in the market, has slowed, big iron ore producers, including Brazil’s Vale VALE , BHP Billiton UK:BLT BHP , Rio Tinto UK:RIO RIO and Fortescue AU:FMG +0.82% plan to boost production and shipments despite the glut.
Australian producers BHP Billiton, Rio Tinto and Fortescue aim to boost output by 170 million tons this year, equal to around 7% of 2013 global supply and 11% of global production outside China, notes Capital Economics. Vale and Anglo-American are also looking to increase output, too.
Why are they boosting production in the face of falling demand?
“It’s because their marginal cost of production is much lower than many of the smaller players globally; and because they operate in different segments, they can absorb a large hit in iron ore mining profitability that others cannot survive,” said Ben Ryan, an analyst at Hedgeye Risk Management, in an email. “They’re ultimately admitting we’re in a downtrend in raw minerals mining (iron ore, copper, and coal) and the announcement to increase production despite prices [being down] 40% year-to-date works to squeeze lower cost producers on the way down. The expectation for the global supply increase works with the apparent decrease in demand to push prices lower. Eventually enough producers get squeezed out of the market and this supply/demand dynamic bottoms out then reverses.”
The situation illustrates the very low cost base for the biggest producers. Caroline Bain, senior commodity analyst at Capital Economics, noted earlier this month that iron ore from Australia’s Pilbara region costs just $20 to $25 a ton to extract. Even with freight costs and royalties, the final cost come in at around $50 to $60 a ton, she calculates. That compares with an average production cost of around $110 a ton in China, she said.
A handful of high-cost producers in China and elsewhere, including Australia, Iran, Malaysia and Mexico, have shut down, Bain noted. But overall, Chinese producers, who account for 45% of global supply, might not be so easy to push around, she said, noting that the regional governments have previously stepped in to support industries faced with overcapacity or profitability problems.
Source: The Wall Street Journal
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