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Are iron ore prices low enough to drive out small producers?

The longer ore prices remain at the present level, the share of imports in Chinese use of this steel-making ingredient will keep rising

Kunal Bose 

What will justify the forecast of China Iron and Steel Association (CISA) that Chinese iron ore imports are to rise 7.1 per cent to one billion tonnes (bt) this year, in the face of a likely fall of 1.1 per cent in crude steel production to 814 million tonnes (mt)? World ore prices are down 50 per cent since the 2014 start to less than $60 a tonne, the lowest since 2009, in the wake of mining majors such as Brazilian Vale, Rio Tinto, BHP Billiton and Fortescue Metals pushing an extra 235 mt of ore into global sea-borne supply in the past two years. Prices remaining at the current level or somewhat higher will perforce claim further victims of "exceptionally high cost" Chinese mining groups. According to a CISA official, low import prices will extinguish up to 70 mt local supplies in 2015, equalling nearly a fifth of domestic output in terms of average ore import grade. In the halcyon days of the steel industry, China found justification in rapidly expanding ore production in disregard of a high production cost of up to $100 a tonne at many a site.

China has enormous ore resources. However, the Chinese mineral, mostly with iron content of 25 per cent or less, requires intense beneficiating to make it usable. Till a few years ago, Beijing, under the impression that a cartel of global miners was manipulating prices to the disadvantage of Chinese steelmakers, thought of making the country at least 50 per cent self-reliant by buying mineral assets abroad and expanding local output. Quite a few shuttered ore mines in places such as Sierra Leone, where, to get hold of assets, Beijing generously provided funds for mines-related infrastructure building, including all-season ports, are partly or fully China-owned. Buying iron ore assets abroad forms part of the nearly two-decade strategy to buy all kinds of natural resources in every continent, particularly in Africa. However, the end of a commodity supercycle and then the rapid price falls have come in China's way to actualising production at many sites.

However, is there a cartel in operation in iron ore? Not in the classical sense. Big miners with exceptionally low production costs, thanks to technology in employment and size of operation are not known to confabulate as to how to drive out small- and high-cost producers from business by keeping ore prices low. At the same, the likes of Vale and Rio pumping in large volumes of extra ore in the market resulting from billions of dollars of investment in new projects led to the removal of 170 mt or 12 per cent of global sea-borne trade originating outside the 'Big Four', says Morgan Stanley. Production cuts by comparatively high cost miners apart, Bloomberg International informs that in the past six months, as many as 22 projects were either cancelled or postponed. A cartel might not be in operation, but the 'Big Four' apparently have a common objective of squeezing out high cost producers by subjecting them to long periods of low prices so that their share of the market continues to rise. Rio Tinto chief executive officer Sam Walsh says, "As a low cost producer, it would not make sense for us to take tonnes off and give those tonnes to high cost producers... It simply doesn't make sense."

The longer ore prices remain at the present level, the share of imports in Chinese use of this steel-making ingredient will keep rising. Last year's experience of Chinese imports growing 14 per cent in the face of virtually flat steel production growth proves the point. In a six-month period, BHP has reduced production cost, excluding freight charges and royalties by 29 per cent to close to $20 a tonne. The other big three must be making more or less identical progress in cost cutting. Ore prices at six-year lows are not, therefore, proving a disincentive to growing production. Low extraction cost is allowing big miners to still make handsome profits, no matter their underlying profits from the iron ore division have fallen significantly from eye-popping highs of the past.

BHP's ore business suffered a 35 per cent profit fall in half year ended December. Ore profits will almost totally extinguish if Axiom Capital's observation of prices sinking to $30 a tonne comes true due to torrent of new supplies from dominant miners. China must be staring at the inevitability of many more mines closure.

First Published: Mon, March 09 2015. 22:32 IST