With iron ore prices testing $60/tonne, we look at the supply response so far.
3rd Tier are giving up
What we term 3rd tier miners have already given up. Typically producing 1-3m tpy, they lack contracts, do not have integrated logistics and are often selling products that are sold at a discount to index. Examples include Eldorado Gold in Brazil (1m tpy) or JSW in Chile (2m tpy); both of which closed in Q4 2014. Along with mines in Mexico, SE Asia, India, Canada, West Africa, Iran and smaller Latin American economies, supply from this sector is expected to decline by around 80m tonnes in 2015 compared to 2014.
2nd Tier are losing money (and will give up)
Increasingly 2nd tier producers are exiting the market or will come under pressure to idle capacity, particularly those with high-cost operations supplying the seaborne market. These 2nd tier miners are bigger – 3-15m tpy, but often lack the integrated logistics that keep costs low and typically mine lower-grade resources.
- In Australia, Atlas Iron has an all-in cash cost guidance of US$50-55/tonne delivered China at current exchange rates. However, even its standard grade is 57.2% Fe and receives a discount from the 62% index. Its 12-15m tpy of forecast output has to be considered very vulnerable. Arrium Onesteel also receives a discounted price (nearly 20% below Platts in Q3) and its Q3 cash costs on an fob basis were close to $60/tonne cfr. It announced the closure of its export-oriented Southern Iron mine with 4m tpy capacity in January. We expect Karara Gindalbie, Atlas, Mt. Gibson and Cliffs to exit the market in 2015. Along with 3rd tier mines already closed, Australian export volumes will fall by almost 50m tonnes.
- In Canada, Cliff’s Bloom Lake (7m tpy) moved to care and maintenance in late 2014 with cash costs as high as $91/tonne fob.
- In Brazil, MMX stopped mining at its 8m tpy operations in Q3 2014.
Overall, we estimate that supply from second-tier miners in Brazil, Australia and Canada will decline by 75m tonnes in 2015 compared to 2014.
The majors are coming under pressure
The declines from 2nd & 3rd tier producers will total approximately 150m tonnes in 2015 compared to 2015.
That volume may be more than offset by rising volumes from the majors. Rio Tinto is guiding to 330m tonnes in 2015 – up 40m tonnes with BHP Billiton guiding to 10-12m tonnes more in 2015 with Fortescue also operating at higher-than-capacity levels expected to increase output by at least 10m tonnes. Vale is guiding to 340m tonnes in 2015 – up 13m tonnes. In total, this is approximately 75m tonnes.
Despite the higher guidance on volumes, prices are now approaching levels at which the Tier 1 miners will come under pressure. That may mean that they are forced to trim production levels.
Both BHP Billiton and Rio Tinto claim C1 costs of US$20-25/tonne. However, including royalties and freight, their delivered cost to China is closer to $40/tonne.
It is Fortescue and Vale that will be of greater concern. For Fortescue, its October cash costs were $29/tonne, but its all-in cost delivered to China is closer to $50/tonne (dry). Moreover, it gets a discount of 9-12% to the 62% index due to its lower iron content, suggesting that it is close to getting $55/tonne currently. That is too close for comfort.
Vale’s 9-month cost of production is claimed at US$23.60/tonne, yet once royalty costs, freight and other costs are taken into account, its delivered cost to China is above $50/tonne. Moreover, we are somewhat cautious of Vale’s statements. Its iron ore EBITDA/tonne in Q3 was just over $13/tonne. The average for Platt’s 62% index in Q3 was $90/tonne. The average in Q4 was $74/tonne (down $16/tonne) and we are forecasting $65/tonne in Q1 2015. Although Vale will gain some relief from currency devaluation, its EBITDA may be negative at present.
What about the Chinese?
Output in November & December began to fall year-on-year in China, but we think that the outlook for Chinese iron ore production will not become clear until March-April, when northern mines return (or don’t return) from their winter idling. Our base case view is that Chinese output will be down around 20-25% in 2015, which will take out around 80-100m tonnes of 62% Fe equivalent.
Supply cuts could mean an iron ore deficit in 2015
Overall therefore, we expect supply to decline in 2015. However, there will be incremental output increases from other suppliers that are ramping up e.g. Minas Rio in Brazil and the market deficit may not be as large as the 170m tonnes shown below. Moreover, the market balance will depend on demand and we are cautious here, while inventories are also elevated so there will initially be some drawdown.
Cumulative Iron Ore Supply – 2015 vs 2014 (m tonnes)
What does this mean for prices?
Our view is that the market remains over-supplied currently and prices will continue to fall. However, once prices hit around $55/tonne, we think that there will be a supply response. With the majors losing cashflow, it makes more sense for them to keep the ore in the ground. As they control 70% of the overall seaborne market, a signal from them (we expect it will be Vale or possibly Fortescue) that they are curtailing output will set a floor on the price. At that point, the market may realise it is in deficit and there will be a modest rebound, but any price improvement will see additional iron ore being supplied so the upside will be limited.
