Iron Ore Prices at 5-Year Low, Do Juniors Even Have a Chance?
Iron ore prices are in the news a lot lately. Iron ore is at a 5-year low of $81.9/metric tonne, down just shy of 40% this year alone. Coking coal is also in the dumps, down even more than iron ore from the 2011 peak. Then there’s the China factor. China imports about 2/3’s of the world’s seaborne iron ore trade. China is, and always will, be a wildcard. The tie between China and 3 of the Big 4 producers is difficult to break.
The Big 4 Producers Control the Market
The iron ore market is dominated by just 4 producers, Vale, Rio Tinto, BHP and Forescue. The smallest, Fortescue, exports 155 million tonnes per year. The entire annual seaborne market is 1.2 billion tonnes. The Big 4 control about 60%-65% of that market. Given the current spot market price and Big 4 dominance, do junior players even have a chance? Most probably don’t. For those that are years from production, with large cap-ex budgets and facing a series of equity raises, the outlook is especially bleak. In fact, a few iron ore companies in Australia have just gone bust, while several global projects are on hold. To add insult to injury, the Ebola plague in weatern Africa is not helping existing producers such as African Minerals and London Mining off 91% and 80%, respectively from their 52-week highs.
Juniors Simply Can’t Compete at Today’s Spot Price
This year has been incredibly painful for small and midsize producers, with no end in sight. Goldman Sachs recently cut its 2016 and 2017 iron ore price targets to $79/tonne and $78/tonne, respectively. Brutal. If this forecast comes to pass, the pain we’ve seen this year will seem like the good old times. In speaking with industry pundits I found that a floor in the spot price might be found in the mid $70’s/tonne because Fortescue has a marginal cost (adjusted for varying ore grades) around that area. However, Fortescue does not want to appear weak, it wants to hang with the Big boys, so the price could certainly fall further. Therefore, analysts are all over the map, some saying that iron ore is technically oversold and will return to $95-$100/tonne by year-end and others saying that the market will continue to fall to $70/tonne, “to see what Fortescue will do.”
To be clear any price below $85/tonne is highly challenging for most players. Vale, Rio Tinto and BHP reportedly have operating costs in the $40’s-$50’s per tonne vs. juniors in the $80’s-$100’s/tonne. The problem is that most were conceived on $125+/tonne ore. Junior projects coming online in 2013-15 were in advanced planning stages and in construction in 2011 when the iron ore price topped out at roughly $190/tonne. Today’s spot price is down 57% from that level. Some might jump in and say that the Australian dollar, recently at about $0.91, is a lot weaker than it was. However, that tailwind benefits 3 of the Big 4. By far the largest amount of iron ore comes from Australia. Only Brazil, largely through Vale, is even close.
As is often the case, China is a wildcard. China’s economic strength, or lack thereof, is typically blamed for movements in the iron ore price. That’s only partially correct. The biggest factor moving prices lower today is over-supply from the Big 4. Morgan Stanley has projected a global supply surplus of 79 million tonnes this year, 158 million tonnes in 2015 and 256 million tonnes in 2018. Goldman says the same thing, namely that the Big 4 are shooting themselves in the their collective feet. China is still a very important factor as it consumes 2/3s of the global seaborne market. China’s economy is widely known to be slowing due to weak housing prices and steel production. Steel (iron ore almost entirely used to make steel) prices in China at about $450/tonne, near multi-year lows. China’s own iron ore industry produces in the hundreds of millions of tonnes. The marginal cost in China is thought to be about $120/tonne. The key is that the vast majority of Chinese production is loss making at this time.
In a normal market, loss making operations would first curtail production and then shut down after a string of negative quarters. Not necessarily so in China where some or perhaps many of the remaining producers are backed by the Chinese state and/or tasked with a mandate to maintain jobs. Therefore, no one knows what the Chinese policies-adjusted marginal cost is. Still, the Big 4 are full steam ahead with production up close to 15% from 1st half 2013 to 1st half 2014. As indicated by Morgan Stanley, Goldman and others, the Big 4 will be expanding in 2015 and 2016 as well. These expansion plans are the culmination of 5-10 years worth of hard work, they aren’t likely to slow unless the price hits $60/tonne.
Pricing Visibility Weak
As bad as a 57% fall in price is, coking coal prices are down almost two-thirds from 2011 highs. Coking coal is used with iron ore to make steel. Many pundits believed that the floor in coking coal was $150/tonne, $140/tonne, $130/tonne… The price seems to have bottomed at $110/tonne. For iron ore, the floor is thought to be $80/tonne, but that appears to be an arbitrary number. A price of $70/tonne would represent a decline of 63% from the 2011 high tick.
The juniors have been reduced to mere call options on a rapid rebound in iron ore prices. Not only is the spot price too low for the vast majority to be viable, but the forecast for pricing is either cloudy or downward trending. A sustained price below $85/tonne will mean the end for an increasing number of players over time. There’s no question of, “what’s the number,” the low $80’s is it. Even so, short-term moves are not going to save the juniors. A select few can survive at today’s prices due to robust balance sheets, but are stuck wondering what the future holds. M&A might be the out for juniors, but only the cream of the crop.
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