Global Iron Ore:Vive La Différence!

Citi’s third global iron ore report. We are downgrading our benchmark iron oreprice forecasts, forecasting a decline to an average of $80/t in 2016 before amodest rebound. We also introduce explicit forecasts for lumps, pellets, 58%, and65% ore, accompanied by granular examinations of these markets. For previousreports, see Strike while the iron is (still) hot? and Pumping Iron II.

    Differentiation is becoming increasingly important as quality productscommand premiums representing a rising share of overall prices. While aforecast fall in iron ore prices is likely to see nominal premiums decline for manyproducts, we expect significantly higher premiums on a percentage basis movingforward. This is being driven primarily by greater emphasis on pollution controls inChina as well as declining domestic ore grades.

    Chinese iron ore production is more resilient than commonly assumed. WhileChinese mines are among the highest cost in the market, several factors are likelyto support production even in the face of falling prices, including vertical integration(70% of output is owned by steel mills), freight advantages, and continueddevelopment of new mines.

    Traditional cost curves present a misleading picture. While many companiespublish cash cost figures, normalizing these for product and grade premiums,freight, moisture, and fx effects yields a very different picture. We currently see thetop of the ex-China cost curve around $100/t on a benchmark equivalent basis, withan increasingly significant portion of supply in the $75-95/t range. We also evaluatethe likelihood of project delays or cancellations, which we expect to play animportant role in balancing the market in the medium term.

    Chinese steel demand is slowing structurally, but even continued demand at2013’s level would be insufficient to absorb the current surge in supply.

    Moreover, scrap supply is likely to increase rapidly as steel produced in the early2000s is recycled, reducing the share of steel production fed by iron ore. Thegovernment’s focus on local government debt and controlling credit is likely to slowdemand but decisions around urbanization will still have a large impact on the pathof demand.

    Iron ore market participants would do well to heed the lessons of coal,aluminium and nickel. Prices will need to fall clearly below cash costs for aprolonged period to force production curtailments. This is especially true as iron orelacks the potential to replicate the inventory financing seen for aluminium, though itshould avoid the fate of met coal.