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How Australia's iron ore miners hit the sweet spot

Sep 21, 2017

Australia is now through its expansion phase and looking at years of price stability. Bloomberg
by Allan Trench
Since the start of the 21st century large mineral markets have been characterised by two constants.
 
First, China consistently surprises with higher-than-expected demand for bulk commodities and base metals, led by iron ore and copper respectively.
Second, global mine supply tends to collectively surprise with lower-than-expected production. A well known list of impediments is rolled out, usually topped by various forms of inclement weather.

Ironically, pun intended, mine production of iron ore has stood out since 2012 as a regular exception to this informal "Chinese demand beats collective global mine supply" rule, as an industry-wide infrastructure-build played out in a previously supply-constrained market. Iron ore demand to feed the Chinese steel sector has more often than not kept its side of the bargain, requiring ever more imported feedstock and displacing higher-cost domestic Chinese mine supply.

The iron ore majors, in particular Rio Tinto and BHP, have regularly hit and exceeded their iron ore numbers. Brazil's Vale has performed solidly too – but Team Australia has been unbeatable. The inevitable price fall – that new supply in any market eventually dictates – tested the whole industry from 2014 onwards. The rise and rise of FMG as a new iron ore major is arguably the greatest Australian mining success story of our time. The business lesson here is straightforward: once infrastructure is in place, iron ore miners routinely deliver, overcoming the mining version of Murphy's Law in the majority of cases.

A production hiccup in 2017 numbers so far is therefore excusable. That is, this year to date is not set to be a vintage one for Team Australia supply. Rio Tinto in the Pilbara is illustrative. Mine production is down, which has meant a drawdown of inventories at Cape Lambert and Port Dampier as a necessity to maintain exports. Rio now indicate 2017 annual exports around the 330 million tonne mark, at the low-end of previous calendar year guidance, requiring a sprint through to December from around a 310 million tonne per annum first-half run-rate. Tonnes from the new Silvergrass project must arrive in the fourth quarter. BHP is also towards the lower end of earlier expectation – CRU Group anticipates 2017 exports of around 268 million tonnes, flat from 2017 financial year expectations that ultimately were not met.
 
Balanced market
Broadly speaking, Australia's surge in supply following the mining investment boom is now largely finished – with Brazil arriving late to the party courtesy of its low-cost S11D project. That mine, however, will return only a modest 8.3 million tonnes in the first half and is on track for 22 million tonnes in 2017. That said, Brazil will beat Australia in 2018 new export tonnes, adding over 30 million tonnes new supply next year. Closer to home, Roy Hill recently hit a run-rate exceeding 53 million tonnes in July, close to nameplate capacity – but this shields a slower than expected ramp-up illustrated by the second quarter, achieving only an annualised rate of just 32 million tonnes.
FMG's stellar ramp-ups of recent years, when the "new force" complained that others, not FMG course, were flooding the export market, have now transitioned towards a stable production outlook.

That Australia's annualised iron ore exports are now nudging 900 million tonnes put all these numbers into context. Indeed, the near decade-long supply surge has prompted many analysts to forecast a version of Armageddon hitting future prices, including suggestions as low as $US30 per tonne – and even below that for the proliferation of ores that now grade around 58 per cent iron versus the more traditional premium product of 62 per cent iron feedstock. These calls for "(much) lower for longer" prices smack of premature extrapolation. We now live in a more balanced global market rather than one of anticipated over-supply.

As the supply side now shifts into reserve replacement, export preservation mode from full-on expansion, Chinese demand still trundles along, with a surge in steel volumes and margins into the third quarter and a new phase of restocking. China's preference for high-quality feedstock has seen premiums expand for high-grade ores and lump. The longer-term outlook for Chinese crude steel production is flat, with internal change redirecting surplus scrap from induction furnaces to electric arc furnaces. Steel demand for the rest of the world nudges forward – courtesy of an improved economic outlook and a lift in manufacturing, but still remains incremental.

Dare I say it, but the next five years in the iron ore world looks almost boring. No doubt a few market surprises may yet prove me wrong. CRU Group foresees annualised prices for 62 per cent fines fluctuating in the $US55 to $US70 per tonne range on a CFR basis through to 2020.