iron ore
Stockpiles of iron ore sit at the ship loading facility at Fortescue Metals Group Ltd.'s Herb Elliott Port in Port Hedland in the Pilbara region, Western Australia, on Tuesday, Dec. 3, 2013. Fortescue, Australia's biggest issuer of junk-rated mining bonds, is targeting investment-grade status as strength in iron ore prices lets the company cut its debt burden. Photographer: Sergio Dionisio/Bloomberg
The rapid decline of the iron ore price over the past three years tested the limits of mining companies globally.

By Andries Louw, industry analyst at Coface, the international trade credit insurance company.

This left the industry questioning whether it was realistic to be hopeful about the price recovery seen over the past few months. With various factors contributing to the volatility seen over the past decade, it is hard to say exactly what the future holds.

Demand for iron ore is primarily driven by industries that require large amounts of steel. For example, the construction and automotive industries account for more than half of worldwide consumption. Iron ore is predominantly used for the production of steel and is therefore dependent on overall economic growth to drive demand.

The commodity is mined in approximately 50 countries, but has a few dominant players progressively gaining market share under the current market conditions. According to the U.S. Geological Survey the top three producing countries accounted for nearly 80% of total production, China being the largest player by a significant margin.

It was expected that output from China and some African countries would slow down under the prevailing market conditions due to higher production costs from some smaller inefficient projects. Smaller mining companies are being put under increasing pressure by the low iron ore price with narrow margins. The result is that the small mines are being forced to close down or seek partnerships in attempt to remain profitable.

Larger companies with low production costs, specifically in Australia and Brazil, are using the difficult industry position to gain market share. This has sustained the global oversupply, forcing iron ore’s price down from the supply side.

Local environment

South Africa is currently the sixth largest producer of iron ore globally and the third largest exporter accounting for approximately 6% of global exports, having produced roughly 80 Mt in 2015. Even though power supply improved significantly in South Africa over the past year, it could still be considered a potential threat to future expansions.

The possibility of labour unrest could also cause major problems for the local mining sector and result in low profit margins. inefficiencies have forced some of South Africa’s largest iron ore producers to consolidate projects, and even consider dis-investing from South Africa.

Closing inefficient operations has been successful for some by decreasing their break-even extraction costs. Most mines are likely to continue their focus on efficiency in an attempt to maximise narrowing profit margins, instead of major capital expenditure for expansion. The majority of new projects in Africa are also facing challenges due to the low commodity price.

Despite the expected decrease in production, South Africa will remain the largest producer of iron ore in Africa for the foreseeable future. Delays in projects in West Africa are likely, due to factors such as political risk, poor infrastructure and weak legal systems.

Regardless of these difficulties, continued investment from China in mining and other projects is expected to yield improvements in the available infrastructure. Local demand for iron ore is expected to remain subdued, as steel manufacturers face increasing production costs.

Global outlook

Amongst other factors, iron ore prices have been driven down by a global oversupply in recent years, with a slight recovery in 2016 that has provided some relief in the short term for iron ore producers. Even with recent developments, it is predicted that iron ore prices will remain relatively low in the foreseeable future.

This oversupply is evident when considering the increasing output of the world’s two largest net exporting countries, Brazil and Australia.

Australia’s iron ore exports contribute to roughly half of the world’s total exports. Currently Australia is the world’s second largest iron ore producer holding a competitive advantage due to low cost production and high-grade iron ore.

During 2015, Australia exported $37 billion in iron ore with a total production estimated of 824 Mt. It is expected that Australia’s iron ore sales will increase at an average of 3% yearly until 2020.

China is the world’s largest iron ore consumer, and consumes about 80% of Australia’s exports. Australian iron ore exports to China have increased by about 10% in 2015, which is significantly lower than the average annual growth rate of 18% over the past ten years.

Brazil’s expansion was smaller in comparison to Australia’s, producing approximately 428 Mtpa. Expansion projects previously started will contribute to the growth in Brazil’s iron ore output in coming years. Australia and Brazil have some of the most cost efficient mining operations globally with an estimated production cost ranging between $30 and $50/t for different projects.

Despite low commodity prices, output from Brazil and Australia are expected to show steady increases over the coming years in an attempt to gain market share.

Iron ore is one of the most mined and exported minerals in Brazil’s mining sector, which is likely to remain a prominent part of their economy. It is projected that 200 Mt of production capacity was inactive globally between 2014 and 2015 due to difficult market conditions.

 

World Mine Production
  2014 2015e
China 1 510 1 380
Australia 774 824
Brazil 411 428
India 129 129
Russia 102 112
South Africa 81 80
U.S. Geological Survey, Mineral Commodity Summaries, January 2016  (million tons)

China is the world’s largest net importer of iron ore, having net imports of $57.9 billion, eclipsing the second largest net importer, namely Japan, which has net imports of $9.3 billion. Therefore the effects of China’s declining economic growth and slowdown of residential property construction has had a drastic impact on global demand, affecting the iron ore and steel industries as a whole.

Although China is the world’s largest iron ore producing country, the grade of ore mined by China is lower. China’s crude iron ore production contains on average only 22% iron content. Therefore more complex and expensive mining processes are needed to refine these ores.

Smaller mining operations account for approximately 60% of China’s iron ore output. Additional factors impacting China’s demand for iron ore include the slowdown in industries with high iron inputs. The drastic drop in iron ore prices witnessed over the past few years was to a large extent due to China’s decline in steel consumption and the use of scrap metal in steel production as a substitute, placing pressure on the commodity price from the demand side.

The price recovery during 2016 is the result of the recovery of Chinese steel demand from its residential construction sector. This was brought about by China’s stimulus policies aimed at stimulating economic growth. Steel mills restocking iron ore has supported the commodity price in 2016 and is expected to continue well into 2017.

This price recovery is likely to prolong inefficient projects coming offline, fuelling the global oversupply. The current stimulus will only support the iron ore price in the short term, with the global oversupply produced by Brazil and Australia anticipated to drive the commodity price back down during 2018.

The latest development was an increase in the iron ore price triggered by Donald Trump’s victory in early November, causing the commodity’s price to rise to its highest point in two years. This 4% increase was due to Trump’s pledge to spend $500 billion on rebuilding US’s infrastructure. The United States produces and consumes only an estimated 2.5% of the global iron ore output.

The real long-term effects would only be known once there is some clarity on the exact implementation of these projects. Despite the recent recovery, the long-term view for the commodity remains unchanged as larger players in the industry plan to increase supply, aiming to take market share from the smaller competitors, feeding the global oversupply during a period of weakening demand.