IRON ORE REVIEW 2012

Magnus Ericsson, Anton Löf, Olle Östensson

Raw Materials Group, Stockholm 2012, www.rmg.se

Steel production

With the world economy and industrial production recovering slowly, mainly in emerging countries but also in parts of the OECD area, world crude steel production increased from 1430 Mt in 2010 to 1527 Mt in 2011, an increase of 6.8 %. World crude steel production in 2011 was thus well above the peak reached in 2007.

China again accounted for most of the increase in production, although both Europe and North America showed some growth. Crude steel production in China increased by 8.9% - from 639 Mt to 696 Mt, a lower rate than the 10.7 % achieved in 2010. In Europe, production rose by 3.9 % but is still below that of 2008. Africa experienced a severe decrease of 20 %, mainly related to power shortages in South Africa. In the Americas production grew by 7.5 %, but was still below the level reached in 2008, before the financial crisis.

The recovery in crude steel production since the financial crisis has been almost entirely due to China, where production started increasing again in November 2008 and previous peaks in monthly production were matched already in April 2009. The rest of the world had still not reached pre-crisis production rates in April 2012. Growth rates in most of the OECD area are likely to be modest over the next few years.

Monthly world crude steel production had regained the pre-crisis peak by May 2010. This was however almost entirely due to China, where production started increasing again in November 2008 and previous peaks in monthly production were matched already in April 2009. The rest of the world had still not reached pre-crisis production rates in April 2012. Growth rates in most of the OECD area are likely to be modest over the next few years.

Iron ore production

In 2011 the world iron ore market continued to grow after the recovery from the recession in 2009 and a new all time high was reached at 1922.5 Mt, some 4.7 % higher than in 2010, with a production of 1836.1 Mt (see Table 1).

Output increased in most regions and countries except in Europe which was a stagnant market, including the CIS countries. Oceania experienced the highest growth rates approaching 12.6 %. Among the major producers Australian, Brazilian and Chinese production increased by 12.7 %, 5.1 % and 2.1 % respectively. Indian production decreased somewhat to an estimated 196.0 Mt, down 7.5 %. Production in the CIS countries fell slightly by 0.5 %.

Chinese production, on a comparable grade basis, was 321.9 Mt, or 16.7 % of total world production in 2011, down from 17.3 % in 2010 but below the top level of 20 % in 2007. We amake our estimates basing on a careful analysis of pig iron production in China and iron ore import statistics. We consider these figures to be more reliable than the Chinese gross figures for iron ore production without considering the grade or iron ore content of the ore produced.

In more general terms, for the long run, Australia and Brazil will be the dominating forces in iron ore production. India, which has large and good quality resources of iron ore, will be hampered by red tape and an on-going internal struggle of use. Over time, as the Indian steel industry grows, most of the iron ore will be used domestically. We also foresee a slow decline in Chinese output.

World pellets production rose by 3.5 % in 2011, from 402 Mt in 2010 to 416 Mt, reaching a new record level. This reflects a continued increase in demand for pellets in many countries, although the weakness of the steel market has led to reduced growth in pellets demand relative to total iron ore demand. It deserves to be noted that production of pellets in China increased by more than total iron ore production, reflecting the beginning of a shift towards increased pellets use.

Iron ore trade

In 2011, international iron ore trade reached a new record level as exports increased for the tenth year in a row and reached 1155.0 Mt, up 7.9 %. The increase was the result of higher demand from mainly China while most other countries in the world had trade levels similar to the year before and have not reached their import levels of 2008.

Australia’s exports increased by 8.9 % to 438.8 Mt in 2011 compared to 2010. With important markets in Europe and the Americas picking up pace, Brazilian exports, which fell sharply in 2009, had definitely turned around by 2011 with an increase of 12.1 % in 2011, compared to 2010, up to 348.6 Mt up from 310.9 Mt. Exports from India fell for the second consecutive year, 2010 was the first time in twelve years with falling exports but the country is still, at 78.8 Mt, down 17.8 % from 95.9 Mt, the third most important exporter. Ukraine, Kazakhstan and Russian Federation increased their exports.

China remains the world’s largest iron ore importer. In 2011, its imports were 686.7 Mt, an increase by 11.0 % compared to 2010. In 2010, China accounted for almost 59.1 % of total world imports. In 2011, this figure had increased to 60.1 %. In Japan, imports fell by 4.4 % to 128.4 Mt. In the Republic of Korea imports increased by 15.3 % to 64.9 Mt. European imports (excluding the CIS countries), increased by 16,8 %, reaching 156.4 up from 133.9 Mt in 2010, corresponding to just above 13.7 % of world imports.

In 2011, the seaborne iron ore trade increased by 7.2 %, to 1060 Mt. The increase was almost entirely due to higher Chinese imports, with trade in other parts of the world stagnating.

Iron ore prices

Iron ore prices continued on an upward trend through most of 2011, as Chinese demand recovered and domestic Chinese iron ore mines producers were unable to keep up with the demand. Towards the end of the year, however, prices declined in response to a slowdown in Chinese growth and worsening outlook for European countries. During the first half of 2012, prices have remained more or less constant, at a level which, although high from a historical point of view, just allows high cost producers, mainly in China, to break even.

With almost all iron ore producers and steel mills having abandoned the benchmark pricing system, there is widespread confusion about prices. Practices for price setting vary widely and there is a large number of published prices and indices, each with a different product specification.

Of the largest producers, Vale and Rio Tinto apply quarterly determined prices to most of their sales, with the price being set on the basis of spot prices during the preceding months. There have, however, been deviations from this practice, particularly in instances when spot prices have fallen rapidly, as in late 2011, and buyers have insisted that the new lower prices be applied. BHP Billiton is believed to sell a large share of its production on a spot basis.

As for published prices, there are three competing price indices (Metal Bulletin, Platts and The Steel Index (TSI)). The indices sometimes differ by a few dollars per ton, but the differences tend to disappear when prices are averaged over a longer period, which means that the variations appear to be the product of random movements and do not reflect fundamental differences in methodology. For individual actors on the market, however, the differences between the indices are a source of uncertainty. Other prices are published on an informal basis. Thus, China Metallurgical Newsletter publishes prices of high grade (66 %) concentrate and imported, mainly Indian, fines of slightly lower grade (62 %). While all the prices mentioned so far are quoted on a Chinese basis, either at a specific point in China or cfr Chinese ports, other newsletters published by financial institutions and market analysts provide fob prices of Australian and Brazilian exports. Finally, the publication of spot trading data by trades made on the China Beijing International Mining Exchange constitutes an effort to improve transparency in the market by providing details of individual trades.

The CME group, SGX (Singapore Exchange), London Clearing House (LCH.Clearnet), NOS Group and ICEX (Indian Commodities Exchange) all offer cleared swaps based on TSI iron ore transaction data. The CME also offers a Platts based swap, in addition to its TSI swap clearing. The ICE (Intercontinental Exchange) also offers a Platts based swap clearing service. The swaps market has grown quickly, with liquidity clustering around TSI's pricing. Singapore Mercantile Exchange (SMX) has launched the world first global iron ore futures contract, based on the Metal Bulletin Iron Ore Index (MBIOI) which utilizes daily price data from a broad spectrum of industry participants and independent Chinese steel consultancy and data provider Shanghai Steelhome's widespread contact base of steel producers and iron ore traders across China. In spite of the rapid growth in the range of possible derivatives trades, both iron ore mining companies and steel mills have so far been relatively slow to start using the hedging facilities. Based on experiences from other markets, however, it is likely that modern price risk management instruments will in the future play an increasingly important role in the iron ore market.

On 8 May 2012, China’s first physical iron ore trading platform,. The CBMX is backed by 26 Chinese steel mills and traders, including Baosteel, Wuhan Iron and Steel, China Minmetals and Sinosteel. A competing platform, GlobalOre, opened less than a month after CBMX, on 30 May. It is backed by iron ore miners BHP, Vale and Rio Tinto and Chinese steelmakers, including Baoshan Iron and Steel.

When considering the future of iron ore pricing it is important to understand that most of the iron ore is sold on long term contracts and that buying iron ore is not like buying other metals. One of the most important considerations for steel mills is the consistency of quality of the iron ore. The operator of a blast furnace wants to be absolutely able to trust that the iron ore to be delivered will be of the same quality as that in the last batch. This means that the system favours long term contracts from steady suppliers.

Corporate concentration

Brazilian Vale remains the world’s largest iron ore producer at 323 Mt in 2011 which is an all time high once again. Its market share fell however to 16.3 %. In tonnage terms, the gap with number two, Rio Tinto, increased but percentage wise it became smaller. In spite of this growth Vale's market share I 2011 was lower than the peak at 18.8 % in 2007. Number two, Rio Tinto has grown by 8 Mt only to reach a market share of 9.6 %, continuing down from 9.9 % in 2010 and 10.8 % in 2009. BHP Billiton increased its production by 24 Mt to reach 173 Mt or 8.8 %, up from 8.2 % in 2010.

The three largest companies, Vale, Rio Tinto and BHP Billiton (the last two with most of their production in Australia), together controlled 34.7 % of world production in 2011. Thus, the market share of the "Big 3" decreased, albeit slightly, from 35.0 % in 2010 and their share is still lower than the peak in 2005 at 36.4 %. The decline is the result of new production being started in many countries by smaller and also midsized producers. (See Table 2).

An alternative way to measure the control of the global iron ore industry is to monitor the share of global seaborne trade of the leading producing companies. Arguably, this method measures real market influence more accurately, since it excludes most captive production. Measured this way, the shares of the major companies are considerably higher than if they are estimated on the basis of production: Vale alone controls 24.9 % of the total world market for seaborne iron ore trade and the 3 largest companies control 57.3 %. The share of Vale, the largest exporter, has been continuously declining during the past years although the pace of this decline has decreased in 2010 and 2011. In 2011, the market share of Rio Tinto also declined, while BHP Billiton's increased from 14.9% to 15.9 %. The total share controlled by the “Big 3” fell from 60 % in 2009 to 58 % in 2010 and 57.3% in 2011.

Capacity increase

New iron ore mining capacity taken into operation since May 2011, as identified at the individual project level, reached 125 Mt. As of May 2012, the total project pipeline contained 796 Mt of new production capacity to come on stream between 2012 and 2014. Of this total, around 270 Mt falls into the category “Certain”, 220 Mt -“Probable”, and 310 Mt - “Possible”. 28 % of the projects are to be found in Oceania (Australia), 15 % in Latin America, 14 % in Africa, 20 % in Europe, 10 % in North America and 12 % in Asia. In general, in any given year not all “Certain” projects will make it and not all of the “Probable” ones will become a mine in the period stated by the company handling the project, but the delay rarely exceeds 3 years. Most of the “Possible” projects will not make it on time but many will actually get going. In spite of these uncertainties it may with some degree of confidence be assumed that around 510 Mt, with a low of 380 Mt and a high of 600 Mt, of new capacity will come on stream in the period up to and including 2014.

In the 3-year period after 2014, some 348 Mt of additional iron ore capacity is listed with a completion date. Given the present circumstances of a higher uncertainty in a combination with increased difficulties to get finance for mining projects we will probably see some start up dates being pushed but as the long term market situation looks good quite a few of these projects will probably be taken forward. However the rate of new additions to the project pipeline might decrease somewhat.

Outlook

The world economic outlook remains uncertain and looks considerably less favourable than at this time last year. Compared to last year, the IMF has revised its forecasts downwards and the figure for world economic growth in 2012 is 3.3 %. Growth in 2013 is forecast at 3.9 %. Developed economies show little dynamism, with developments in the Euro zone posing downward risks for the world economy as a whole. The World Steel Association’s short term forecast for world steel use, presented in April 2012, anticipates a rise in steel use by 3.6 % in 2012, followed by an increase of 4.5 % in 2013. The World Steel Association thus expects global steel demand to continue growing at relatively high rates from a historical perspective, albeit slower than in the years preceding the financial crisis. In particular, China’s growth is expected to slow down considerably from previously very high rates.

On the basis of the prospects for a return to stronger growth in the second half of this year, we expect world crude steel production in 2012 to be about 1530 Mt, or about 4 % higher than in 2011. Beyond 2012, we would expect steel use and production to increase at an annual rate of just below 4 %.

At present, in June 2012, the iron ore market is still relatively tight and although spot prices have declined in recent months they are still high from a historical perspective, supported by Chinese demand. Chinese steel production continues growing, albeit at a reduced pace, and domestic production cannot meet the additional demand. Chinese iron ore production, which in the past has been characterized by its flexibility, with output expanding quickly in response to price increases, appears to be running up against constraints.

We estimate that iron ore use will increase from 1922 Mt in 2011 to about 2000 Mt in 2011 and 2080 Mt in 2013.

We estimate that the world iron ore market will be characterized by tight conditions for several years to come, although prices will decline as new production comes on stream. There are a large number of projects in the investment pipeline. However, supply chains are already under strain, with delivery times for all kinds of equipment lengthening. Moreover, with new regulations requiring banks to increase their capital ratios and to avoid risks, several of the smaller projects are facing financing problems. There are therefore reasons to believe that new capacity will take longer time to enter production than is planned at the moment.

We are not prepared to conclude that the iron ore market is facing imminent reversal. First, as already mentioned, there are reasons to believe that recent expansion plans are somewhat optimistic. Second, the figures for capacity additions refer to what is added at the end of the year, and a part of it will not be in operation until late in the year. Third, and most important, the market will be tight due to the existence of two mechanisms placing a cushion under prices: the large iron ore producers can implement their expansion plans with a great deal of flexibility, and a considerable segment of the Chinese iron ore mining industry, would close if prices were to fall dramatically below present levels.

Accordingly, we believe that while the market is certainly moving towards a balanced supply and demand situation, it will remain tight, with a strong possibility of modest price increases during the second half of 2012, and the next few years will be characterized by a gradual adaptation of supply, by way of addition of new capacity, to a continuously growing demand. Prices, while declining slowly from 2013 onwards, will remain at levels that must be considered high from a historical perspective, with a floor at around 100-120 USD/ton delivered in China.

The background material for this article is extracted from ‘The Iron Ore Market 2011-2013’, published by UNCTAD in July 2012. This study is researched and compiled by Raw Materials Group (www.rmg.se) for UNCTAD, and can be ordered from: ironore@unctad.org or by fax from Ms Amelie Zethelius Mermet at +41-22 9170509.