HSBC confirms the iron ore bust is here

Here is yesterday’s iron ore price table with a nice bounce across the complex on whatever trivia blew in:

But that’s where the good news ends. HSBC yesterday released its quarterly commodities update and iron ore took a pounding, with forecast prices for 2013 falling 27% to $105. It is not a relief exactly, but it is nice I suppose, to find a respected bank finally following my thoughts on the future of the iron ore price. The HSBC rationale was rock-solid:

Our major single change in this review is in iron ore prices, where we cut our 2013 forecasts by 27% to USD105/t, which we believe is below consensus. This is partly due to poor demand conditions, but also because we now question the consensus view of marginal costs at USD120-130/t. We have been careful to consider a consistent group of outcomes – and are cutting capex, supply growth and cost inflation for the iron ore majors. We do not believe the industry will use leverage to fund organic growth, so the swing factor is now clearly capex, which in our view has peaked.

Kaching! In short, either way, whether it’s price or volume or both, the boom is busted. They go on:

We have lowered our price forecasts and considered the impact on cash generation – for many producers, the cut from USD130 to USD105 will approximately halve operational cash generation and must, therefore, impact capital spending considerations. We have cut our supply assumptions for all the majors, partly due to this but also due to company specific factors (eg pushing out Minas Rio yet another year).

  • We think cUSD100/t prices will continue to deter marginal investment in the west, and see the pullback in Q3 by FMG from its growth plans as a precursor to more restraint by junior producers in Australia, where currency pressures remain an issue, and Africa.
  • We have cut our forecast for production growth in 2013 from 5% to 4% (down from our April estimate of 8%).

Moreover, the assumptions underpinning these forecasts are still more bullish than my own:

We have cut our estimates of global crude steel production growth from 2.9% to 2.4% in 2012, and from 3.5% to 2.1% in 2013. This reflects a period of contracting demand in Europe and a cyclical slowing in China.

  • We do not believe that this is sign of a structural change, and expect growth to return to 3.5-4% post 2013. Although our fieldwork in China confirmed that demand and confidence was poor, we still see significant structural upside due to ongoing urbanisation, particularly away from developed costal areas. We continue to see installed steel in China representing only c4t/capita, vs 14t in the US and 18t in Japan.
  • We expect demand growth for iron ore to reach just 2% in 2013, down from 4% in our last review. This will be the lowest level of demand growth since the 2008/9 financial crisis.

They may not want to say so, but that chart looks like a structural shift to me, down from trend growth in demand near 10% to under 5%. Still, HSBC’s assumptions for growth in global steel demand remain around 4% per annum, driven largely by 5% per annum growth in Chinese output. My own view is that as China shifts its growth drivers, the risks are all to the downside of these figures. My base case for growth rates is roughly half those of HSBC.

The next sacred cow to be slaughtered by HSBC is the “price floor”:

Iron ore is searching for a new equilibrium price – one that incentivises some production growth in the west and keeps some high-cost mines operating in China. We have focussed on this latter point recently (see our corresponding sector note today What is the iron ore price telling us? Changing our view) and increasingly question the consensus assumption about the amount of ore in the supply chain that is genuinely high cost. We acknowledge that there is very little fundamental data on this issue, and there is now more upside than downside risks to our forecasts.

  • We do think that the reaction of marginal producers in Australia and China indicate that there is a firmer floor at 90-100/t than at 130/t. We believe that for prices to average below USD90/t, demand would have to begin to contract globally.

Exactly. The bank now has a long term forecast of $88 for iron ore.

All still slightly on the bullish side in my view but very much confirming my base case. HSBC was more bullish on coking coal, expecting a rebound to $200. I don’t see that coming. It will track iron ore. There is surplus supply in that market as well. Thermal they see remaining at current busted levels.

For Australia this comes three years too early. It will mean very large current account deficits while we wait for LNG exports to come on stream in a big way in 2015.  It means the notion of volume growth driving the net-exports component of GDP for the next three years is very weak. It means consistent pressure on the national and commodity state budgets. It means lower interest rates for longer and, if housing is triggered as the alternative growth vehicle, a huge current account deficit within eighteen months.

I don’t often agree with Marius Kloppers. But today I do. We need a national hair shirt.

121017 Metals Quarterly Q4 2012 (1)

David Llewellyn-Smith
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Comments

  1. We have overpaid ourselves for doing too little for too long; we have become fat and complacent on unsustainable levels of debt, which you rightly point out so often on this blog, has been enabled by a strong resource sector. The inconvenient reality Mr Kloppers is alluding to, is that our wages need to fall, discriminatory taxes against the resource sector must be abolished, and with it our expectations of the kind of lifestyle we are ‘entitled’ to – the one funded by our resource sector. Time to start earning our keep again now – more competitive wages, more competitive taxes. There is no other option. That is the national hairshirt we must wear.

    • discriminatory taxes against the resource sector must be abolished

      What we need, and what we have always needed, is a profits-based tax on the resources sector. We would have benefited when coal and ore prices were in the stratosphere, and the miners would be getting tax relief now as margins are squeezed.

      But the loony right prevented that from happening.

      • And where do you imagine we would be now, with that tax in place ? Would BHP and RIO be any MORE inclined to invest right now with iron ore and coal prices back down to earth, and with an even greater tax disincentive against profits still in place ? Was the ALP championing investment in diversifying our skills base using the proceeds of that money appropriated from the businesses that took the risk to create the wealth ?

        The biggest loonies in the scheme of things are the Union movement and their political cohorts in the ALP who are feathering their own nests to the long-term detriment of this country.

          • I’m glad to hear that surpluses are important to you. Logically then, you will not be voting for the ALP or Greens, who are pathologically incapable of maintaining them. There are more sound ways of achieving a surplus than the discriminatory taxing of businesses that generate a substantial amount of investment, employment and wealth for this country. Investment and jobs they are not obliged to keep creating here, it bears remembering. And why would they continue to invest in a country that views them at once as parasitical AND the goose that laid the golden egg. If you think we can restore this country to surplus in the long-term by increasing taxes, welfare, wages, government debt, all at once, and all the while prices for our exports are falling, and all the while investment is moving to countries with a more competitive wage and taxation system – then I fear you are inhabiting an alternative reality.

          • I’m glad to hear that surpluses are important to you. Logically then, you will not be voting for the ALP or Greens, who are pathologically incapable of maintaining them.

            Nor the Libs, who only created surpluses by selling assets, then when they couldn’t do that, left office with a structural deficit in place.

            The Greens are the only political party interested in creating a sustainable economy. The rest are just promoting the same infinite growth debt ponzi that got us into the current situation.

          • The Greens are the only political party interested in creating a sustainable economy.

            Based on fantastical notions of what drives human activity and demand for energy. The Greens are not so subtly intent on destroying capitalism, and installing a global totalitarian system of confused socialism/neo-paganism. They will gladly impoverish billions of people in developing countries in the name of protecting what are perfectly resilient eco-systems. They should be seen for the religious fundamentalists that they truly are.

          • +1 loony.

            This latest era of the Greens in power is the best thing that happened for Australia really. It will act like an innoculation.

            Sure there are the gullible diehards who will need to feel good voting for them. But the practicalities of the Greens war on the economy combined with their religious beliefs and totalitarian bent have shone through.You only have to look at that economic dynamo – Tasmania. How are they going providing jobs and a future for their kids?

            The Greens are now in God’swaiting room killing time. Good riddance.

          • Based on fantastical notions of what drives human activity and demand for energy.

            Like what ?

            The Greens are not so subtly intent on destroying capitalism, and installing a global totalitarian system of confused socialism/neo-paganism. They will gladly impoverish billions of people in developing countries in the name of protecting what are perfectly resilient eco-systems.

            I must have missed that part of their policy platform. Maybe you can highlight it for me ?

          • The Greens are not so subtly intent on destroying capitalism, and installing a global totalitarian system of confused socialism/neo-paganism.

            Oh noes, not the one world guberment!

        • And where do you imagine we would be now, with that tax in place ?

          With a lot more wealth in the country than out of it.

        • And the Howard Government did a stirling job squandering billions on middle class welfare. You right wingers are just as delusional as any lefty or greeny.

      • It was interesting watching the Presidential debate replay – both candidates falling over themselves to attract mining and energy investment, each claiming to be the more receptive; the bigger supporter.

        About time in this country we fully embraced, encouraged and promoted our natural resource base via incentives, special investment zones, attractive (eg Ireland) corporate tax rates and streamlined regulatory framework.

        Bring it on.

        Mod: 3d1k is a paid representative of the mining sector

        • You’ve been waiting to lay that little egg for a while.

          Mining does not need that kind of help. But we do need a more flexible labour market.

          I’m all for a special economic zone in Pilbara, only for manufacturing.

        • In America today, there are Walmart employees who work full-time, but are so poorly paid that they need food stamps to survive.

          That is not the kind of society that majority of Aussies aspire to become. So, go away, take your chubby robber barons and their offensive corporate propaganda with you.

          • Mav, as usual the wrong end of the stick is yours. I am talking about creating an environment that embraces success and provides opportunity for all – across the board.

            Part of that includes sensible regulation and a modest fair tax base – let’s celebrate success rather than penalising it.

          • What do you mean by “sensible regulation” and a “modest fair tax base”?

            Please explain.

            let’s celebrate success rather than penalising it

            You mean what we are doing right now is penalising success? Was introduction of GST “penalising success” ?

          • In America today, there are Walmart employees who work full-time, but are so poorly paid that they need food stamps to survive.

            Well, that’s just their own fault for irresponsibly not working harder – two full-time jobs – so they don’t have to leech off the rest of society.

          • n America today, there are Walmart employees who work full-time, but are so poorly paid that they need food stamps to survive.

            That’s nothing. In Australia, we had a Prime Minister so poorly paid he had to eat his own ear wax to survive.

          • Mav, we don’t all have to be deadly serious all the time. I don’t mind playing the fool occasionally if it lightens the mood.

          • Ok. But you won’t get the prize for comedic timing on this one. Besides, it’s the 2nd time you reused the same old joke.

        • The debate highlighted a central division between political aspirations of the the two nations: the US still sees itself in an entrepreneurial light, recognising that encouraging and developing business opportunities widens to opportunity for all, encourages independence and possibility of wealth.

          Australian political vision shows little entrepreneurial zeal; rather a propensity to regulate and tax endeavour and success in the relentless pursuit of redistributive outcomes, if not careful will eventually strangle the source altogether.

          What can grow here post boom with a vision so flawed.

          • “rather a propensity to regulate and tax endeavour and success in the relentless pursuit of redistributive outcomes, if not careful will eventually strangle the source altogether.”

            Yes, the Euro model. It’s working out wonderfully. This childish indulgence Australia has of being feverishly jealous of the incomes of others is stoked by greedy Govts eager to stay in power. The fools comply, participating in the pantomime. All the while our true national potential is left on the shelf. There is a far better balance to be achieved.

        • Australia doesn’t have to prop up its minerals industry, the high exchange rate is a testamont of its success.

        • Actually no. It’s time we diversified our economy so that we aren’t dependent on only two things:

          1. credit-fuelled ponzi financing of established dwellings in the main; and

          2. raping the land of any valuable minerals and exporting this in ever increasing volumes (and probably contributing significantly to global warming and irreparable environmental damage in the process)

          Mining has it’s place in the economy obviously, but the two-trick economic bet is fairly uninspired thinking for the 21st century and makes us vulnerable to a downturn in both sectors. Like about now.

      • What we need, and what we have always needed, is a profits-based tax on the resources sector.

        We already have that. It’s called ‘company tax’.

    • From what I’ve seen, this is the most attention iron ore has ever got, but as you know all good booms tend to end in a bust and this boom has definately been the mother of all booms.

  2. The mining tax/mrrt or whatever its now called doesn’t look like its going to raise much. The talk here is generally that Mining Companies aren’t paying their fair share of tax etc etc. But do they not pay tax at 30% on their net taxable income like any other company if they have a profit? Or do they have a different tax rate or something?

  3. By my count 9/40 comments on this thread come courtesy of the minebot. He’s like the Terminator!