Outright denial, it seems, is no longer cutting it for miners with their investors. A more subtle approach is required. From Reuters:
BHP Billiton expanded iron ore production too rapidly, causing the Anglo-Australian miner to overlook the underlying growth of its overall business, its chief executive said on Thursday.
However, Andrew Mackenzie said that despite the iron oremarket
facing temporary overcapacity, there was enough demand coming back from China and elsewhere to justify the firm’s capacity increase.
“We don’t quite see the case for the scale of investment we saw in last 10 years … But the base business we built is going to be a strong bedrock for decades to come,” Mackenzie told reporters in Beijing.
If you say so. My view is that that investment case has only just begun to unravel. It has years to get worse as the correction in Chinese investment – that hasn’t even happened yet – plays out.
There is another reason too why it will get much worse in time. Big spikes in steel demand are unique among commodities because they create their own demand for steel. The infrastructure, transport and mining build-out required to support a huge steel tramp-up amplifies everything and then reverses. David Stockman puts it well today:
Nearly every year since 2008, in fact, fixed asset investment in public infrastructure, housing and domestic industry has amounted to nearly 50% of GDP. But that’s not just a case of extreme of growth enthusiasm, as the Wall Street bulls would have you believe. It’s actually indicative of an economy of 1.3 billion people who have gone made digging, building, borrowing and speculating.
Nowhere is this more evident than in China’s vastly overbuilt steel industry, where capacity has soared from about 100 million tons in 1995 to upwards of 1.2 billion tons today. Again, this 12X growth in less than two decades is not just red capitalism getting rambunctious; its actually an economically cancerous deformation that will eventually dislocate the entire global economy. Stated differently, the 1 billion ton growth of China’s steel industry since 1995 represents 2X the entire capacity of the global steel industry at the time; 7X the size of Japan’s then world champion steel industry; and 10X the then size of the US industry.
Already, the evidence of a thundering break-down of China’s steel industry is gathering momentum. Capacity utilization has fallen from 95% in 2001 to 75% last year, and will eventually plunge toward 60% and a half billion tones of excess capacity. Likewise, even the manipulated and massaged financial results from China big steel companies have begin to sharply deteriorate. Profits have dropped from $80-100 billion RMB annually to 20 billion in 2013, and are now in the red; and the reported aggregate leverage ratio of the industry has soared to in excess of 70%.
But these are just mild intimations of what is coming. The hidden truth of the matter is that China would be lucky to have even 500 billion of annual “sell-through” demand for steel to be used in production of cars, appliances, industrial machinery and for normal replacement cycles of long-lived capital assets like office towers, ships, shopping malls, highways, airports and rails. Stated differently, upwards of 50% of the 800 million tons of steel produced by China in 2013 likely went into one-time demand from the frenzy in infrastructure.
Indeed, the deformations are so extreme that on the margin China’s steel industry has been chasing its own tail like some stumbling, fevered dragon. Thus, demand for plate steel to build dry bulk carriers has soared, but the underlying demand for new capacity was, ironically, driven by bloated demand for the iron ore needed to make the steel to build China’s empty apartments and office towers and unused airports, highways and rails.
In short, when the credit and building frenzy stops, China will be drowning in excess steel capacity and will try to export its way out— flooding the world with cheap steel. A trade crisis will soon ensue, and we will shortly have the kind of globalized import quota system that was imposed on Japan in the early 1980s. Needless to say, the latter may stabilize steel prices at levels far below current quotes, but it will also mean a drastic cutback in global steel production and iron ore demand.
…The reality of truly obscene current profits and the propaganda about endless growth in the miracle of red capitalism, combined with the cheap debt available in global capital markets, resulted in an explosion of iron ore mining capacity like the world has never before witnessed in any mineral industry. The attached story on the massive new capacity still coming on-stream in western Australia provides a dramatic picture of how far this got out of hand.
So the mother of all commodity bubble collapses is virtually baked into the cake. As one CEO quoted in the story makes clear, his cash cost of production is about $20 per ton and he will not hesitate to keep producing for positive variable profit. That means iron ore prices will also plunge far below the current $94 per ton quote.
Dramatic, certainly, but also more or less true.
