Alan Kohler returns today with some iron awful:
The Government’s mid-year economic and fiscal outlook statement last year managed to pick the bottom on the iron ore market: the day after it was released, the iron ore spot price hit $US38, since then it has gone up by 50 per cent.
Anyway, in the MYEFO on December 15, the day before the $US38 bottom, Australian Treasury chose $US39 as its iron ore price assumption, down from $US48 in the budget in May.
…Like other commodities, iron ore has become a thing for Chinese funds to speculate with. Understanding this more deeply is an impossible task.
…First, the plan by BHP, Rio Tinto and Vale to drive the small, high-cost Chinese producers out of the market by flooding it with iron ore, while drastically cutting costs and pushing the price down (and at the same time crashing Australia’s national income, but that’s another story) is finally starting to work.
Second, President Xi Jinping’s $US1 trillion “One Belt, One Road” project, for which the Asian Infrastructure Investment Bank was created, is designed, in part, to provide work for China’s steel industry, especially the land-based “Silk Road Economic Belt”.
Here is my advice to Treasury: do not take the advice of a peripatetic commentator to set the Budget’s key input price. The arguments here are poorly researched and just plain wrong in parts. The Budget price is not $39, it is $44-46 spot equivalent when we add freight. The iron ore rally has nothing to do with OBOR or the major’s market share battle. The market has been hit by a perfect storm of short term positives:
- a big draw down in Pilbara shipments over Jan/Feb plus Samarco withdrawing 100mt temporarily;
- the Tangshan flower show restock;
- steel mills short of inventory when stimulus arrived;
- a well-timed FMG/Vale JV sting, and
- the broader commodity price short squeeze.
In my view the Budget price is too high given it will cover the 2016/17 period when:
- Roy Hill ramps up;
- S11D ramps up;
- Sino ramps up;
- Samarco returns;
- RIO and BHP complete their ramp ups;
- FMG an Vale begin their war on low cost ore;
- India returns, and
- China keeps slowing.
But don’t take my word it. Use the futures market. That’s what it is for. If Chinese markets are too volatile for you then use the more sober Singapore swap which does a good job of forecasting prices. It is currently at a one year price of $39. Subtract your freight cost and you should be cutting your FOB Budget iron ore price to $32-34.
