Iron ore prices for February 12, 2019:
Spot is tumbling. Paper fell further overnight. The panic is ebbing.
Clyde Russell has a nice little piece on where we’re headed:
Firstly, Chinese steel mills can substitute higher-quality iron ore with lower grades, which are likely to be more readily available, but this will result in lower output.
Secondly, they can continue using higher-quality iron ore, but reduce production to keep costs more or less steady, and hope to make up the difference on rising steel prices.
Thirdly, they can keep production steady using higher-grade ores, but they will likely have to enter into bidding wars against each other to secure sufficient supply.
We’ll definitely see more of the first but not too much given it will require more supply constrained coking coal. The second is coming anyway via weakening demand in China. The third has already happened.
There is a fourth option, more scrap. Expect mills to take that as well. Via Vertical Group:
China’s Iron Ore Demand Is Set to Structurally Weaken… Irrespective of N-Term Price Uncertainty. As we see it, it is too early to ascertain the net impact on global iron ore supply from VALE’s Brumadinho dam collapse. However, this has not stopped us from updating our bottom-up Chinese steel demand model. From our work, China’s “modernizing” economy implies lower iron ore demand ahead. Specifically, although CISA expects “solid demand in ‘19”, we anticipate a fall-off in new housing starts to follow weakness in space sold observed in ’18 (sales typically lead new starts), slowing growth in heavy machinery to extend thru ’19 (albeit infrastructure spending should offer some support), & a steepening fall in auto sales – 3 segments of China’s economy that account for >60% of domestic steel consumption. Crediting 55MMt of net steel exports, and adjusting to the crude-equivalent, we model China’s crude steel production at 898MMt in ’19, -3% y/y, & 905MMt in ’20, +1% y/y; taking another 40MMtpa of net capacity out of the market, on our ests., China’s avg. utilization rate would be 88%, ’19-’20 – Ex. 4-7. Yet, scrap steel used in BOF prod. jumped >4% last yr., based on our checks, & the share of EAF capacity is growing (we est. 12MMt are added in ’19-‘20), both of which imply less iron ore demand. This is a trend, we argue, many are not fully appreciating or are simply chalking off as a long-term phenomenon; but we already saw it begin to play out in ’17-‘18, and in a big way (i.e., China’s steel output was +7% y/y in ’18, to 927MMt, while iron ore output was -40% y/y, to 92MMt, yet iron ore imports were -1% y/y, to 1,065MMt). To gauge this trend, we follow the crude iron-to-steel prod. ratio, which fell prominently in ‘17/’18 (Ex. 8); effecting this ratio for our ests. on net capacity changes, we est. China’s pig iron output, & hence iron ore demand (1.6x pig iron), at 732MMt in ’19, -4% y/y, & 729MMt in ’20, -41bps y/y. Assuming domestic ore output of 90MMt in ’19 & ’20, net from demand, seaborne imports would be -2% y/y in ’19 and -36bps in ’20.
Barring further shocks from Vale or China stimulus, my $10 premium to business as usual still looks about right, diminishing over time.