A global outlook for iron ore and steel: Part One
By Paula Wallace
The opening presentations at The Australian Journal of Mining’s 12th Annual Global Iron Ore & Steel Forecast conference, on March 24th, gave delegates a global “bigger picture” of the economic downturn, its effect on steel and commodity markets and its possible ongoing effects.
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Citi’s chief economist Paul Brennan has never seen the likes of the slump in the world economy which came down late last year, and whilst the recovery may be protracted he said it’s interesting that commodity prices do remain well above historical norms.
“Given the life support systems that the Governments and central banks have put in place it is showing some early signs of working. However more needs to be done,” Brennan said.
With the huge fiscal stimulus in China approaching four per cent of GDP, Brennan believes we won’t see China “turn inward” as it has in the past.
“Chinese investment, foreign investment in Australian industries, just tells us that China is not going to turn inward and of course…the incredible pressure of rising living standards in China will drive recovery ultimately.”
Putting the current financial crisis into a broader historical context, Brennan said, “This is not the Great Depression revisited. In the Great Depression what we saw was money that would supply growth actually was contracting at around about a 20 per cent rate.
“This time round what we’re seeing is money supply growth is actually positive, so we’re a long way from happened back in those days.”
He also cited the “risk appetite’ measure used by Citi which has indicated an upward trend in recent months. It includes a range of measures including emerging markets, sovereign spreads, US credit spreads, and measures of volatility in various markets.
“A further sign that there’s been progress made in terms of dealing with the excesses and imbalances that were built up in this financial crisis, is that the share of the financial index in the S&P500…how much that has contracted, so how much smaller financials are in the share market,” said Brennan.
With better financial conditions we are starting to see some tentative signs of improvement in parts of the US economy, he said.
“…the banks [are] becoming slightly more willing to lend…and that I suspect will continue given the announcement last night of quite a serious attempt by the US Government to remove toxic assets off bank’s balance sheets.”
In regard to commodity prices he remarked that reading newspaper reports on recent coal price negotiations one would “think it was the end of the world”.
He said that whilst, “the RBA commodity price index has fallen quite sharply you can see that it’s well above historical norms.”
Alan Heap, MD of global commodity analysis for Citi then took up the mantle. He said, “Iron ore spot prices…collapsed falling by more than 60 per cent followed by a subsequent rally early this year which is now starting to weaken again.
“We can see the same kind of phenomenon on the inventory side, iron ore inventory in China built rapidly during 2008 to alarmingly high levels and is now slowly starting to be worked off, but again they’ve started to pick up again in the last month.
“And last month data just through is pointing to a dramatic rebound in iron ore imports in China in February.”
His primary message to conference delegates was that the iron ore market is going into protracted and potential oversupply and some production curtailments will be required – “where they are going to occur and at what prices is going to be the key.”
Corporate strategies will also be critical now in determining those outcomes said Heap.
“It’s never been a question of ‘If’ in our view it’s always been ‘when’,” he said “and that ‘when’ has arrived a lot sooner than we thought just 12 months.”
He noted that production costs are falling, margins are going to become compressed, and he estimated that there will be a 50 per cent fall in iron ore prices in the next two years.
“In the current year margins are at 70 per cent, we expect those to be come back to the 50 per cent level, meanwhile costs are going to fall by about 25 per cent and as a consequence prices…are set to fall by 50 per cent.
“Our forecast is for a 30 per cent fall in the current round of contract negotiations followed by 20 per cent thereafter.”
Heap believes the iron ore market faces a number of challenges, including issues of volume versus price and looming changes in the way in which iron ore prices are determined.
“…there’s already something approaching 40 per cent of iron ore trading on spot markets, if one includes the Indian and domestic Chinese material.
“It’s not beyond the realms of possibility that we have already seen the last annual contract benchmark price in the iron ore industry,” he said.
Heap said the uncertainties surrounding the global economic outlook and its flow through effects into steel demand, steel production and iron ore demand are enormous.
“…the rate of decline of economic growth we are looking at is unprecedented in the modern era, and our forecasts continue to be cut” said Heap.
He want on to say that Citi’s interpretation of what’s been happening in steel markets in recent months in China is that, “traders bought steel early this year essentially on a punt that the Chinese fiscal stimulus would come through and there’d be an acceleration of demand for steel.
“They built inventory, they drove prices up, triggered a recovery in steel production and now all that is starting to unravel as it becomes clear that fiscal stimulus is not coming through as quickly as some thought.”
In terms of fiscal stimulus, Heap said the source of potential boost in demand for commodities in steel and iron ore in particular would be China. Of the 4 trillion RMB stimulus announced by Beijing, there was a portion of this already accounted for in analysts’ forecasts.
“In addition however it’s clear to us anyway that of the remainder only a portion, maybe only about half is going to be financed through Beijing and the rest of the finance is going to have to come from state-owned enterprises, provisional Governments and the private sector in china, all of whom are struggling,” said Heap.
Citi’s forecasts for steel production in key regions made for sobering reading. It sees global steel production down 8 per cent this year with a modest rebound in 2010.
“China is the best of bad bunch,” said Heap, “however I have to again underscore the risks behind these numbers. They are dependent on expectations of an economic recovery and there are risks attached to that.”
AJM print edition – out in MAY 09
The next print edition of The Australian Journal of Mining will include an in-depth feature on the iron ore industry, including reports from the AJM’s Global Iron Ore & Steel Forecast conference. If you would like to contribute to this feature contact the editor at: paula.wallace@informa.com.au. If you would like to promote your organisation within this feature contact the advertising manager at: andrew.jones@informa.com.au
To read the second part of this report, click here.
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