ANALYSIS: Spot iron ore prices heading south

Iron ore prices slumped again on Thursday June 6 as bearish sentiment returned to the market, snuffing out a modest mid-week recovery.

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The Metal Bulletin 62% Fe Iron Ore Index had fallen to a seven-month low of $110.79 per tonne cfr China last week but rose on each of the first three trading days of this week to $118.99 per tonne cfr.

Many market participants had warned that this was only a temporary respite, and they may be proven right. The index fell $5.29 per tonne to $113.70 on Thursday, with sentiment looking weaker again during the day on Friday.

It is too early to say whether the spot iron ore market has bottomed out, market participants said.

“The rebounds showed that the market needed an upward correction after it plunged,” an analyst with a trading house in Beijing told Steel First.

Market fundamentals had not improved on Monday, but there was some change in sentiment, he added.

China’s crude steel output is expected to slide in the coming months, as a number of steel mills have begun maintenance while even more are expected to follow suit during summer. Seaborne iron ore supplies, however, are on the increase.

These all point to lower iron ore demand and prices in the coming period, although it is not clear yet just how quickly or how far prices could decline to.

Steel mills’ dilemma
Chinese mills produced a record high 2.19 million tonnes of crude steel per day in early May. Output fell only slightly to 2.185 million tonnes in mid-May, according to China Iron & Steel Assn (Cisa).

“Steel mills are making losses, even though raw material prices have fallen,” an iron ore trader in Shanghai said.

“The only way (for a steel mill) to survive is to cut production, as there’s no support for steel product prices and steel mills will keep losing money if they continue to produce more,” another steel mill source in Beijing said.

That points to an immediate need to cut output, but, as usual, every mill seems reluctant to be the first to do so.

Planned maintenance announced by steel mills so far will have a very limited impact on the market, with just the production of 1.11 million tonnes of crude steel affected, according to market data provider Umetal.

Several steel mills in Hebei province, including Guofeng Steel, Ganglu Steel and Xinjin Steel, told Steel First that they did not have summer maintenance plans at all.

Concerns over the loss of market share, social responsibility, debt pressures and a possible spike in downstream demand from expected stimulus packages from the government are discouraging steel mills from scaling back production. They are well aware that suspending operations at blast furnaces also has a high cost.

“If one steel mill cuts production, steel product prices will rise due to reduced supply. But this will only benefit other mills, so no one wants to make that sacrifice,” a steel mill source in Central China said.

“Steel mills are dragging their feet due to uncertainties within the industry. It is a protracted game. If it is very clear that steel industry will see no tomorrow, private mills won't hesitate to exit the business,” the source said.

In the medium term, high crude steel output will keep demand for iron ore firm and prices high, but at the same time, gnawing at mills' profitability as steel product prices struggle to stay up.

There is the risk that continued overproduction will simply fuel the now familiar cycle of boom and bust, with steel mills producing too much and then being forced to make much more rapid cuts later.

But in contrast to 2012, steel mills have been keeping their iron ore stocks low and will have to return to the market more often, industry participants told Steel First.

“Steel and iron ore markets are correlated, so the slump in steel product prices will dampen the iron ore market from time to time, like what we saw last week,” the first analyst said.

“And steel mills rushing back to replenish their stocks will trigger iron ore price rebounds at intervals,” the steel mill source in central China said.

Higher crude steel output
China’s crude steel output up till mid-May has shown an increase of more than 10% year-on-year, according to Cisa numbers.

“Steel consumption is better this year, as the day-to-use ratio of steel inventory has fallen. But the much higher output weighs on steel prices,” the first analyst said.

China's higher crude steel output has led to increased demand for iron ore. But supplies of the steelmaking raw material are rising even more.

Major new projects this year include Fortescue Metals Group’s 40-million-tpy Firetail project and Rio Tinto’s 53-million-tpy Cape Lambert expansions, apart from other miners' expansions and new projects.

Many mills have adopted a strategy of keeping iron ore inventory low because they expect prices to move structurally lower as new mines increase the supply in the iron ore market.

“Some greenfield iron ore mines overseas are feeling the squeeze right now due to high costs. They are going through what Chinese steel mills are suffering from,” the first trader in Shanghai said.

“Even banks that had extended loans to them would pressure them into producing iron ore or proceed with their projects,” he added.

A further increase in the supply of iron ore will eventually bring down prices.

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