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Covid-19 disruption peaked in iron ore markets in Q3 2020
Chinese iron ore demand, though remaining close to record highs, had reached a saturation point. Blast furnace utilization fell slightly from record levels of above 95% seen in August 2020. Mill profit margins also ebbed, reducing the incentive to maintain such high output. Stocks of iron ore at main Chinese ports have recovered to pre-Covid levels. On the supply side too, iron ore output has been steadily increasing as miners endeavor to respond to the high-price environment.
Though a bearish combination of factors mounted for Q4 2020, prices continued to rise right to the end of the year and into early 2021. The reasons for this was continued strong Chinese demand and a slight recovery in ex-China demand that kept the market tight during this period, though it is possible that the "financialization" of iron ore as a commodity also contributed.
Fear of currency debasement and inflation in the wake of widespread stimulus measures from governments around the world has seen global macro investors flowing into the commodities sector as a whole, while iron ore has attracted particular interest for its qualities as a proxy for China’s strong post-pandemic recovery. Although many of the potential gains may already have been realized, it seems unlikely that the underlying reasons for the move into China-focused industrial commodities will unwind in the near term prior to a full and effective rollout of Covid-19 vaccines in other major economies.
High-grade iron ore pulls ahead in 2021
We anticipate that the higher-quality segment may fare better than the low and mid grades in 2021. China’s high rate of industrial production has seen levels of pollution in major cities starting to rise. We saw an increase in sintering restrictions to control air quality as we progressed through the winter months and we do not expect the restrictions to be lifted before the end of the two sessions held by the Chinese government this month. As discussed earlier, the seasonality effect means that lump and pellet premiums can typically see improvements in the first quarter. Likewise, the market for pelletizing concentrates also tends to tighten in winter as cold weather subdues domestic mining operations.
Another significant tailwind for high-grade premiums is the high price of metallurgical coal and coke, both of which have been rising in China since the country banned imports of Australian coal. At the start of 2021, Fastmarkets MB’s index for cfr China Premium Hard Coking Coal had surged to above $200 per tonne – more than $100 higher than the equivalent grade fob Australia basis index (Figure 1). Higher-purity iron ores generate less slag when consumed in blast furnaces, allowing coke rates to be kept lower, while direct-charge ores such as lump and pellet also lessen the consumption of coke breeze in the sintering process. Using higher-grade iron ore feedstocks is therefore preferable for mills when coking coal prices are high. As it stands, there is little evidence to suggest that the Sino-Australian tensions responsible for the import ban will be resolved in the near term, and thus the elevated costs of coke in China are likely to persist for some time.
Figure 1: Prices of coking coal imports to China have soared since the country imposed a ban on all Australian coals. By the start of 2021 the spread between premium hard coking coal on a cfr China basis vs. fob Australia was around $100 per tonne, though fob-basis prices have closed this gap somewhat due to improving ex-China demand.
Iron ore futures market indicates higher grades will see higher demand
Lastly, a key indicator of the price expectations with respect to quality is the difference in the futures market forward curves for the 65% and 62% Fe grades. At the time of writing in January 2021, the backwardation in the SGX 65% Fe futures contract was slightly shallower than that of the SGX 62% Fe contract. In other words, the 65-62% Fe forward differential is in contango, suggesting the market is expecting the spread to grow over the coming months, perhaps in response to increased demand for higher-productivity and less polluting feedstock, or in anticipation of potential high-grade supply disruptions during northern Brazil’s rainy season. For those interested in better understanding the near-term market dynamics with respect to grade, this forward curve structure in the 65-62% Fe SGX contracts has become a useful metric to track (Figure 2). It is also one of the few areas in the iron ore futures arena where a contango dynamic can often be seen, adding an angle of interest for traders when compared with the near-perpetual backwardation in the outright contracts.
Figure 2: The SGX forward curves for 65 and 62% Fe fines were showing a contango in the 65% vs 62% Fe differential as of the start of 2021, indicating market participants expected this spread to widen in the coming months.
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To learn how to optimize tomorrow’s investments with today’s pricing, read our global iron ore case study from Brian Levich, Consultancy & Special Project Director.