COMMENT: Iron ore market debates if 17% price rise since Jan 25 is an overreaction
The seaborne iron ore market agreed on the logic behind the rise in prices on the first day of trading after China’s return from the Lunar New Year on Monday February 11 but by day two it failed to reach an agreement on the rally’s sustainability.
Fastmarkets MB 62% Fe Iron Ore Index stood at $90.58 per tonne cfr China on Monday, the highest level since March 2017, with market participants re-calibrating their supply expectations for the year following the suspension of operations at several of Vale’s mines in Brazil.
The 65% Fe Iron ore index, which is underpinned by Vale’s high-grade product produced in the Carajas region where mining operations have not been suspended, dropped $0.80 per tonne from February 8 to reach $102.50 per tonne on February 11.
The rise in steelmaking raw materials prices on Monday “was expected”, most market participants said. Although some sources cautioned there was still plenty of uncertainty regarding supply and demand making it difficult to forecast the sustainability of the rally and the extent of the price rise in the coming months.
Markets started showing signs of cooling off on Tuesday February 12, with the futures contract on the Dalian Commodity Exchange (DCE) closing at 634 yuan ($93.49) per tonne, down 1.7% from the previous settlement price.
Fastmarkets MB 62% Fe iron ore index dropped $2.93 per tonne from the previous day to $87.65 per tonne on February 12, while the 65% Fe iron ore index dropped $2 per tonne to $100.50 per tonne cfr China, also day on day.
The supply side factor driving the rise in prices is straightforward.
Vale has suspended operations at some of its mines following its decision to decommission some upstream dams and predicted a production impact of up to 40 million tonnes per year.
Another 30 million tpy of supply may be affected due to the cancellation of the provisional operational authorization (APO) of the Laranjeiras dam that resulted in the suspension of operations at its Brucutu mine, the company said.
At the Bructu mine however, the company has claimed there was no technical or legal basis nor risk assessment to justify cancelling the APO and that it would adopt the appropriate administrative and legal measures related to this decision.
This has led to uncertainty among market participants regarding the duration of Vale’s suspended operations and created concerns about a wider crackdown on mining operations in Brazil.
“The cancellation of the APO may mean that the time it takes to get supply running again might be longer,” a steel mill source said.
The wider Brazilian industry is also feeling the repercussions.
Steelmaker and miner ArcelorMittal decided to evacuate the community around its dormant Serra Azul dam on Friday February 8 as a precautionary measure after the producer’s site assessments, “following recent incidents in the Brazilian mining sector.”
Despite market participants being uncertain of how domestic Brazilian authorities and miners will respond to future operations due to the fatal accident on January 25, most believe there are several factors that may mitigate the supply lost in Brazil.
These include iron ore stocks at Chinese ports.
Portside trading in China has flourished in the last three to four years given the shorter lead times, flexible cargo sizes and less onerous financing arrangements involving such cargoes.
Vale itself has brought iron ore closer to its consumers in recent years through the development of blending operations and distribution centres in Malaysia and at Chinese ports.
“Domestic Chinese port inventories for Brazilian Blend Fines are still high so there shouldn’t be an immediate impact on its prices but it will become more clear in the next 1-2 months as stocks deplete,” a source at a major iron ore importer and distributor in China said on Monday.
“On the first day of trading there weren’t too many deals done so it is not clear what level buyers will be willing to pay for such cargoes,” the source added.
Another trader source agreed that port stocks would provide a buffer against seaborne supply tightness but conceded that port trading needed to pick up more to provide a clear gauge of the market’s appetite.
Fastmarkets MB China Ports Stocks Index stood at 686 yuan per wet metric tonne (implied 62% Fe China Port price at $90.23 per dry tonne) on Monday, up by 69 yuan per tonne from Friday February 1 and up another 2 yuan on Tuesday.
The potential supply from Australian miners is another factor that market participants expect to serve as a buffer against the astronomical rise in seaborne prices.
Australia’s iron ore exports will reach 879 million tonnes this year, up 4.6% year on year with exports expected to reach 882 million tonnes in 2020, according to a forecast released in December 2018 from the office of the chief economist.
Miners in Australia may be incentivized to ramp-up production given the high price, however there was limited room for the country to post any significant increase in output, one participant said.
While the market has cited sufficient factors that may check the rally in iron ore prices, many market participants expect prices to average higher this year than their previous expectations.
“Chinese mills will be keen to keep larger inventories than is typical due to the supply uncertainty, which will provide support to seaborne iron ore prices,” the Chinese importer and distributor source said.
Another trader source said that, in their opinion, the biggest concern in the market is around further regulatory scrutiny on mining operations in Brazil, including some potential voluntary or mandated steps that may lead to scaled back operations while risk aversion heightens.
“It is also important to note that there might be an impact across the logistics chain,” the trader source added.
Last week, Vale announced the city government of Vitoria’s decision to interdict a part of the wastewater treatment system at Vale’s Tubarao port in the state of Espirito Santo, which affected the supply stocking area, the port services of coal and some pelletizing plants, the miner said.
While much of the iron ore market is focused on understanding the supply-side impact on iron ore prices, Chinese demand will also influence how prices move in the coming months, a buyer source pointed out.
Vale’s outage comes at a time when Chinese mills’ profitability has been narrowing amid weak seasonal demand for downstream products and the government’s lighter production cuts on steelmaking operations for the November-March 2019 period compared with the same period last year.
This has meant that even before the Vale outage, buyers had been focusing on costs that resulted in a greater uptake of lower-grade materials, typically sold by Australian producers.
The demand aspect is an important one to factor in because the suspension of operations at Vale’s mines should particularly affect the availability of the flagship mid-grade low-alumina material – Brazilian Blend Fines (BRBF).
The material is produced by blending ore from the miner’s Southern System mines with its Northern System mines.
BRBF premiums surged last year amid Chinese buyers chase for low-alumina materials while they focused on productivity, though penalties for low-alumina materials were widely expected to reduce this year amid mills’ narrowing margins.
Market participants are still divided on how the demand situation will pan out, with some stating that mills might be able to pass higher raw materials costs on to their customers.
“When margins drop below a certain level, mills prefer a blend of high-grade products such as IOCJ materials with low-grade material such as Super Special Fines, so demand for mid-grade materials start taking a hit,” a source explained.
One response to high iron ore prices would entail either passing on those costs to downstream customers or cutting production to reduce demand for steelmaking raw materials themselves, a buyer source from Taiwan said.
“We are still negotiating with our customers about passing on higher raw materials costs, which will be a key driver that determines to what extent our margins are cut,” the buyer added.