FOCUS: Iron ore market braces for changing seaborne supply, Chinese demand

The official end of the winter heating season in China – the world’s largest iron ore consumer – a few days ago has coincided with a pick-up in market interest in the price spreads between different grades of the steelmaking raw material.

On Monday April 1, a total of 350 lots of the Singapore Exchange’s (SGX) 65% Fe iron ore cfr China futures contract were cleared and traded. The following day, 2,050 lots were traded and cleared.

By 6.30pm Singapore time on Wednesday, another 300 lots of the contract had been traded and cleared.

The pick-up in trading activity has been attributed by some market participants to traders taking positions on the spreads between iron ore grades.

In the physical market, China’s demand for high-grade iron ore is poised to rise in the months to come amid an expected seasonal improvement in downstream sectors.

The price spreads between iron ore grades are driven - to a large extent - by the mix of available supply in the global marketplace and Chinese demand.

Typically, when steelmaking profit margins narrow, mills will be more conscious of their input costs and start consuming lower-grade ores. Inversely, when steel prices rise and profit margins widen - often as a result of strong downstream demand - mills will consume more higher-quality raw materials to maximize their steel output to capitalize on the situation.

In recent years, an additional factor determining Chinese mills’ preference for iron ore grades has been the environmental policies in China. An increased focus on environmental protection in the country has been a consistent factor buttressing demand for high-grade steelmaking raw materials.

Product mix
But this year, supply disruptions are expected to play a bigger role in determining the movement of iron ore prices.

Since late January, when a deadly breach occurred at one of Vale’s tailings dams in Brazil, sparking a string of restrictions at its mining operations throughout the South American country, prices for the steelmaking raw material have been steadily rising.

Vale, the world’s largest producer of iron ore, last month warned that some 92.8 million tonne of its production and up to 75 million tonnes of its shipments could be affected by various suspensions affecting the mines in its Southern and Southeastern Systems in Brazil.

The suspensions are also expected to have an impact on the miner’s flagship high-grade product - Iron Ore Carajas (IOCJ) - from its Northern System.

“Carajas supply, which was forecast to increase because of the ramp-up of the S11D project [in the Northern System], will not increase as much [as originally expected],” Vale’s chief financial officer Luciano Siani said last week.

He added that, in terms of seaborne supply, the miner’s focus was now on maintaining the quality of the Brazilian Blend fines (BRBF), its top product in the mid-grade segment that is sought-after for its low alumina content.

BRBF is produced by blending high-silica ore produced at Vale’s Southern/Southeastern Systems with the high-Fe Carajas ore produced at its Northern System.

Amid the various suspensions imposed on its operations, the miner will now need to divert more Carajas ore to maintain the quality of its BRBF.

Vale’s other focus is on ensuring the delivery of contractual volumes of IOCJ and to mitigate the impact of mining suspensions on its pellet production. It expects up to 11 million tonnes of its pellet production to be affected this year due to the suspensions.

“The pellet feed that was formerly blended to make niche products such as Sinter Feed Low Alumina is being redirected [to] pellet plants and those niche products are being removed from the market,” Siani said.

Vale is most optimistic about the resumption of operations at its Brucutu mine, among all the suspended mines.

The Brucutu mine is part of the Minas Centrais operations that form part of Vale’s Southeastern System. It was following the suspension of Brucutu that Vale declared force majeure on shipments for certain iron ore and pellet contracts.

The mine accounts for about a third of the overall production loss that Vale has warned the market about.

But while the Brucutu mine could be a “swing factor” in terms of the future of Vale’s supply, it is not the only one.

The extent to which the miner uses the dry-processing method to process its ore - because it complies with stricter safety standards - and the amount of ore inventories it has at its mines and at ports in China are also expected to have an impact on this year’s product mix in the global market.

While Vale has not made any comment about its inventories in China, market sources have said that their availability was an insulating factor against any further seaborne supply shocks this year.

Export data from Brazil is finally beginning to shed light on the extent of the country’s supply woes, however.

Brazil’s iron ore exports in March fell 26% year on year to 22.18 million tonnes, the lowest level in six years, according to Brazil’s foreign trade ministry, MDIC.

The drop is a concern because the full impact of the mining suspensions in Brazil on seaborne supply will likely to only become clearer in the months ahead due to the 45-day voyage time for shipments between the South American country and China.

There are also uncertainties surrounding Vale’s ability or desire to ramp up production at mines that are not affected by the tailings dam collapse and the timeline for operations to resume at the suspended ones.

The miner has emphasized that it was making the safety of its dams and operations as its main priority when it came to restarting operations and that the “safety perception within the industry” - both from the perspective of the authorities and the miner - had changed following the latest tragic accident.

Chinese demand
The second quarter of a year has traditionally marked the onset of healthier downstream demand in China amid a revival of construction activity following the winter lull from October to March.

Restrictions imposed on steelmakers for environmental reasons also tend to loosen in the summer months, which further fuels demand for iron ore.

In fact, China’s crude steel and finished steel output already posted significant increases in the first two months of this year due to healthy profit margins, winter steelmaking restrictions that were not as stringent as a year earlier, and good demand.

Around the same time, the average spread between prices for 65% Fe iron ore and 62% Fe iron ore narrowed over the first three months of the year, from $14.30 per tonne in January to $11.30 per tonne in March.

More importantly, the discount for low-grade products has also been shrinking. Australia’s Fortescue Metals Group narrowed the downward price adjustment for March shipments of its 56.5% Fe Super Special fines and 58.2% Fe Fortescue Blend fines to 16% and 7% respectively - based on a 62% Fe index - from 33% and 22% for February shipments of the products.

The narrowing spreads between the different tiers of iron ore and lower discounts for low-grade products as well as expectations of improving downstream demand have led to expectations among some market participants that demand for higher-grade ore will strengthen in the coming months. If that happens, the spread between grades will widen again.

That said, the recent emergence of supply disruptions in Australia - a major producer of mid-grade iron ore - will likely provide support to prices for products in this segment.

Both BHP and Rio Tinto have warned that their output could fall by up to 22 million tonnes this year as a result of damage caused Cyclone Veronica, which hit Western Australia last month.

On the demand side, a lot will also depend on macroeconomic conditions in China, which in turn are influenced by both the Chinese government’s policies as well as the country’s trade war with the United States.

At the National People’s Congress last month, Chinese Premier Li Keqiang announced a target growth rate of 6-6.5% for the country’s gross domestic product this year - below last year’s growth of 6.6%, which itself was already the lowest in close to three decades.

At the same meeting, China’s environment minister said that while the country had made progress in tackling its environmental problems, there should not be any easing of such measures and more needed to be done to tackle them.

How these two factors play out alongside the supply disruptions in the seaborne market will shape demand from China - the world’s largest iron ore consumer and steel producer - and ultimately, the trajectory of prices for the steelmaking raw material.

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