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1、Martin Yu,30 August 2012Fixed Income Researchhttp:/www.credit-Up:Iron Ore CurtainFalls on Era of Windfall PricesCommodities Research,Research AnalystsRic Deverell+44 20 7883 2523ric.deverellcredit-Marcus Garvey+44 20 7883 4787marcus.garveycredit-,Back to the futureIron ore markets have been under th
2、e hammer again this week,with the spotprice having fallen to around US$90/t for the first time since late 2009.While thepace and timing of the fall has wrongfooted most forecasters(including CreditSuisse),it is worth bearing in mind that we(and most others)have for some timeseen a substantial retrac
3、ement from the extraordinary prices seen for the bulk of,2010 and 2011 as inevitable,with the major uncertainty being one of timing.Andrew Shaw,+65 6212 4244andrew.shawcredit-+44 20 7883 2150martin.yucredit-,To us the main question at the current juncture is whether the fall is a short-termdip,promp
4、ting wide cuts in Chinas iron ore concentrate supply which in turnwill see the price rebound towards the levels seen as recently as six weeks ago or whether the plunge is the beginning of the inevitable move back towardsmore normal pricing?As is often the case during such dramatic market moves,the r
5、eal answer probably lies somewhere in between.Our feeling is that the current adjustment is in large part a move to alower trading range:In trend terms global steel production looks to be nowincreasing at around a 2.5%p.a.rate,while seaborne exports of iron orecontinue to grow at an 8%annual pace.Th
6、is suggests that the prospect ofrenewed pronounced tightness has diminished substantially.It is worth noting,however,that markets tend to overshoot to the downsideduring dramatic falls.While the risk in the near term is for further damage,weexpect prices to rebound to around US$100 in Q4.More broadl
7、y,weconsider it highly unlikely that prices settle anywhere near the low levels seenin the early 2000s,a period we see as an historical outlier.Exhibit 1:Iron ore prices have averaged almost US$80/t in real termsin the past century the pronounced price boom is probably ebbingReal 2010 US$log,6.1,pri
8、ce,hptrend,average,up2sd,low2sd,Overshoot?5.65.1Returning,4.64.13.6,Stable prices around long runaverage of$80,Historical outlier,to longrunaverage?,1885,1895,1905,1915,1925,1935,1945,1955,1965,1975,1985,1995,2005,Source:Credit Suisse,IMF,the BLOOMBERG PROFESSIONAL serviceANALYST CERTIFICATIONS AND
9、IMPORTANT DISCLOSURES ARE IN THE DISCLOSURE APPENDIX.FOR OTHERIMPORTANT DISCLOSURES,PLEASE REFER TO https:/firesearchdisclosure.credit-.,CREDIT SUISSE SECURITIES RESEARCH&ANALYTICS,BEYOND INFORMATIONClient-Driven Solutions,Insights,and Access,2,30 August 2012Iron Ore The Beginning of the End?Curtain
10、 falls on era of windfall pricesAnother week of punishment for spot iron ore prices has seen the TSI measure slide toaround US$90/t for the first time in almost three years.As we go to press the rout has noappearance of ending,with the current price nearly 40%below the average Q1 level.In our view p
11、rices could slip further in the near term.However,the main question at thecurrent stage is whether the recent fall is a short-term plunge which will see a largeshutdown in Chinese supply,and in turn be followed by a price rebound towardsthe levels seen as recently as six weeks ago?Or is the dip the
12、beginning of theinevitable move back towards more sustainable pricing?Note that while a spot price below$100 feels very low relative to recent history,therehas been a substantial change in the pricing dynamics in the iron ore market,with thespot price only a very small part of the total market as re
13、cently as 2009.It is worth noting that the current prices being paid remain around the levels seen duringthe“boom”in Q3 2008,when Australian miners were on average receiving$97 FOB.Exhibit 2:Received prices have still been above 2008s“peak”levelsUS$/t,Price received by Australian iron ore exporters,
14、180160140120100806040200,Australian iron ore price based on export value and qty,Estimate,2000,2001,2002,2003,2004,2005,2006,2007,2008,2009,2010,2011,2012,Source:Credit Suisse,Customs DataOur view centers on a growing likelihood that we have entered a new era of moderateddemand growth for steel,as w
15、e have highlighted before,combined with a weaker-than-,New era ofmoderated growthand a cyclical stallin demand,expected cyclical break,which has allowed time for supply momentum to alleviate apreviously tight market for iron ore.Our feeling is that the current adjustment is in large part a move to a
16、 lower tradingrange:In trend terms,global steel production looks to be increasing now at around a2.5%p.a.,while seaborne exports of iron ore continue to grow at an 8%p.a.pace.,With global growth momentum weak,and Chinas steel demand having moderated,wenow believe that the opportunity for a return to
17、 a market in shortfall has diminished.It is worth noting,however,that markets tend to overshoot to the downside duringdramatic events.Given the cuts to Chinese production under way,and a“buyers strike”by mills,while the risk in the near term is for further falls,we expect prices to reboundto around
18、US$100 in Q4,before slowly eroding towards longer-run averages oversubsequent years.Bulking Up:Iron Ore Curtain Falls on Era of Windfall Prices,3,30 August 2012 Importantly,however,we consider it most unlikely that prices settle anywhere near thehistorically low levels seen in the early 2000s,which
19、we feel will prove to be thehistorical outlier.While a bounce is likely,the assumed stabilization will need a substantial reduction inChinese iron ore production,as well as some recovery in steel production as thestimulus feeds through.Absent both of these factors,prices could still surprise to thed
20、ownside.Exhibit 3:Iron ore prices have plunged alongside steel spot prices the TSImeasure sits 40%below average Q1 levelsUS$/t,850,Shanghai Rebar Spot,Iron Ore Spot(rhs),200,170750140650110,550450,8050,Jan-09,Jul-09,Jan-10,Jul-10,Jan-11,Jul-11,Jan-12,Jul-12,Source:Credit Suisse,the BLOOMBERG PROFESS
21、IONAL servicePrices have massively undershot our forecasts for Q3 is this it?Iron ore prices are now fully US$50 below the average for Q2,with our original expectationof US$135 in Q3 and US$140 in Q4 now highly improbable;even a modest revivalremains dependent on a stronger China recovery than seems
22、 plausible before 2013.Moreover,cash costs(though not capital cover for many projects)are well below currentprices for a large proportion of the supply curve.Further stagnation in demand could stillsee a retreat,albeit temporarily,below the US$80,the long-term historical price average.Bulking Up:Iro
23、n Ore Curtain Falls on Era of Windfall Prices,4,30 August 2012,Exhibit 4:Global steel production growth has“normalized”at lower rates since 2007Mt,monthly,SA,natural log,Exhibit 5:Chinas steel demand,and henceproduction,has also moderatedMt,monthly,SA,natural log,12.011.8,Global,CAGR=2.4%,11.5011.00
24、,China,World Ex-China,CAGR=2.5%,11.611.411.211.010.8,CAGR=2.5%,CAGR=8.3%,10.5010.009.509.008.508.00,CAGR=8.6%,CAGR=8.2%CAGR=21.7%,1990,1993,1996,1999,2002,2005,2008,2011,1990,1993,1996,1999,2002,2005,2008,2011,Source:Credit Suisse,WSA,the BLOOMBERG PROFESSIONAL serviceExhibit 6:Iron ore supply has o
25、utpaced moderatedsteel outputSeaborne iron ore supply proxy,natural log,SA,Source:Credit Suisse,WSA,the BLOOMBERG PROFESSIONAL serviceExhibit 7:Australia has contributed consistently tothis persistent growthSeaborne iron ore supply proxy,natural log,SA,18.518.3,18.017.8,World Ex-AustraliaAustralia,C
26、AGR=5.7%,17.6,18.117.917.7,CAGR 01/02-06/08=15.2%,CAGR 06/08-05/12=8.0%,17.417.217.016.8,CAGR=15.6%,CAGR=12.3%,17.516.6,17.317.1,16.416.2,2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012,2002,2003,2004,2005,2006,2007,2008,2009,2010,2011,2012,Source:Credit Suisse,Customs Data,Source:Credit Suis
27、se,Customs Data,Supply growth is overwhelming moderated demandOn the surface,the reason for the sharp tumble seems simple,although a destockingphase for iron ore also lies behind the precipitous price collapse:iron ore supply has runahead of underlying demand in the production of crude steel.Despite
28、 global steelproduction holding up above 1.5 Bt/y in July(see More Hope and Expectation),at a globallevel,steel output growth has slowed to a trend 2.5%p.a.since the collapse ofLehman.In contrast,iron ore supply has risen at a reasonably stable 8%p.a.,led byconsistent expansion of Australian supply
29、where exports have grown at a stable 12%annual rate year(see Exhibits 6 and 7).Further,increases in demand for iron ore outside China,almost the sole growth engine,are likely to remain modest and well below the pace of expansion earmarked by a broadrange of iron ore miners and developers.It is hard
30、to envisage strong trend growth in thedeveloped world,or a replacement in the emerging market world for 2000s steel-consuming juggernaut.Bulking Up:Iron Ore Curtain Falls on Era of Windfall Prices,5,30 August 2012,Challenges forpromoters of ironore projects,With this in mind,we are now of the view t
31、hat not all of this planned new supply willbe needed and that many unfinanced projects are under threat.Even those projectsalready under way may face financing challenges in the event of a further retreat in prices more than a passing possibility.,The lions share of required growth in iron ore suppl
32、y will stem from those programsalready in train at BHP Billiton,Rio Tinto and Vale we expect“The Big Three”willclaim greater market share in the years to come,although longer-dated capitalprograms in these portfolios may also be reined back.As we have stated before,while this does not prevent price
33、falls,the prevailing oligopoly structure of supply willresult in higher iron ore prices for producers than otherwise would have been the case.Steelmakers are unlikely to retain much market power.The implications are clear supply abundance is likely to cap price rises even whenChinas recovery gathers
34、 greater speed beyond 2012.As we approach the 2020swe are likely to see further moderation of Chinas steel demand growth,as well as asteady rise in the rate of recycling of scrap steel,pinching out the demand for virgin ironunits.In other words,the best years for iron ore pricing are behind us.Exhib
35、it 8:Short-run marginal costs of supply are setting prices at less thanUS$100/tChina iron ore production costs US$/t at 62%Fe equivalent(left scale);percentage cumulative supply(lower scale)Source:Credit Suisse estimates,CMMA,SteeleaseBulking Up:Iron Ore Curtain Falls on Era of Windfall Prices,1,6,3
36、0 August 2012Marginal supply is falling away,but prices likely to undershootPrices are now sufficiently low to prompt deeper supply cuts among Chinas mines andconcentrators,although others remain profitable or,as we have indicated previously,aresupported by other factors.Here we highlight that there
37、 is no single level at which cost support emerges.Not allmines have the same cost structure and prices are set by the changing dynamics of bothsupply and demand;immediate responses from suppliers are rarely achievable given thelevels of fixed costs and other considerations in the very short term.Equ
38、ally,as marketspinch,so too costs eventually fall back.,High cost inflationin Chinas iron oresectorOperating rateshave fallen sharplyin north-east China,As we show in Exhibit 8,we estimate the median cost of iron ore concentrate production inChina is now above RMB600/t,equating to just under US$100/
39、t at todays exchange rates.According to cost surveys undertaken by local consultant,Steelease,average costs ofproduction at mines in Hebei,Chinas main producing region,have risen from RMB523/t in2010 to RMB630/t in the first half of 2012 and similar patterns apply to neighbouring ironore producing r
40、egions,although“average”costs mask a wide spread.However,there are still considerable volumes with cost structures below todays prices.Also,not all those mines with costs above current price levels will cut back immediately inresponse to theoretical losses about 25%of Chinas supply comes from minese
41、ffectively captive to steel mills or run by state-owned enterprises.Decisions to lay offworkers are not always straightforward.At the global level,prices would need to fall back further to prompt major reductions insupply outside China,although we are hearing of deferring of cargoes from India andSo
42、uth America.Cash operating costs of supply from the Australian and Brazilianoperations are less than US$65/t(approximately the 50th percentile of the supply curve toChina)1.Under a deeper slowdown in demand,prices therefore have the potential to sliplower,as was the case in 2008-09 when prices trade
43、d in a US$60-80 range,CFR China.Imports displacing Chinas domestic tonnageNevertheless,cuts have deepened over the summer months in China,mainly at small andmedium-sized private,“township village enterprises”(TVEs).Exhibit 9 indicates thatoperating rates in the four major producing provinces of nort
44、hern China have fallen below,60%.However,there are other factors behind these closures.Heavy rainfall associated with tropical storms has badly affected north-east China,hampering mining operations and trucking activity.Restrictions on the use of explosives have intensified as we approach the Octobe
45、r PartyCongress(in a similar move to the Beijing Olympic Games in 2008).Although operating rates are beginning to recover at mines and plants hit by bad weather,the slide in prices and the lack of explosives are likely to see operating rates held back wellinto Q4 and possibly through Q1 of next year
46、 when seasonal stoppages reach their peak.A monthly production run rate of just below 59 Mt of crude steel points to monthly demandfor iron ore of about 87 Mt,at an equivalent grade of 62%Fe and allowing for use of scrap(mainly through EAF production).Monthly imports look to have stabilized at aroun
47、d 60 Mtin 2012,implying a reliance of close to 30 Mt/m from domestic sources in the remainder of2012.This may prove a tall order in light of the sharp fall in prices since early July.There are a number of service providers constructing cost curves for iron ore,but there are pitfalls in the value of
48、these analyticaltools for a number of reasons:Firstly,prices of iron ore products vary,and supply curves often ignore the effect of pricedifferentials(e.g.for pellets and lump).Secondly,costs vary over time,as do prices-input costs,for example for consumablesand labor,change with demand,as do exchan
49、ge rates and other factors,albeit with lags.Bulking Up:Iron Ore Curtain Falls on Era of Windfall Prices,7,30 August 2012Destocking cycle a strong influenceA heavier reliance on imports should therefore be needed,assuming we maintain aproduction run rate close to 700 Mt/y in Sep-Dec.While spot market
50、 prices would suggestthat supply is more than sufficient to meet current levels of demand,we suspect thatdestocking of iron ore at mills(and a gradual accumulation of finished steel stocks held atDestocking has plants)is playing a strong hand in allowing mills to defer fresh purchases,contributing t
