How the iron ore price busted above $US100 a tonne
The iron ore price has pushed above $US100 a tonne. It may not be able to hold at these heights, but experts forecast prices could stay elevated well into next year.
But while mining shareholders and the Treasury department have reason to celebrate the dividends generated by the bulk commodity’s highest price in five years, it’s worth noting the roots of today’s price spike lie in tragedy.
On January 25, a dam collapsed near iron ore giant Vale’s Feijao mine in Brazil. That breach led to 11.7 million cubic metres of mining waste from ore processing, known as tailings, flooding the mine site and associated infrastructure, killing about 300 people.
That disaster ultimately ripped 93 million tonnes from seaborne iron ore supply, or about 6 per cent of the total market. Unsurprisingly, prices for the bulk commodity jumped from about $US75 a tonne to above $US90.
Vale’s stock lost a quarter of its value on the day of the disaster, and today trades at about 15 per cent lower on the Sao Paulo exchange. In the cold logic of the market, the Brazilian miner’s pain was its competitors’ gain, as the higher price for the steel-making ingredient has translated into booming earnings.
Since the tragedy, BHP shares are up 17 per cent, Rio Tinto’s are almost 30 per cent higher and Fortescue’s have almost doubled. All this against the broader ASX’s rise of 10 per cent.
The big Aussie miners have been quick to return this cash bonanza to their investors, upping their scheduled payouts and announcing out-of-cycle payments. For example, last Tuesday Fortescue offered a special, fully franked dividend of 60¢ a share – a whopping $1.85 billion – bringing dividends paid this financial year to 90¢ per share, implying a yield of almost 10 per cent.
Of course, there’s no way iron ore could have hit triple digits without a big lift in demand. The massive supply shock has been met by a jump in demand for steel in China, which has moved to stimulate its economy in response to last year’s slowdown, pushing steel prices higher.
The lofty iron ore price “all depends on the margins of steel mills”, Commonwealth Bank of Australia commodity analyst Vivek Dhar says. “If they can afford to pay it, they will.”
So far, they can.
As Chinese steel production has hit record highs, Hexavest portfolio manager Étienne Durocher-Dumais has become more optimistic about the sustainability of the iron ore price, which he initially viewed as solely a supply issue.
“When you look at the trade war being extended, that probably means China will need to stimulate more,” says Durocher-Dumais, who holds Rio and BHP in his portfolio.
The question is whether bulk commodity prices – metallurgical coal prices are also well up in 2019 – can maintain their lofty heights, or whether we are about to collapse back towards the marginal cost of production for the iron ore miners, which is generally considered about $US55 a tonne.
The potential supply response looks muted. Vale has said it will take two to three years for its damaged mine to get back online, and Australian mines are already running at capacity.
The market universally expects some kind of increased production from Chinese iron ore mines, and this is being watched closely by analysts. But the scale of that increase is likely to be blunted by regulatory restrictions aimed at improving environmental and safety outcomes.
Meanwhile, Vale may be able to add about 30 million tonnes if Brazilian authorities allow it to reopen its smaller mines, but it’s a large question mark and the timing is uncertain.
On the demand side, China’s steel production peak “season” runs between March and September, which should be supportive of bulk commodity prices and the potential for further policy stimulus.
Dhar says he will be scrutinising Chinese steel mills’ iron ore stockpiles: if they climb again, that flags a potential softening in bulk commodity prices as steel mills become more comfortable with their holdings.
The CBA analyst expects some of the heat to come out of the price in coming months. But he doesn’t expect a collapse. He sees iron ore fetching about $US85 a tonne by the end of the year – and there is “upside risk to that” if stockpiles keep falling. Dhar expects the price to average $US72 next year, and $US65 in 2021.
Source: Australian Financial Review