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Australia’s iron ore industry is bracing itself for further casualties following the collapse of two junior miners because of a slump in prices that has put pressure on high-cost producers and raised question marks over some new projects backed by Chinese investors.
The demise of Termite Resources and Western Desert Resources comes amid a ramp-up in supply by industry heavyweights BHP Billiton, Rio Tinto, Fortescue and Brazil’s Vale, coupled with weaker than expected demand from a cooling Chinese economy.
“There are some high-cost producers in Australia and those guys entered the market when iron ore prices were high, so they either have to reduce their costs or do something a little different,” says Nev Power, Fortescue chief executive.
He says up to 100m tonnes of high-cost production must withdraw from the market before iron ore prices can recover, leaving high-cost producers in Australia, China, Africa and elsewhere vulnerable.
Iron ore prices fell to five-year lows of A$82.20 this week – a decline of almost 40 per cent this year – which is alarming investors, who have invested hundreds of billions of dollars in new mines to capitalise on a decade of historically high prices.
Australian production of the reddish brown ore – the main ingredient in steel – increased 40 per cent between 2010 and the end of 2013 and the country now supplies half of global exports. But just as supply is growing to record levels, concerns about the health of China’s property market are slowing demand.
The sharp drop in iron ore prices is discouraging many Chinese steel mills from buying, for fear they would be left holding expensive stockpiles of raw materials as finished steel prices were also falling.
Traders have also curtailed purchases thanks to difficulty obtaining credit and the fear that in a falling market they would have to sell at a loss.
That is contributing to the tumble in prices to levels last seen in 2009. It also means the pain has been felt more in Australia, with its huge surplus of iron ore, than in China, with its huge surplus of steel production capacity.
High-cost iron ore producers now face a fight for survival, with Goldman Sachs this week forecasting an “end to the iron ore age”.
Research by UBS shows Cliffs Natural Resources, a US company that operates mines in Australia, Gindalbie Metals, Grange Resources and Atlas Iron have break-even prices above $83. Several other miners are producing ore at costs slightly below current prices and are vulnerable to further falls.
Rio and BHP are in a more comfortable position because they are lower-cost producers. A dip in prices reduces their ability to increase dividend payments to shareholders, but analysts say it provides the advantage of eliminating competitors.
“It is in the interests of major miners for iron ore prices to be well south of levels seen in the past few years in order to prevent and discourage new entrants,” says Daniel Morgan, UBS analyst.
There is no sign of a let-up. Rio and BHP plan to bolster their iron ore production 12 per cent and 11 per cent respectively in 2015, as they seek to grab market share and force high-cost producers in China and elsewhere to withdraw from the market.
The global supply glut is forecast to grow in the years ahead, with Vale also planning to expand annual production from 310m tonnes to 450m tonnes by 2018.
The industry shakeout is prompting junior miners to slash costs, divest operations and consolidate. Last month BC Iron offered A$257m to buy its smaller rival Iron Ore Holdings, while Cliffs has hired bankers to sell its Australian iron ore mines.
In China, some higher-cost iron ore producers are leaving the market, although not as rapidly as Australia’s big miners had expected, which is compounding the oversupply problem.
“They are a lot more tenacious perhaps because they have become more established due to the high prices enjoyed over a long period,” Mr Power says.
There are concerns in China that Australian producers should not gain too much control over the iron ore market. Last week an official at China’s central planning agency lectured BHP Billiton’s China head on the need for a “new model” in pricing, according to a transcript of the meeting released by the agency.
Albert Calderon, a former BHP executive, expects China’s iron ore miners to survive at the expense of high-cost miners in other countries, including Australia.
“Yes, there will be closures but new and more efficient mines are being built. China will repeat what it has done already in aluminium and thermal coal: create an oversupply of iron ore that will benefit them as a consumer country,” he says.
If he is right, some big iron ore projects planned to come on stream in the next few years could struggle to attract investment. These include an $7bn plan backed by China’s Baosteel, and South Korea’s Posco to develop a mine, port and railway in Western Australia to compete against BHP, Rio and Fortescue.
“To try and get a return on that [investment] in this price environment becomes much more difficult,” Mr Power says.
“There has been a lot of concern in the market about investments that haven’t made those good returns and I would think that would make them a lot more hesitant to push on ahead with that.”
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- [Editor:sunzhichao]
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