Global iron ore prices at five-year high, but India fails to cash in

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What could be this if not self-harming? Driven by supply shrinkages from accident-struck Brazil and Australia and more than expected demand from Chinese steel mills, world iron ore prices are at a five-year high. But New Delhi continues to drag its feet over rejigging the export duty structure. At present, zero export duty is available on iron ore with iron (fe) content of up to 58 per cent. Local miners have asked that this duty benefit be extended to iron ore with fe content of up to 62 per cent. Without this, India remains outpriced in the global market just as the world is losing appetite for low grades of ore, because their use is damaging to the environment.

Because Indian miners are denied the benefit of nil export tax on medium grades of ore, the cut-off point being 62 per cent fe-bearing ore, that their Australian and Brazilian peers have, India could not cash in on the surge in the mineral price since the end of January, which coincided with the rupture of a tailings dam linked to the Brazilian Vale-owned Brumadinho iron ore mine that killed more than 300 people. Yet another disruption in iron ore shipments was soon to occur when tropical cyclone lashed the Pilbara region of Western Australia leading to port closures and slowed mine operations. 

The contraction in shipments from Brazil and Australia is a major factor but not the only one to have caused major rallies in iron ore futures for September delivery on China’s Dalian Commodity Exchange (DCE). In a quarterly report last year, the Australian government’s department of industry said Chinese steel production would top out at 886 million tonnes (mt) in 2018 and then tail off in the next two years. Quite a few consultancies at that point shared Canberra’s assessment of China steel outlook. Even as late as last month, China’s Iron and Steel Association (CISA) advised steelmakers to “rationally increase output” in the second half of 2019 as steel demand growth will wane in sectors such as property, automobile and energy. 

In reality, however, more and more stimulus from Beijing to grease the country’s economic wheels continues to support steel demand, particularly from housing and infrastructure. What is to follow is the nearly 10 per cent rise in Chinese steel production in the first half of 2019 at 492.169 mt against 447.825 mt in the same period last year. China’s steel capacity use is approaching a high of 75 per cent. Buoyancy in steel demand is ensuring a fall in stocks with dealers. One disturbing feature of China production upsurge is the minnows of steel industry taking advantage of the uneven enforcement of environmental laws continue to ramp up output. Describing the scene, a consultancy says the Chinese steel production and demand are a surprise on the upside and the level of iron ore supply shortfall is a shock on the downside. 

According to S&P Global Market Intelligence, the global seaborne iron ore trade this year will be in a 54 mt deficit and it will take three years for the balance to be back. Earlier another consultancy, RBC, estimated a deficit of 83 mt in ore in 2019 caused by an unexpected Chinese demand rise on the back of dislocation in mine operation in the two major producing nations. No wonder, then, in early July the benchmark 62 per cent fe ore for China delivery rallied to a five-year high at $126.50 a tonne. The spot market has somewhat cooled since on reports of production improvement at Australian iron ore majors. That the ore commanded a price of $191.90 a tonne in February 2011 or $160 during the last big rally seven years ago is no relief for steelmakers. 

Bloomberg Intelligence estimates that the present iron ore cost alone accounts for about a third of the revenue Chinese steelmakers can hope to get from hot-rolled coil. Add to this the high cost of coking coal and scrap, the margins of steel producers are down to 5.3 per cent. In a situation like this, says Bloomberg, “any steel mills bearing heavy debt loads will be flirting with losses”. Remember, steel and coal are among the most indebted sectors in China. 

What happens on the DCE futures market is taken as a price benchmark. This is because of the size of Chinese steel industry, which has more than half the share of world steel production and at the same time accounts for over two-thirds of 1.5 billion tonne (bt) seaborne trade in the steelmaking ingredient. The clean environment campaign by Beijing is the reason Chinese steelmakers are showing increasing import preference for better grades of ore. HSBC says in a report that the inevitable fallout in the face of growing demand for quality ore is the continuing shrinkage of extraction in China where the fe content is now unacceptably low. No wonder China’s iron ore production is down 40 per cent compared to the 2017 level. “Unfortunately, we could not seize the opportunity available in China because of export tax factor,” laments an Indian producer-exporter. 

The spot price of a commodity is usually below that of a futures contract, which captures price expectation at a future point. In the present case, this is borne out by several contracts for September delivery being done at about $135 a tonne on DCE. More recently, futures action has shifted to DCE January delivery where trades are recorded at close to $110 a tonne. Commodity price forecasting is a tricky business where analysts’ reputation is always at risk. 

After a fairly long bull run, many in the price-anticipation business have started wondering if the news of Australian mines having started putting behind weather-related production disruptions, output and shipments at Vale improving, albeit at a slow pace, and China’s port inventories, which are down to 115 mt from the year-high of around 149 mt in early April, growing once again are indicative of ore prices have peaked. What may also put a lid on prices are Chinese steelmakers openly airing their unhappiness about the strong rally in the commodity and their telling the government to look into the role of “non-market factors” in DCE deals. In response, market regulators have promised tightening of supervision of money flows in DCE. However, some analysts still believe that iron ore still has some way to go, riding on Chinese hunger for the commodity.

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