Analyst Research
1 March 2020
1. The Fundamentals of Iron
Iron ore prices continued to hit five-year highs as of June 2019, surging on the back of shortfalls in the Brazilian and Australian markets, and a reduction in Chinese port stockpiles, which are being drained to meet the ore demand required for China’s world-leading steel production.
Iron ore future pushed higher to above $100 per tonne in Singapore, closing at their highest point since 2014 as a result of tightening supply. Iron ore’s value is not a flash in the pan either, as the main ingredient in the production of steel, it retains a permanent place of importance in global commodities markets. Steel typically contains around 95% iron ore, and 98% of the world’s iron ore that is produced is used to create steel.
Steel is a substance that is used to make automobiles, locomotives, ships, beams used in buildings, furniture, paper clips, tools, reinforcing rods for concrete, bicycles and thousands of other items.
It is the most used metal in the world by both tonnage and purpose, accounting for 90% of the metal used each year. Its overwhelming popularity for a multitude of purposes stems from its relatively low cost and desirable properties, meaning it is the main structural metal in engineering and building projects.
Around 60% of iron and steel products are used in transportation and construction, 20% in machinery manufacture, and most of the remainder in cans and containers, in the oil and gas industries, and in various other household appliances and equipment.
Steel isn’t about to be replaced as the global metal of choice either, partially because it is already eminently reusable. In North America, 69% of steel is recycled, which is more than paper, aluminium, plastic and glass combined. In fact, steel can be recycled without incurring any loss of strength.
The steel industry is also helping power the renewables market, providing the main material for capturing renewable energy sources like solar, hydro and wind. Presently, the steel industry directly employs two million people globally, and over 6 million within the broader steel industry, and that number is on the increase.
The estimated global turnover of the steel industry is US$900 billion a year, making it the third largest industry worldwide behind only gas and oil. Its applications are extremely widespread; 75% of all appliances contain steel, and the computer you are presently reading this on will likely contain around 25% steel.
Come 2050, steel use is projected to have increased to be 50% higher than present levels in order to meet global population growth, and it will require an equivalent rise in the amount of iron ore in order to be able to produce it.
But you won’t have to wait 30 years for the demand for steel to rise; in the past twelve months global steel production is up 4.1%, and the world’s largest steel producer, China, has seen its output increase 9% from a year ago.
2. What is Driving Iron Ore Prices?
The January mining disaster in Brazil that resulted in the tragic loss of 300 lives led to the Brazilian courts making the decision to shut down not only Vale’s collapsed mine, but the surrounding iron ore mines as well.
Analysts from UBS projected that this decision by the court had instantaneously removed over 90 million tonnes of iron ore from the market, creating immediate global shortages in production.
Vale also announced that it would fetter production at a further site, which used a different construction method from the collapsed Brumadinho dam. Christopher LeFemina, an analyst at Jefferies commented on the closure;
“These closures were not expected. A continuation of iron ore supply issues in Brazil, combined with improvements in Chinese demand due to tighter steel markets and an expected VAT cut starting in April, should lead to a prolonged period of high iron ore prices.”
Vale, the world’s largest iron ore producer, announced in April 2019 that it would sell between 50-70 million tonnes less of the key steel ingredient than it had last year as a result of the disaster. But Vale is not the only producer feeling the production pinch.
Rio Tinto and BHP Group, the second and third largest iron ore producers respectively, have also reduced their projected production levels in 2019 owing to the effects of tropical Cyclone Veronica in March the same year. BMO Capital Markets estimated that along with similar losses suffered by Fortescue, 20 million tonnes has been cut from the iron ore market as a result of the cyclone. To cap it all off, Rio Tinto also suffered a serious fire at one of its export terminals in the same West Australian region.
“Taken together the two events threaten to significantly tighten the iron ore market, which was expected to be broadly in balance this year. Adding up the anticipated production and shipments disruptions…we could see a total impact on seaborne iron ore production (fines and pellets) of 85-113 million tonnes,” said BMO.
According to commodities traders, the Chinese steel industry has remained relatively unaffected by the iron ore shortages thus far, but that could be about to change, placing further pressure on prices. Experts suggested that there was a time delay between iron ore shortages in Brazil and Australia, and the pinch being felt in China, as their stockpiles dwindle.
3. Current and Forecasted Prices
Despite their own woes as a result Cyclone Veronica, both Rio Tinto and BHP, alongside Fortescue, have experienced significant upticks since the beginning of 2019 as a result of the rapidly rising price of iron ore.
Since the beginning of 2019, shares in Rio Tinto are up 32%, shares in BHP up 17%, and FMG shares are trading almost 95% higher over the same period.
These boosts that Australia’s major iron ore producers have generated in their share price has largely come on the back of a significant increase in the price of the commodity itself, unsurprisingly. BHP, for example, estimates that for every $1 move in the iron ore price, it adds $225 million to its underlying earnings. This has led to all three of the aforementioned companies signalling that they are boosting returns to shareholders, and flagged further potential payouts later in 2019.
“We’ve seen those trends continue and that’s driving strong demand for seaborne iron ore. There’s significant investment continuing, that’s driving demand for steel, and that’s driving demand for iron ore.”
– Fortescue Chief Executive Officer Elizabeth Gaines, March 2019, Bloomberg Television interview. 
In early 2016, the price of iron ore languished at around US$40 per tonne, as of 2019 that price sits above US$95. In April 2019 alone, iron ore prices increased 29% on where they were in December of 2018.
But the good times for iron ore prices are not projected to stop rolling soon either; steel isn’t a substance that’s going to disappear anytime soon, and steel requires iron ore to be produced, a significant quantity of it.
While the present high prices aren’t projected to carry on infinitely, they are projected to remain strong for the foreseeable future. This is great news for iron ore producers, who will be looking gleefully at the forecasts for steel production which show a steady increase in the need for steel over the next few decades.
Rio Tinto is predicting a particular increase in the demand for high-quality iron ore from China, as the country implements more stringent policies and regulations on the environment. Rio CEO Jean-Sebastien Jacques commented;
“In the context of the new environmental policy introduced by China, even if the consumption of steel was to fall, the need for high-quality iron ore will increase in order to improve environmental footprint, and that’s what we have experienced already in the last few years.”
Furthermore, Bloomberg Intelligence senior analyst of metals and mining Zhu Yi said the rising usage of high-quality iron ore, driven by government’s strict implementation of environmental protection standards, particularly in China, will generate higher margins for the sellers of premium products.
Jacques also cited the emergence of China’s new Belt and Road initiative, which aims to fund significant infrastructure projects all across the globe, wherever countries are willing to take investment. Naturally, this will result in a large demand for the resources and materials required to build on such a scale, particularly for most buildings key ingredient; steel. And where there is high demand for steel, there is inherently a high demand for iron ore to match.
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This document is provided by Gordon Capital Pty Ltd (Gordon Capital) and InterPrac Financial Planning Pty Ltd (InterPrac). The material in this document may contain general advice or recommendations which, while believed to be accurate at the time of publication, are not appropriate for all persons or accounts.
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