Did China Break the Iron Ore Cartel? Maybe Not

There is a good deal of doubt on the Iron Ore outlook over the next few years, most of it is predicated on an ongoing downturn in the global economy, but before selling your Iron Ore companies let's take a look at the facts.

Iron ore contract prices next year are forecast to average $US151 a ton as growth in supply from Australia, coupled with expected weaker steel production, particularly in OECD economies, place downward pressure on prices, the Australian government forecaster said in a report.

Mining companies in Western Australia state alone are spending about $A45 billion on developing and expanding iron ore mines, according to the state's Department of Mines and Petroleum.

Iron ore for immediate delivery was $US177.40 a ton on Sept. 20, according to a price index compiled by The Steel Index Ltd. The price reached a record $US191.90 on Feb. 16.

China has been on a decade-long drive to break the stranglehold of Rio, BHP and Vale by bankrolling rival mines. Chinese investors, mainly state-owned steelmakers, have funded at least 20 iron ore companies in Australia including Sundance Resources Ltd., Fortescue Metals Group Ltd. and Mount Gibson Iron Ltd. In August, Shandong Iron & Steel Group Co. agreed to buy a 25 per cent stake in African Minerals Ltd.'s Tonkolili project in Sierra Leone for $US1.5 billion.

In the last decade, China had to absorb six years of gains in contract prices and failed to stop the three top suppliers moving to spot pricing, heightening tensions between the suppliers and the Chinese government.

China's drive to secure larger-scale ore production was set back in June 2009 when Rio, the world's second-largest exporter, rejected a planned $US19.5 billion investment by Aluminum Corp. of China, or Chinalco, that would have included stakes in Rio's Australian iron ore operations.

World trade in iron ore is forecast to gain 8 per cent next year to 1.2 billion tons, with China expected to account for the largest share, Australia's Bureau of Resources and Energy Economics said this week in a report. Meanwhile, the pace of growth in steel demand in China, the biggest ore buyer, may ease to 2.6 per cent annually through 2015 from the 4.6 per cent forecast for this year, as its economy slows, the China Iron & Steel Association said in April.

Rio said last month a 10 per cent drop in iron ore prices will cut its annual underlying earnings by $US1.7 billion and BHP said a $US1 a ton decline in the price will reduce net income by $US90 million for this financial year. Rio and BHP are set for record profit this year of $US17.6 billion and $US25.3 billion respectively.

At Rio, earnings before interest and tax from iron ore are forecast to drop to $US11 billion in 2015 from an expected peak of $US21.3 billion next year, Deutsche Bank AG said Aug 4. Iron ore provided almost two-thirds of the London-based company's 2010 earnings before interest, tax, depreciation and amortization, or Ebitda.

At BHP, where iron ore comprised 26 per cent of Ebitda in fiscal 2010, the earnings will peak at $US16 billion in 2013, before falling to $US11.6 billion in 2015 and $US7.9 billion in 2016, Bank of America Corp. said in a report. Overall Ebitda will drop 25 per cent in the five years through 2016, the bank forecast.

In conclusion, the Iron Ore market will still see growth in demand over the next few years despite the pessimistic growth outlook, if that outlook is wrong, as I believe it might be then Iron Ore demand may exceed expectations.

The USD is another factor, given the Feds long term low rate policy can we expect a USD that will strengthen year on year in the immediate future, the laws of economics say that is doubtful.

It is Possible Rio, BHP et al may be a touch oversold.


Shayne Heffernan

Shayne Heffernan oversees the management of funds for institutions and high net worth individuals.

Shayne Heffernan holds a Ph.D. in Economics and brings with him over 25 years of trading experience in Asia and hands on experience in Venture Capital, he has been involved in several start ups that have seen market capitalization over $500m and 1 that reach a peak market cap of $15b. He has managed and overseen start ups in Mining, Shipping, Technology and Financial Services. www.livetradingnews.com