Whilst steel making capacity in China has kept pace with the surge in demand, it has been the supply of iron ore that has lagged and has, as a result, led to a quadrupling of the iron price over the past 10 years.

Key to the supply issue of iron ore has been the inability of the Brazilian producers to add incremental new supply to offset mine maturity, as well as the environmental and political challenges that have faced the world’s largest iron ore miner, Vale. Chart 1 highlights the inability of Vale to deliver net new tonnes.

vale-supply-guidance-has-consistently-dissapointed

Vale is now at risk of losing its title as the world’s biggest exporter of iron ore to Rio Tinto if it continues to fail to deliver new tonnage. This could happen within two years.

The seaborne response to the Chinese demand for new iron ore has been led by Australia. It has been dominated by production increases from the incumbent majors, BHP Billiton and Rio Tinto, but has also been supported by the successful growth of Fortescue Metals which is now the fourth-largest iron ore producer globally. Chart 2 highlights the seaborne response from Australia versus Brazil, which has continued to find it difficult to add additional net tonnage to meet the ever-increasing demand from China.

australia-is-leading-the-supply-response

The importance of the supply response is the main driver in reducing the key input cost into steel making – iron ore. The slow response of the supply of iron ore versus the more timely increase in steelmaking capacity has caused sharp spikes in the iron ore price and has led to low profitability of steel mills.

Supplementing iron ore over the past five years has been the high-cost, low-quality domestic iron ore from within China. Ore grades in China are as low as 15% (versus the global benchmark of 62%) and require significant beneficiation (refinement) in order to be useful in the steel making process. As a result, a large proportion of Chinese iron ore sits high on the iron ore cost curve. Chart 3 highlights where the Chinese ore currently is assumed to sit at around USD 130 per tonne CIF (costs of production, insurance and freight).

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