The Iron Ore Price and China's Dodgy Steel Production Numbers

Pity the iron ore producers — well, maybe not after seeing what massive profits they’re making, but they do live in an uncertain world and the pressure of shareholder expectations must be tough to manage.

On the one hand, they face supply disruptions due to weather, and on the other, delays in bringing new production on stream due to infrastructure and skills shortages. Just this week the FT reported on Sinosteel, a state-owned Chinese metals producer, suspending work on a $2 billion iron ore project in Australia because delays in developing infrastructure.

New project delays are a major hurdle to the steel industry’s hopes for greater iron ore supply and hence lower prices this decade. Producers can’t even be sure how much their clients are consuming. China, the world’s largest steel producer and largest seaborne iron ore consumer, is also a major iron ore producer from domestic sources. The Australian, Indian and Brazilian producers have a good idea how much they are selling, but cannot be sure how much China is producing domestically — even domestic steel production is now being questioned.

An FT article argues out estimates that China is under-reporting steel production by some 40 million tons per annum, the equivalent of Germany’s steel production. The 40 million-ton estimate is by Meps, a UK steel consultant, who estimates China’s true production at 672 million tons against the official figure of 627 million tons. Quite how they arrive at that figure is not clear, but the under-reporting is said to be due to regional governments hiding uneconomic and less environmentally friendly plants that continue to operate against Beijing’s clampdown on over-production.

As a result, a gap is said to have developed between reported steel production (and hence iron ore consumption) and actual steel production (and hence iron ore consumption). The greater-than-expected demand is what is in part keeping prices for iron ore higher than some had expected by this point in the year.

Not all agree with Meps estimates. The World Steel Association said there may be a small amount of under-reporting from China, but nothing like Meps estimates. However Xu Zhongbo, an analyst with Beijing Metal Consulting, admitted steel output figures coming from China were routinely adjusted to fit stated government policy.

Vale’s finance director Guilherme Cavalcanti in an interview with the FT said the firm expected iron ore prices to remain above US $150 per metric ton for the next five years whether he meant FOB prices or CIF prices is not clear, but we take it to be CIF. Much of the case for falling prices seems to center around rising supply, but many analysts are beginning to question whether firms are going to be able to raise supply that much that fast. Vale has recently reduced its production forecast for 2015 by 10 percent due to new project delays.

Clarifying China’s true level of steel production will be a key element in understanding the demand/supply balance over the next few years; either way, China’s own cost of production will create a floor under global iron ore prices. HSBC, in a recent quarterly Metal & Mining review, estimated China’s own reserves as being of poor quality and relatively high cost, putting a figure of $130 per ton on the cost of production. If they are right, maybe Vale’s number is not so far off the mark.

–Stuart Burns

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