Iron ore prices have fallen sharply over the course of the last year or so. Benchmark 62% Fe iron ore fines prices stood at $68 per dry metric ton (dmt) at the end of January, around 47% lower on a year-over-year basis.. The decline in iron ore prices was due to a combination of weakness in demand and rising global iron ore production, resulting in an oversupply situation. This has led to a sharp decline in the stock prices of major iron ore mining companies over the course of the last year, as indicated by the chart shown below. Given that iron ore prices have halved over the last year, an important determiner of the prospects of major iron ore mining companies is the likely trajectory of iron ore prices over the next couple of years. In this article, we will try and understand the likely trajectory of prices of iron ore prices in the near term.
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From the perspective of iron ore demand, China is the most significant player, accounting for over 60% of the seaborne iron ore trade. Iron ore is primarily used in the production of steel, and therefore demand for iron ore by the steel industry largely constitutes the overall demand for the commodity. With Chinese economic growth slowing, the demand for steel, which is largely correlated with macroeconomic growth, is also slowing. As per the latest IMF estimates, Chinese GDP growth is expected to slow to 6.8% and 6.3% in 2015 and 2016 respectively, from 7.4% in 2014. As per estimates by the World Steel Association, Chinese steel demand growth is expected to slow to 2.7% in 2015, from 6.1% and 3% in 2013 and 2014, respectively. Thus, demand for iron ore in the near term is unlikely to grow at rates seen over the last couple of years.
The supply side is characterized by an expansion in production by major iron ore mining companies. Companies such as Vale, Rio Tinto, and BHP Billiton are rapidly ramping up their iron ore production, despite weakness in demand. These companies have low-cost iron ore deposits and are able to operate profitably even at current price levels. These companies are betting on the long-term strength of iron ore demand from China, and the curtailment of high-cost iron ore production capacity, to bring the demand-supply equation back into balance. Though there has been a reduction in output from high-cost iron ore miners, given the prevailing weak demand conditions, the oversupply of iron ore is unlikely to dissipate anytime soon. As per projections by major Wall Street banks, the worldwide surplus of seaborne iron ore supply is expected to rise to 300 million tons in 2017, from an expected surplus of 175 million tons in 2015, and a surplus of 72 million tons and 14 million tons in 2014 and 2013, respectively. If demand picks up faster than expected or iron ore majors curtail their planned expansions in production, the extent of oversupply may lessen. However, oversupplied markets will certainly put pressure on iron ore prices over the next 2-3 years. With the lowest cost miners in the world producing iron ore at around $50 per ton, prices are unlikely to fall as drastically as seen over the past year. Though the worst is over in terms of price declines, prices are likely to remain subdued for an extended period of time. Thus, prospects for iron ore miners remain bleak in the near term.
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