A September 10th report from Goldman Sachs Commodity Research highlights the fact that the iron ore market has collapsed over the last few months, with the iron ore spot price down 38% year-to-date to US$84/ton. However, despite the steep price decline, the report argues that weak demand from China and the structural character of the market surplus means a near-term recovery is improbable.
Goldman Sachs analysts Christian Lelong and Amber Cai summarize their perspectives on the iron ore market in the overview of the report. “In our view, iron ore has already transitioned to an exploitation phase where the commodity prices are typically subject to the deflationary pressure of mining productivity and the depreciation of commodity currencies. We maintain our US$80/t forecast for 2015 and we apply our updated assumptions on cost deflation by lowering our 2016-17 forecasts to US$79/78/t (down 4%, 8% respectively).”
China demand unlikely to ramp up
As the GS report notes, excess iron ore can only be absorbed with an increase in inventory and/or the displacement of marginal production. Since the Q1 2014, stockpiles at Chinese ports have seen a 23Mt increase, while low prices have led to the idling of.48Mt in grade-adjusted Chinese and seaborne production capacity.
Both of these “inventory safety valves” will be pushed to their limits, in our view, but stockyard space is clearly limited and port restocking is also likely to decline from 2015 onwards. Lelong and Cai argue this “will leave Tier 2 seaborne producers vulnerable, with up to 40Mtpa in seaborne capacity at risk of closure in both 2015 and 2016.”
Structural problems with iron ore market
Lelong and Cai argue that the current oversupply in the iron ore market is largely structural, and results from several years of over-exploration and over-production, and it’s simply going to take some time for demand to catch up to supply.
They also point out that a decision to operate at a loss for a period of time is rational given the costs of idling or closing a mine. For metallurgical coal, the GS analysts note that spot prices have remained below their US$140/t estimate of marginal production costs since the fourth quarter 2013. Several marginal mines have been scheduled for closure since then, but only after several quarters of operating losses.
The report argues that marginal mines will continue to be a significant factor in the structural oversupply of the iron ore market over the medium term. Lelong and Cai believe management will try to delay the closure of a non-economic mine until their hand is forced by a lack of funds to finance their business or definitely concluding that the asset will not produce profits in the foreseeable future.