Production cutbacks won’t be sufficient to eliminate the industry’s oversupply problem in the near future
By Anton Löf and Magnus Ericsson
Last year was a difficult one for the metals and mining sector in general, and iron ore in particular. Amid lackluster recoveries in Europe, Japan and the United States, slowing demand from China and continued difficulties among emerging countries, the industry ended up oversupplying most mined commodities and suffered falling prices as a consequence. Iron ore prices decreased by around 40%—as did nickel, roughly—during 2015, while base metals and coal fell by about 20%.
With 346.1 million mt of production in 2015, Vale remains the largest producer of iron ore, accounting for roughly 17% of total world production. BHP Billiton ranks second with 273.8 million mt of production last year. (Photo: Vale S.A.)
Although economic growth strengthened somewhat in developed countries in 2015, world crude steel production declined 2.9%, compared with an increase of 1.3% in 2014. The decline was particularly severe in North America.
For the first time in decades, China’s crude steel production declined, falling 2.3% in 2015 primarily due to the shift in China’s economy away from a dominant focus on exports and investments to domestic, less steel-intensive consumption.
According to the Organization for Economica Cooperation and Development (OECD), the world’s steelmaking capacity increased by 478 million metric tons (mt), from 1.893 billion mt to 2.371 billion mt between 2010 and 2015. Meanwhile, steel production (according to the World Steel Association) over the same period rose 190 million mt from 1.433 billion mt to 1.623 billion mt. This suggests that overcapacity has risen from 460 million mt in 2010 to 748 million mt in 2015, a growth of almost 63% (288 million mt) over the five-year period.
Chinese exports increased their share of the world steel trade in 2015, driven by the growing gap between Chinese steel production and use. While Chinese exports grew 21% in 2015, exports by the rest of the world declined 3%. The surge in Chinese exports is a source of concern to many other steel producers, and several countries have introduced trade measures against selected Chinese steel products.
In 2015, steel prices continued the downward trend started in 2011, with S&P Global Platt’s world steel price declining 28% over the year. The combination of weak demand, excess capacity and lower input prices—those of iron ore, coking coal, natural gas and oil have all declined—contributed to the weak prices. However, prices turned upward in January 2016; the Platt’s world steel price rose 36% during the first five months of the year, regaining levels seen at the beginning of 2015. However, the price remains at less than half of the July 2008 peak.
Iron Ore Market
In 2015, the iron ore market shrank for the first time since 2009, after an increase in production of just 0.9% in 2014. The global output of iron ore declined 2.5% to 2.015 billion mt in 2015. Output increased in the two most important producing countries—Australia and Brazil—and declined elsewhere. Australia, which saw continued growth of 9% in 2015, to 811 million mt, surged ahead of Brazil, where output increased 5.8% to 422 million mt.
Asian production, which reached a peak in 2007 at 647 million mt, has declined almost every year since, mainly due to shrinking output in China and India. In China, output (with Chinese production converted to a standard 62% Fe, an estimate based on imports and pig iron production) fell 38% in 2014 and 36% in 2015, to 123 million mt. In India, the trend may have turned, with production increasing slightly in both 2014 and 2015 to 142.5 million mt, although it is still well below the 2009 peak of 223.6 million mt.
In Europe, including CIS countries, production declined 4.6% in 2015, to 235 million mt. In Africa, production fell 25% to 82 million mt in 2015, mainly because of a large decline in production from Sierra Leone following the bankruptcy of its two main iron ore miners and a smaller decline in South Africa.
The drop in Chinese and Indian production, together with expansion in Australia, has led to a notable decrease in the portion of world iron ore output accounted for by developing countries, from 55.2% in 2012 to 43.5% in 2015.
Iron Ore Trade
The growth in global trade in recent years reflects the changed composition of production, with a considerable increase in Chinese imports as a result of reduction of domestic capacity in the country. However, after several years of rapid growth in world iron ore trade, global exports increased by only 1.3% in 2015. World total iron ore exports have almost doubled since 2005 and amounted to 1.438 billion mt in 2015.
Australia has benefited the most from mine closures in China and its exports continued to increase, reaching 767 million mt in 2015, 7% more than in 2014. Brazilian export growth was not far behind, rising 6.3% in 2015, to 366 million mt. South Africa is now the third largest exporter with 65 million mt in 2015. India’s exports have declined precipitously from the 2009 peak of 117 million mt, to a little more than 4 million mt in 2015. This is the result of government policies that imposed export taxes on iron ore lumps and fines, bans or caps on production in the states of Karnataka, Goa and Orissa, and action against illegal mining.
China’s imports of iron ore increased 2% in 2015, following 13.8% growth in 2014. With rising imports and falling domestic production, Chinese import dependency has reached new heights of 88.5%. At 951 million mt, China accounted for two-thirds of world imports in 2015.
Global production of pellets in 2015 reached 443.9 million mt, a decrease of 4.4% compared with 2014. Exports of pellets fell slightly less, at 1.3%.
The share of pellets in total iron ore production has decreased since the late 1990s, when it ranged from 26%–27%. Over the past several years, however, it has remained roughly stable, at 22%–23% (21.8% in 2015). Developments in recent years have underlined the sensitivity of pellet demand to world market conditions and prices.
Seaborne Iron Ore Trade
In 2015, the seaborne iron ore trade increased 1% to 1.36 billion mt. As in earlier years, the increase was entirely due to higher Chinese imports.
Iron Ore Prices
Iron ore prices reached a peak of more than $180/ton (62% Fe CFR north China) in early 2008 before collapsing during the global financial crisis. They recovered almost to their precrisis levels by mid-2011, but have since been in a five-year bear market. In December 2015, prices had fallen to around $40/t, a level not seen since the benchmark prices. Iron ore prices improved substantially during the early months of 2016, rising from below $40/t to almost $70/t in April, before falling back to around $50/t in May, but have since been increasing slowly, reaching toward $60/t in September.
The main factor behind the fall in prices was the faster-than-expected increase in the supply of iron ore, particularly from the three largest producers (Vale, Rio Tinto and BHP Billiton). Together, these three companies added about 50 million mt of production (mainly through minor expansions by Rio Tinto and Vale) in 2015. The second factor was the slowdown in Chinese demand. Chinese pig iron production, which is the best proxy for Chinese iron ore use, was weak in 2014 (up 0.8%) and fell by 2.5% in 2015.
The combination of these two factors explains the rapid decline in global iron ore prices since the end of 2013. Market sentiment became increasingly bearish during the second half of 2014, through 2015. An illustration of this change in sentiment is that forward iron ore prices, which held up relatively well in 2014, declined more rapidly in 2015, particularly in March and April.
The “domestic premium” in China (i.e., the difference in price between locally mined ore and imported material) has narrowed in recent years. This declining advantage of domestic production has contributed to the shrinkage by more than 250 million mt of Chinese iron ore mining capacity since 2011, of which 50-75 million mt has occurred since early 2015.
The impact of the falling price of iron ore on producers has been somewhat mitigated by declining operating and freight costs. All iron ore producers and steel mills have abandoned the benchmark pricing system, and the more flexible index-based pricing system has now been widely accepted. The latter accounts for 80%–90% of deals, with spot deals accounting for the remaining 10%–20%, while annual prices have been almost completely abandoned.
Both the steel and iron ore industries are gradually beginning to accept the need for active price risk management and the use of futures markets. However, recent sharp futures price movements illustrate that these markets are still relatively thinly traded and sensitive to shocks.
Corporate concentration in the iron ore industry increased in both 2014 and 2015. The trend of decreasing concentration among the largest producers, seen during the 2005-2008 period, was reversed in 2009. Since then, industry concentration has increased steadily, and in 2015, the 10 biggest producers accounted for 61.6% of total production (60.8% in 2014). The “Big 3” iron ore mining companies (Vale, BHP Billiton and Rio Tinto) have also steadily increased their share of total world iron ore production from 36.4% (2013) to 39% and 43.8%, respectively, in 2014 and 2015.
Vale remains the world’s largest iron ore producer, with 346 million mt of iron ore produced in 2015, up from 332 million mt in 2014, a new all-time high. All of Vale’s mines are located in Brazil and its market share rose from 16.1% in 2014 to 17.2% in 2015, compared with its peak share of 18.8% in 2007. BHP Billiton remained in second place in 2015 with a market share of 13.6% (12.3% in 2014). Except for a joint venture in Brazil with Vale, all of BHP Billiton’s mines are in Western Australia. Rio Tinto has been the third largest producer since 2013, when it was overtaken by BHP Billiton. The company produced 263.3 million mt in 2015. Like BHP Billiton, Rio Tinto has most of its mines in the Pilbara region in Australia, and in addition controls the Iron Ore Co. of Canada (IOC) with mines in Labrador.
However, the measurement of corporate control at the production stage underestimates the real concentration of the iron ore sector, especially by the three largest companies. Large portions of total output do not enter the market, but are produced at captive mines or mines that have a protected or restricted market. If measured by the share of leading companies in global seaborne trade, then corporate concentration (the share of the three major companies) is considerably higher. Vale alone controls almost 23% of the total world market for seaborne iron ore trade, and the three largest companies in 2015 controlled 62.5%, an increase from 57.1% in 2014.
Corporate concentration will continue to increase in the current low-price environment as only the low-cost mines of the major producers continue to expand, and unprofitable mines around the world are closed.
Overall, about 109 million mt of new global iron ore capacity was added in 2015. The lower iron ore prices led to some site-specific cutbacks, but permanent closures were limited to 30-50 million mt in China, with very little elsewhere. However, this follows on larger permanent closures in 2013 and 2014 of iron ore mines in Sweden and Norway and also a host of mines in non-traditional iron ore exporting countries such as Honduras, Swaziland, Argentina and others.
There are also a number of iron ore mining projects in the investment pipeline, and considerable capacity might be added over the next two to three years. We estimate that at least 115 million mt, and perhaps as much as 236 million mt if all announced projects proceed, which is highly unlikely, of new capacity will come on stream in the period up to and including 2018. These additional-capacity tons are almost exclusively located in Brazil and Australia with larger projects, already in the pipeline and commissioned, being finalized. While some further closures will take place, most of the very high-cost capacity has most likely already been eliminated. This suggests that there will be a net addition to iron ore capacity over the next three years.
Despite the better-than-expected continuation of global economic recovery during the first half of 2016, the Brexit vote had IMF revising its projections for 2016 and 2017 by 0.1%, down to a projected growth in global GDP of 3.1% in 2016 and 3.4% in 2017. The recovery is projected to strengthen in 2017 and beyond, driven primarily by emerging markets and developing economies. But uncertainty has increased, and weaker growth scenarios are becoming more realistic. Chinese GDP growth is continuing its downward trend and the projections from IMF suggest that China will reach a GDP growth of 6.6% in 2016. Chinese national figures report a growth of 6.7% during the first half-year of 2016, which seems in line with the IMF forecast.
The growth in world steel production halted in 2015 and, so far, 2016 points toward a further contraction of steel output. The decisive factor for steel market prospects are the direction of economic change in China. It is not the slowdown in Chinese growth per se that would lead the slower steel demand growth over the longer term, but rather the reduced share of investment in Chinese GDP. This reduction is now happening more rapidly than many observers have forecast.
The World Steel Association’s short-term forecast for world steel use, presented in April, anticipates a decline in world steel demand by 0.8% in 2016, followed by an increase of 0.4% in 2017. It is particularly notable that China’s steel demand is expected to decline both in 2016 and 2017, after having also fallen in 2014 and 2015.
Some observers are, however, marginally more optimistic than the World Steel Association. Over the next two to three years, global steel use and production could continue to increase at an annual rate of 0.5 %–1%. The underlying scenario has the following features:
- Growth in China continues to be redirected toward consumption, with a consequent fall in the growth of capital investment and, therefore, in the growth of steel demand.
- Growth in the Eurozone countries picks up slowly as contractionary macro-economic policies are gradually relaxed, leading to a higher rate of growth in steel demand. Japanese growth also increases slightly, while there is a return to somewhat more solid growth in the United States.
- The rest of Asia experiences relatively slow growth, due to slowing Chinese demand, which is to some extent offset by both rising domestic consumption and a continued increase in intraregional trade not involving China. Beyond the next couple of years, growth in this region, especially by India, will become relatively more important for overall world steel demand.
- Developing countries outside Asia continue to grow reasonably well, mainly due to resumed growth in commodity exports.
Given China’s importance in steel supply and demand, any assumptions concerning its performance are crucial in determining global market conditions. Therefore, the successful reorientation of Chinese growth is essential both to the health of the world economy and to continued steel demand growth. Chinese steel demand could retreat 2% in 2016 and 2017 and level out at zero growth in 2018. For the rest of the world, an increase of 2.5% in steel demand in 2016 and 3% in both 2017 and 2018 is not impossible.
This scenario would yield global growth of 0.5% in 2016, 0.8% in 2017 and 1.7% in 2018. It is further assumed that growth in Chinese steel exports is likely to come to a halt, so that changes in steel demand will equate to changes in crude steel production in China and in the rest of the world.
If compared with actual figures from the first eight months of 2016, we can see that crude steel production growth for January-August 2016 was -0.9% compared with the same period in 2015. However, the figures have improved considerably and from May to August, global production in crude steel increased compared with the same period 2015. Chinese steel production shows a similar development with total crude steel production growth for January to August down 0.1% compared with the same period last year. The first four months show a decline of 1.9% compared with the same period of 2015 while the next four months, May-August, show growth compared with 2015 of 2.3%.
Last year’s report raised the possibility that the iron ore supply overhang, which had developed in 2014-2015, was the result of a massive miscalculation on the part of the larger iron ore mining companies. Subsequent events appear to have confirmed this hypothesis. The major producers have not been spared from the consequences of low prices and have had to drastically cut costs, cancel investment projects and delay payments to suppliers. Meanwhile, the three largest producers strengthened their market positions in 2015 and are continuing to do so in 2016. The main losers are the Chinese miners. The volume of iron ore from domestic mines to feed the Chinese steel industry has continued to decline, while the share of imports in total iron ore use in China is clearly on a rising trend. The reduction of Chinese iron ore production has probably come to an end and will most likely not continue below 100 million mt.
Assuming that the ratio between the use of iron ore and scrap in the Chinese steel industry will remain unchanged in 2016-2018, iron ore use in China over the next three years will decline at the same rate as the expected decline in demand and production of steel—some 2% annually in 2016 and 2017—and will be stable in 2018. In the rest of the world, estimates are that iron ore use will grow at the same rate as steel use. The resulting world demand for iron ore would then increase from 2.015 billion mt in 2015, to 2.025 billion mt in 2016 and 2.077 billion mt in 2018.
Since at least 115 million mt of new capacity will come on stream in the period up to and including 2018, the world iron ore market will be characterized by potential or actual oversupply for a few years to come. This will result in weak prices in 2017 provided the majors do not alter their investment plans.
Anton Löf is an independent consultant in Stockholm, Sweden. Magnus Ericsson is a consulting professor at Luleå University of Technology, Sweden. The background material for this article is extracted from Iron Ore Market 2016, published by UNCTAD. For further details, contact UNCTAD at [email protected],
[email protected] or Löf at [email protected].