China, the world’s largest buyer of iron ore, will continue to drive and dominate the market for the foreseeable future, even as its economic growth rate shows signs of mild deceleration

By Magnus Ericsson, Anton Löf and Olle Östensson

With the world economy and industrial production recovering slowly, mainly in emerging countries but also in parts of the OECD (Organization for Economic Cooperation and Development) membership, world crude steel production rose from 1,430 million mt in 2010 to 1,527 million mt in 2011, an increase of 6.8%. World crude steel production in 2011 was well above the peak reached in 2007.

China again accounted for most of the increase in production, although both Europe and North America showed some growth. Crude steel production in China increased by 8.9%— from 639 million mt to 696 million mt, a lower growth rate than the 10.7% achieved in 2010. In Europe, production rose by 3.9% but was still below that of 2008. Africa experienced a severe decrease of 20%, mainly related to power shortages in South Africa. In the Americas, production grew by 7.5%—still less than the level reached in 2008, before the financial crisis.

Monthly world crude steel production regained its pre-crisis peak by May 2010. This was, however, almost entirely due to China, where production started rising again in November 2008 and previous peaks in monthly production were regained by April 2009. The rest of the world had still not reached pre-crisis production rates in April 2012. Growth rates in most of the OECD area are likely to be modest over the next few years.

Ore Production Up Globally
In 2011, the world iron ore market continued to grow after the recovery from the recession in 2009 and an all-time high was reached at 1,922.5 million mt, some 4.7% higher than in 2010, with production of 1,836.1 million mt (See Table 1).

Table 1—Global Iron Ore Production (million mt)
Country/Region 2009 2010 2011
Sweden 017.7 025.3 026.1
Sub-total, Europe excl. CIS 023.0 031.8 033.2
CIS 177.1 204.4 203.5
Sub-total, Europe 200.1 236.2 236.7
Canada 033.0 037.5 037.1
USA 026.7 049.5 053.6
Brazil 305.0 372.0 391.0
Venezuela 014.9 014.0 016.0
Sub-total, Americas 407.3 506.1 534.2
Mauritania 011.4 011.3 011.4
South Africa 055.4 055.0 052.9
Sub-total, Africa 070.1 069.3 068.9
India 218.6 212.0 196.0
Sub-total, Asia excl. China 271.2 273.9 270.6
China1 222.7 315.4 321.9
Sub-total, Asia 493.9 589.3 592.5
Australia 394.1 432.8 487.9
Sub-total, Oceania 396.2 435.2 490.2
Total, World 1,567.5 1,836.1 1,922.5
1 Iron ore production tonnage figures have been converted to an iron-ore content level roughly equal to rest-of-world average:
Ore production, China (unconverted): 880.2 1,064.7 1,327.0
Source: UNCTAD 2012

Output increased in most regions and countries except in Europe, where the market was stagnant, including the CIS countries. Oceania experienced the highest growth rates, approaching 12.6%. Among the major producers Australian, Brazilian and Chinese production increased by 12.7%, 5.1% and 2.1% respectively. Indian production decreased somewhat to an estimated 196 million mt, down 7.5%. Production in the CIS countries fell slightly by 0.5%.

Chinese production, on a comparable grade basis, was 321.9 million mt, or 16.7% of total world production in 2011, down from 17.3% in 2010 and far below the peak of 20% in 2007. We make our estimates based on a careful analysis of pig iron production in China and iron ore import statistics. We consider these figures to be more reliable than the Chinese gross figures for iron ore production without consideration of grade or iron content of the ore produced.

In more general terms, for the long run Australia and Brazil will be the dominant forces in iron ore production. India, which has large and good-quality resources of iron ore, will be hampered by red tape and an ongoing internal struggle. Over time, as the Indian steel industry grows, most of its iron ore will be used domestically. We also foresee a slow decline in Chinese output.

World pellet production rose by 3.5% in 2011, from 402 million mt in 2010 to 416 million mt, reaching a new record. This reflects a continued increase in demand for pellets in many countries, although the weakness of the steel market has led to reduced growth in pellet demand relative to total iron ore demand. It deserves to be noted that production of pellets in China increased by more than total iron ore production, reflecting the beginning of a shift toward increased use.

Iron Ore Trade Stagnant, Except for China
International iron ore trade reached a new record in 2011 as exports increased for the tenth year in a row to 1,155.0 million mt, up 7.9%. The increase was largely the result of higher demand from China, while most other countries in the world had trade levels similar to the previous year and have not reached their import levels of 2008.

Australia’s exports increased by 8.9% to 438.8 million mt in 2011 compared with 2010. With important markets in Europe and the Americas picking up pace, Brazilian exports, which fell sharply in 2009, had definitely turned around in 2011 with an increase of 12.1% compared with 2010, to 348.6 million mt up from 310.9 million mt. Exports from India fell for the second consecutive year after 2010 marked the first time in 12 years that the country had experienced decreased exports; but at 78.8 million mt, down 17.8% from 95.9 million mt, India is still the third most important exporter. Ukraine, Kazakhstan and Russian Federation increased their exports.

China remains the world’s largest iron ore importer. In 2011, its imports were 686.7 million mt, an increase of 11% compared with 2010. In 2010, China accounted for almost 59.1% of global imports; in 2011, this figure had increased to 60.1%.

In Japan, imports fell by 4.4% to 128.4 million mt. In the Republic of Korea, imports increased by 15.3% to 64.9 million mt. European imports (excluding the CIS countries), increased by 16.8%, reaching 156.4—up from 133.9 million mt in 2010, corresponding to just above 13.7% of world imports.

In 2011, the seaborne iron ore trade increased by 7.2%, to 1,060 million mt. The increase was almost entirely due to higher Chinese imports, with trade in other parts of the world stagnating.

Prices Keep Rising
Iron ore prices continued on an upward trend through most of 2011, as Chinese demand recovered and domestic Chinese iron ore producers were unable to keep up with the demand. Toward the end of the year, however, prices declined in response to a slowdown in Chinese growth and a worsening outlook for European countries. During the first half of 2012, prices remained more or less constant at a level which, although high from a historical point of view, only allows high-cost producers, mainly in China, to break even.

With almost all iron ore producers and steel mills having abandoned the benchmark pricing system, there is widespread confusion about prices. Practices for price setting vary widely and there is a large number of published prices and indices, each with a different product specification.

Vale and Rio Tinto apply quarterly determined prices to most of their sales, with the price being set on the basis of spot prices during the preceding months. There have, however, been deviations from this practice, particularly in instances when spot prices have fallen rapidly, as in late 2011, and buyers have insisted that the new lower prices be applied. BHP Billiton is believed to sell a large share of its production on a spot basis.

As for published prices, there are three competing price indices: Metal Bulletin, Platts and The Steel Index (TSI). The indices sometimes differ by a few dollars per ton, but the differences tend to disappear when prices are averaged over a longer period, which means the variations appear to be the product of random movements and do not reflect fundamental differences in methodology. For individual actors on the market, however, the differences between the indices are a source of uncertainty.

Other prices are published on an informal basis. China Metallurgical Newsletter publishes prices of high grade (66%) concentrate and imported, mainly Indian, fines of slightly lower grade (62%). While all of the prices mentioned so far are quoted on a Chinese basis, either at a specific point in China or CFR Chinese ports, other newsletters published by financial institutions and market analysts provide FOB prices of Australian and Brazilian exports. Publication of spot trading data from trades made on the China Beijing International Mining Exchange constitutes an effort to improve transparency in the market by providing details of individual trades.

The CME group, SGX (Singapore Exchange), London Clearing House (LCH.Clearnet), NOS Group and ICEX (Indian Commodities Exchange) all offer cleared swaps based on TSI iron ore transaction data. The CME also offers a Platts-based swap, in addition to its TSI swap clearing. The ICE (Intercontinental Exchange) also offers a Platts-based swap clearing service. The swaps market has grown quickly, with liquidity clustering around TSI’s pricing. Singapore Mercantile Exchange (SMX) has launched the world first global iron ore futures contract, based on the Metal Bulletin Iron Ore Index (MBIOI) which utilizes daily price data from a broad spectrum of industry participants and independent Chinese steel consultancy and data provider Shanghai Steelhome’s widespread contact base of steel producers and iron ore traders across China.

In spite of the rapid growth in the range of possible derivatives trades, both iron ore mining companies and steel mills have so far been relatively slow to start using the hedging facilities. Based on experiences from other markets, however, it is likely that modern price risk management instruments will in the future play an increasingly important role in the iron ore market.

On May 8, 2012, China’s first physical iron ore trading platform, China Beijing International Mining Exchange. The CBMX is backed by 26 Chinese steel mills and traders, including Baosteel, Wuhan Iron and Steel, China Minmetals and Sinosteel. A competing platform, GlobalOre, opened less than a month after CBMX, on May 30. It is backed by BHP, Vale and Rio Tinto and Chinese steelmakers, including Baoshan Iron and Steel.

When considering the future of iron ore pricing it is important to understand that most iron ore is sold on long-term contracts and that buying iron ore is not like buying other metals. One of the most important considerations for steel mills is the consistency of quality of the ore. The operator of a blast furnace wants to be absolutely confident that the iron ore to be delivered will be of the same quality as that in the last batch. This means that the system favors long term contracts from steady suppliers.

Industry Concentration Weakens
Vale remained the world’s largest iron ore producer at 323 million mt in 2011, an all-time high. Its market share fell, however, to 16.3%. In tonnage terms, the gap between Vale and number two producer Rio Tinto increased but percentage-wise it became smaller. In spite of this growth, Vale’s market share in 2011 was lower than its peak at 18.8% in 2007. Rio Tinto’s production grew by 8 million mt—but only achieved a market share of 9.6%, down from 9.9% in 2010 and 10.8% in 2009. BHP Billiton increased its production by 24 million mt to reach 173 million mt or 8.8%, up from 8.2% in 2010.

The Big 3—Vale, Rio Tinto and BHP Billiton (the last two with most of their production in Australia)—together controlled 34.7% of world production in 2011. Thus, the market share of the Big 3 decreased, albeit slightly, from 35% in 2010 and from a peak of 36.4% in 2005. The decline is the result of new production being started in many countries by smaller and mid-sized producers (See Table 2).

 

Table 2—Control of Production in the Global Iron Ore Industry, 2011
Controlling Entity Tonnage Produced Industry Share
(million mt) (Percent)
Vale (Brazil) 323.0 16.3
Rio Tinto (U.K.) 189.0 9.6
BHP Billiton (Australia) 173.0 8.8
ArcelorMittal (Luxembourg) 054.9 2.8
State of India1 52.0 2.6
Fortescue Metals Group (Australia) 47.8 2.4
Anglo American (U.K.) 44.7 2.3
Cliffs Natural Resources (United States) 41.1 2.1
Metalloinvest (Russia) 38.3 1.9
System Capital Management (Ukraine) 31.3 1.6
Total, 10 largest 995.0 50.3
Total, World 1,980.0 100.0
1 State of India includes SAIL and NMDC.
Source: Raw Materials Group Data, Iron Ore, 2012.

An alternative way to measure the control of the global iron ore industry is to monitor the share of global seaborne trade of the leading producing companies. Arguably, this method measures real market influence more accurately, since it excludes most captive production. Measured this way, the shares of the major companies are considerably higher than if they are estimated on the basis of production: Vale alone controls 24.9% of the total world market for seaborne iron ore trade and the three largest companies control 57.3%. Vale’s share has continuously declined during the past years, although the pace of this decline slowed in 2010 and 2011. Rio Tinto’s market share also declined in 2011, while BHP Billiton’s increased from 14.9% to 15.9%. The total share controlled by the Big 3 fell from 60% in 2009 to 58% in 2010 and 57.3% in 2011.

Capacity Additions Face Uncertainty
New iron ore mining capacity taken onstream since May 2011, as identified at the individual project level, reached 125 million mt. As of May 2012, the project pipeline contained 796 million mt of new production capacity scheduled to come onstream between 2012 and 2014. Of this total, around 270 million mt falls into the ‘Certain’ category, 220 million mt as ‘Probable,’ and 310 million mt as ‘Possible.’ Globally, 28% of the projects are to be found in Oceania (Australia), 15% in Latin America, 14% in Africa, 20% in Europe, 10% in North America and 12% in Asia.

In general, in any given year not all Certain-category projects will reach production and not all Probable projects will become operational within the period stated by the project owner or operator, but the delay rarely exceeds three years. Most of the Possible-category projects will not meet their original target date but many will eventually go onstream. In spite of these uncertainties, it can reasonably be assumed that around 510 million mt, with a low range of 380 million mt and a high of 600 million mt, of new capacity will come onstream in the period up to and including 2014.

In the three-year period after 2014, some 348 million mt of additional iron ore capacity is listed with a completion date. Given the present circumstances of higher uncertainty in combination with increased difficulty in obtaining funding for mining projects, we will probably see some start dates being pushed out, but because the long-term market situation looks good quite a few of these projects will probably go forward. However, the rate of new additions to the project pipeline may decrease.

Modest Growth in Production, Demand and Prices
The world economic outlook remains uncertain and appears considerably less positive than at this time last year. Compared with last year, the IMF has revised its forecasts downwards and its forecast for world economic growth in 2012 is 3.3%, and 3.9% for 2013. Developed economies show little dynamism, with developments in the Euro zone posing downward risks for the world economy as a whole. The World Steel Association’s short-term forecast for world steel use, presented in April 2012, anticipates a rise in steel use by 3.6% in 2012, followed by an increase of 4.5% in 2013. The association thus expects global steel demand to continue growing at relatively high rates from a historical perspective, albeit slower than in the years preceding the financial crisis. In particular, China’s growth is expected to slow considerably from earlier very high rates.

On the basis of the prospects for a return to stronger growth in the second half of this year, we expect world crude steel production in 2012 to be about 1,530 million mt, or about 4% higher than in 2011. Beyond 2012, we would expect steel use and production to increase at an annual rate of just below 4%.

When this report was written in mid-2012, the iron ore market was still relatively tight and although spot prices had declined in recent months they remained high from a historical perspective, supported by Chinese demand. Chinese steel production continued to grow, at a reduced pace, and its domestic production cannot meet the additional demand. Chinese iron ore production, which in the past has been characterized by its flexibility, with output expanding quickly in response to price increases, appears to be encountering constraints.

There are a large number of projects in the investment pipeline. However, supply chains are already strained, with delivery times lengthening for all types of equipment. Moreover, with new regulations requiring banks to increase their capital ratios and to avoid risks, several of the smaller projects are facing financing problems. Thus, it is quite likely that new capacity will take longer to enter production than anticipated.

We are not prepared to conclude that the iron ore market is facing imminent reversal. First, there is reason to believe that recent expansion plans are somewhat optimistic. Second, figures for capacity additions refer to what is added at the end of the year, and a part of it will not be in operation until late in the year. Third, and most important, the market will be tight due to two mechanisms placing a cushion under prices: 1) the large iron ore producers can implement their expansion plans with a great deal of flexibility; and 2) a sizable segment of the Chinese iron ore mining industry would shut down if prices were to fall dramatically below present levels.

Accordingly, we believe that while the market is certainly moving toward a balanced supply and demand situation, it will remain tight—with a strong possibility of modest price increases during the second half of 2012—and the next few years will be characterized by gradual adaptation of supply, by way of addition of new capacity, to a continuously growing demand.

We estimate that iron ore use will increase from 1,922 million mt in 2011 to about 2,000 million mt in 2011 and 2,080 million mt in 2013. Prices, while declining slowly from 2013 onward, will remain at levels that must be considered high from a historical perspective, with a floor at around $100–$120/ton delivered in China.

Magnus Ericsson is senior partner of RMG and acting CEO as well as a co-founder of the company. Anton Löf is senior iron ore analyst and head of the consulting department at RMG. Olle Östensson is an independent consultant, specializing in analysis of commodity markets and governance of the mining and metals industries.

The background material for this article was extracted from The Iron Ore Market 2011-2013, published by UNCTAD in July 2012. That study was researched and compiled by Raw Materials Group (www.rmg.se), and can be ordered from: ironore@unctad.org or by fax (contact Amelie Zethelius Mermet, fax +41-22 9170509).

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