by Peter Ker
Australian iron ore miners are set to benefit from China's latest effort to shut inefficient, outdated and even illegal steel mills, with Fortescue Metals Group predicting the policy could see Chinese demand for iron ore rise by 40 million tonnes per year.
China recently revealed plans to shut down its fleet of electric arc steel furnaces in a bid to allow larger, more efficient blast furnaces to grow their market share.
Analysts have suggested the strategy could be good for Australian miners, given that electric furnaces are typically fed with scrap steel and scrap metal, and their closure will allow the steel mills that are fed iron ore and coal to soak up the gap in the market.
Fortescue's director of Sales and Marketing David Liu said the policy was an "enormous bonus" for those selling iron ore to China and could increase Chinese demand for iron ore by 40 million tonnes per year.
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"Steel production is projected at similar levels, but then the eradication of electric furnace operations is an enormous bonus for the iron ore imports, because as an estimate there is anywhere between 40 million to 60 million tonnes of this illegal steel production will be out of the picture by latest mid this year," he said.
"So we will see a lot of replacement done by the integrated steel mills, which will use mostly imported ores to produce steel."
Fortescue's estimate is broadly in line with Macquarie's recent estimate that the steel reforms would create demand for an extra 30 million tonnes of seaborne iron ore each year, although J-Capital managing partner Tim Murray is less convinced, suggesting in a recent note that the majority of electric arc furnaces will continue to operate and Chinese demand for iron ore will slide by 30 million tonnes to 40 million tonnes per year.
If the steel reforms do spark extra demand for iron ore, it will come at a time when supply of iron ore from Australia and Brazil is starting to ramp up.
Brazilian miner Vale recently started exports from its S11D expansion project, BHP Billiton announced that its Western Australian railway improvements would be finished sooner than expected and exports from Australia's Port Hedland reached a record high of 43.9 million tonnes in December.
Small iron ore miners like Mt Gibson are also looking at ways to bring shuttered mines back into operation, and the collection of supply signals comes as iron ore stockpiles in China are higher than normal.
Fortescue chief executive Nev Power said the iron ore market was approximately balanced, and the could cope with the extra demand for iron ore associated with the steel sector reforms.
"They all start to add up and despite all that, S11D and Roy Hill and BHP and all those things, the price has been pretty resilient and that is a pretty good sign that the market is coping with that increase in supply that we have had and if there is no further major increases then we should see reasonable stability in the price," he said.
"We have seen domestic iron ore production in China be replaced by increasing levels of seaborne, and that is why seaborne iron ore (imports) hit a record in 2016 of about 1.02 billion tonnes."
Fortescue is on track to beat its full year iron ore guidance of between 165 million and 170 million tonnes, after produced 86 million tonnes in the first half of fiscal 2017.
Cyclone season could yet hamper the miner's stellar performance in fiscal 2017, and shipping from Port Hedland was interrupted by a cyclone for 17 hours over January 27 and 28.
The company also took its unit costs below $US13 per tonne for the first time in the December quarter, with an average "C1" cost of $US12.54 per wet metric tonne.
That cost figure is excluding royalties and other corporate costs, but means Fortescue has lowered its cost for the 12th consecutive quarter.
Mr Power said Fortescue would continue to devote most of its cash to debt repayments, but the company was keen to increase returns to shareholders and would reveal more at its half year results in February.
The company's gross gearing is now just 36 per cent, and it has no repayments due until 2019 when a $US1.97 billion senior secured credit facility falls due.
Fortescue's ore typically has lower iron content than the product produced by rival exporters Rio Tinto and BHP Billiton, and therefore sells at a discount to the benchmark iron ore price.
Fortescue told investors to expect its ore to sell at between 85 and 90 per cent of the benchmark price in fiscal 2017, but in the December quarter it sold for 91.7 per cent of the benchmark price.
That means Fortescue's average realised price for the quarter was $US64.87 per tonne; well above the $US35 per tonne that Fortescue requires to break-even according to UBS estimates.
The benchmark iron ore price was fetching $US83.34 per tonne on Tuesday and Fortescue shares closed 18¢ higher at $6.66.
FMG Price at posting:
$6.81 Sentiment: Hold Disclosure: Held
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