austock report - $1.66 price target, page-14

Iron Ore Price firm seaborne market prompts forecast upgrade

Austock have lifted our price forecast for the December 2010 to 2015 period by ~$10-15/t, with a declining trend from a present US$147/t fob for 62% Pilbara fine ore equivalent.

Our long term forecasts for iron ore start from 2016. We have lifted our nominal price forecast by 17.5% from US$57/t to US$67/t, fob for standard Pilbara Fine product (62%Fe). We believe that though there is a range of opinions in the market the price profile is close to consensus.

Price Forecast over the next 3 years up ~US$15/t

Key reasons for the near term price increase reflects the continuance of a tight seaborne iron ore market::

Seaborne supply of iron ore in 2011 is unlikely to keep pace with the growth in demand for iron ore. Supply from Brazil, Australia and Africa are unlikely to meet the 160mt to 185mt of additional iron ore import demand over this and next year. If the shortfall is greater than our modest expectations, then we believe there is upside in our 2011-12 forecasts.

The tight market has been assisted by a fall in Indian iron ore exports in 2010, due largely to Indian Government export restrictions. We think these could extend into 2011, cutting seaborne supply by ~40- 50mt pa.

Though recovering in 2010, Chinese domestic production of iron ore is unlikely to exceed previous high production levels reached in 2007. Resource depletion, falling grades and increasing costs will mean that total iron content of domestic ores will likely trend down for the rest of the decade.

Expansion of supply has undershot industry expectations of growth in the past. Recently projects have been slowed due to delays in environmental approvals, need for more complex infrastructure expansions and the impact of the GFC and the MRRT slowing progress of project development. We expect shortages of key skills and inputs will play a part in delaying mine/port expansions in 2011-12 period.
Operating costs have already started to rise and will likely continue their ascent.

From 2012 onwards, we do expect iron ore prices to retreat, though remain at historically high levels. This is due to a gathering iron ore supply response from majors such as Rio Tinto and emerging producers including Fortescue and the Mid-West producers. In addition we could see some slowdown in Chinas steel demand growth.

Longer Term Price forecast raised 17.5% to US$67/t
Longer term we expect capital and operating costs to boost iron ore clearing prices:

Chinese import dependency will continue to rise, while India will likely cease to be a material exporter of iron ore. This necessitates both brown and green-field expansion of iron ore mines. Spare capacity and easy mine/infrastructure expansions are a memory so expansions are generally at higher capital and operating costs.

Although premier producers, like Rio Tinto, are able to bring on capacity at ~US$130-135/annual tonne, these competitive ore sources will be insufficient to supply the 60-80mtpa increase required annually until the middle part of this decade. Smaller scale and magnetite projects costs are circa twice the capital cost.

Operating costs are also rising, with oil prices of US$80/bbl or more likely to persist, in addition to sourcing ore further afield from deposits with less favourable geologic conditions or lower grade.

Price impact

We expect that despite the increase in seaborne traded iron ore, China as the largest iron ore market will still require ~100 to 225mtpa of home production to satisfy its needs. The Chinese cash cost curve is steep with volumes above ~100mtpa quickly rising from US$75/t to US$110/t.

Our long term US$67/t iron ore price in this context remains both achievable and potentially conservative. The analysis may also prove conservative as developing nations such as China, India and Brazil have yet to reach satiation of demand as their incomes rise.