(MORE TO FOLLOW) Dow Jones Newswires January 30, 2012 20:30 ET...

(MORE TO FOLLOW) Dow Jones Newswires
January 30, 2012 20:30 ET (01:30 GMT)
PRESS RELEASE: Fitch Street InterView: Australian Iron Ore Bullish Despite China Slowing


The following is a press release from Fitch Ratings:

Fitch Ratings-Seoul/Sydney/Hong Kong-30 January 2012: Matt Jamieson spoke with Peter
Archbold and Vicky Melbourne, Fitch's commodity analysts based in London and Sydney
respectively, about the slowdown in China and the potential negative impact this could
have on Australia's major iron ore exporters - BHP Billiton Limited/Plc (BHPB;
'A+'/Stable), Rio Tinto Limited/Plc (RT; 'A-'/Stable) and Fortescue
Metals Group Limited (Fortescue; 'BB+'/Stable). Matt is Head of APAC Research
in Fitch's Corporate Ratings Group.
Despite the slowdown in Chinese steel production in the final quarter of 2011, the
Australian resource giants are aggressively expanding their iron ore production capacity
based on their view that growth in China will remain strong over the long term. Peter and
Vicky point out that as the Australian iron ore companies are high-grade and low-cost
producers, then even in a scenario where Chinese demand growth stalls and iron ore prices
fall significantly the extent of the negative impact on their operating profiles should
be limited compared to other iron ore producers.
Matt: With China representing more than 60% of Australia's iron ore exports,
clearly the viability of capacity expansion is heavily dependent on China continuing to
grow strongly. However, in light of Fitch's expectation for Chinese economic growth
to slow in 2012 and the current downturn in the Chinese property market, including
government policies on residential real estate, isn't there a concern that the
Australian resource companies are increasing their capacity at the wrong time?
Peter: While China's economy looks set to slow from the 9-10% level achieved over
the past 3 years, Fitch still expects it to grow in the 8-9% range over the next 2-3
years. Importantly the size of China's economy is now around 40% greater than it
was in 2008. With this in mind Fitch expects that Chinese steel consumption will
continue to grow in an absolute sense in 2012, supported by government programs to expand
infrastructure and social housing construction. Nevertheless, in view of the
government's current tight policy on the property sector, the annual growth rate for
commodity demand is likely to moderate down from the double digit growth experienced over
the past few years.
Matt: But how can we explain BHPB's, RT's and Fortescue's plans to
increase iron ore production by 19%, 44% and 300% respectively, in the context of a
slowdown in Chinese steel production? Production figures issued by the China Iron &
Steel Association (CISA) show Chinese monthly steel production slowed to 51.3 mt in
December 2011 (minus 3% yoy) compared to around 60.0 mt per month over the March to
August period. CISA are only expecting 4% growth in steel production in 2012, compared
to 10% in 2011. So wouldn't this suggest that China has put the brakes on steel
production, and hence its iron ore requirement for 2012 could fall well short of what the
Australian resource companies are hoping for?
Peter: Well the reality is that BHPB and RT did not experience any slowdown in iron ore
orders to China, despite the slowdown in Chinese steel production in 2H 2011. Using
Australia's Port Hedland as an example, where BHP is the biggest user, a record 60.9
mt of iron ore was shipped in 4Q 2011. Moreover, in the month of December alone, the
port's iron ore shipments climbed 23% yoy to 21.4 mt.
Importantly the Australian resource giants' expansion plans are not formulated on
likely demand over the next 2-3 years, but rather a view that growth in Asian emerging
markets will continue to grow over the long term, led by China. Also margins available
on iron ore, even after taking account of expected price falls, would be higher than most
other commodities in their portfolios (exceptions would be petroleum, copper and possibly
bauxite). Therefore, when the companies are comparing project returns internally, iron
ore expansion is an easy decision to approve relative to other commodities including
aluminum, lead or zinc.
Vicky: Specifically in the case of Fortescue, we view their expansion plans as
relatively secure given that the company has signed offtake agreements of up to 120mt or
80% of its expanded tonnage.
I think it's also worth noting that iron ore imports from India are declining.
India exports about 50% of its total iron ore production (about 96mt in 2010) with 95% of
that going to China. However in July 2010, bans on iron ore production by the Indian
state of Karnataka, which accounted for about 25% of India's total iron ore
production, were enacted while officials investigated illegal mining activity. While the
ban was subsequently lifted in some regions, losses in production led to a reduction in
India's iron ore exports. According to China's General Administration of
Customs, imports of Indian iron ore in 2011 fell 24% yoy to 73.3 mt. In addition to the
environmental related mining bans, increased export tariffs and pressure from
India's steel mills to retain their iron ore for future domestic needs strongly
suggest that India's trade with China will further decline in 2012.
Matt: What about the risk posed by the Chinese government's 12th Five-Year Plan
(2011 to 2015), where it firstly intends to boost reliance on domestic iron ore supply,
and secondly aims for 40% of China's imported iron ore to be sourced from mines
owned or invested by Chinese firms by the end of 2015?
Peter: We expect this will be a gradual transition process that is unlikely to
negatively impact BHPB, RT and Fortescue in a significant manner. Chinese domestic iron
ore production is typically low-grade and accordingly of higher cost to produce compared
to imported iron ore. With iron ore prices likely to soften in 2012, the viability of
domestic production will be under pressure, and hence it will not be easy for the Chinese
to increase their output of iron ore significantly. Moreover, China needs higher grade
foreign ores to blend with its local product, and this together with the close proximity
of Australia means that Chinese demand for high-grade ore from BHPB, RT and Fortescue
should remain strong.
Vicky: While we understand that China has invested in a capacity of some 150 mtpa of
iron ore deposits abroad, less than 10% of these mines are actually producing. As part
of the plan, China has invested significantly in Australian projects - Sino Iron project
being just one example. Importantly the five-year plan no doubt includes China's
intention to invest in existing producers. In this regard Hunan Valin Iron and Steel
Group became Fortescue's second largest shareholder following a placement in May
2009 and it currently has a 15% stake.
Matt: In a worse-case scenario where the Chinese economy slows significantly
(approaching a "hard-landing"), and in addition to the current slowdown in the
private housing market the Chinese government's level of infrastructure and social
housing spending slows compared to previous years, to what extent will the Australian
iron ore producers be negatively impacted?
Peter: Although there would be a negative impact on their operating and financial
profiles, we would still expect the Australian iron ore producers to fare relatively
well in such a worse-case scenario. This is because they are adding capacity at the
bottom of the iron ore cost curve, so in a weaker demand/price environment they can
continue to generate good project returns when the viability of other producers come
under question and their expansion plans will potentially be deferred.