the music for the iron ore stocks will stop

Iron ore price train is coming to a stop

Barry FitzGerald
March 14, 2011

http://www.theage.com.au/business/iron-ore-price-train-is-coming-to-a-stop-20110313-1bsxn.html

Oversupply will see the price of the product, and the stock of the companies that mine it, decline.

IT WAS not that long ago that iron ore prices were knocking on the door of $US200 a tonne. For the good stuff anyway. But the same sort of uncertainty and risk aversion that knocked the stuffing out of base metal prices in recent weeks is also at play in the iron ore market. Prices have come back to $US170 a tonne.

Unlike most of the base metals where prices are expected to recover - and the haven status afforded to gold and silver - there is a deep longer-term concern with iron ore as the market is racing towards oversupply.

Advertisement: Story continues below Encouraged by the bumper prices - it costs Rio Tinto and BHP Billiton no more than $US40 a tonne to produce iron ore in the Pilbara - there is an almighty expansion in global iron ore capacity under way.

The world's biggest exporters of the stuff (Rio, BHP and Vale) are leading the way, knowing that when the inevitable price crunch in response to over supply does come, they will still be at the bottom of the global cost curve.

The big question is when will the crunch come? It is not that far off, raising fears for the dozens of Aussie iron ore hopefuls that are yet to get into production or which don't yet have a solution to their rail and port infrastructure shortcomings.

Goldman Sachs reckons that the iron ore market will move into over supply in 2014 and that ''prices will fall significantly at that time''.

It is forecasting modest oversupply in the traded (seaborne) market in 2013 of 48 million tonnes or 4 per cent, growing to a surplus of 147 million tonnes or 12 per cent in 2014 and some 266 million tonnes or a 20 per cent surplus in 2015.

To put that in perspective, BHP is currently producing at an annual rate of 148 million tonnes from its Pilbara operations. So come as early as 2014, an equivalent amount of iron ore - be it from the Pilbara or anywhere else - will be surplus to world demand.

There are no prizes for guessing that prices will come tumbling down at that point. Goldman Sachs estimates a price in 2013 of $US115 a tonne, falling to $US85 a tonne in 2014 and $US80 a tonne in 2015. It didn't say so, but the $US80 a tonne level is also roughly the price at which iron ore production in China and India becomes uneconomic. So even at the lower levels, Australia's greatly expanded iron ore production will find a home. It's just that the current magical profitability of the sector is not going to last.

The lesson in all this is that investors in iron ore stocks need to plan ahead. The market can be expected to take to the share prices of iron ore stocks at least 12 months before the supply crunch hits.

On current thinking, that means that the music for the iron ore stocks will stop late 2012, early 2013.