19/07/2013 - 13:54

Last hurrah for the iron ore boom?

19/07/2013 - 13:54


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Strong June quarter production data have confirmed iron ore as the one bright spot in Western Australia's troubled mining sector, though for how much longer is the critical question for the industry and government.

Taken in isolation, the three months to June 30 were a time of near-boom conditions for iron ore miners, big and small.

Rio Tinto and BHP Billiton surprised investors with higher rates of production and the promise of more to come as expansion projects continue to ramp up output.

Profits, which are yet to be reported, should also surprise on the upside as the increased tonnages were sold into a strong market, boosted by the twin effects of a lower Australian dollar and widespread cost-cutting programs, which have resulted in thousands of workers losing their jobs.

Last week's reports, which included Rio Tinto hitting a quarterly production record 51.8 million tonnes of iron ore and BHP Billiton producing a record 47.7mt, were not what was expected after last year's price-crash panic.

Little more than 12 months ago the iron ore industry was in crisis thanks to a sharp fall in the price.

Fortescue Metals Group, the third biggest producer, suffered a near-death experience and was forced to make emergency funding arrangements, which sent shock waves through the sector.

Over just 19 grim trading days between August 10 and September 6 last year, FMG's share price fell by 38 per cent from $4.55 to a 12-month low of $2.81.

The cause of the fall, which also knocked the stuffing out of other producers such as Atlas Iron (down 40 per cent from $1.90 to $1.14) and Mt Gibson (down 30 per cent from $1.02 to 71.5 cents), was the disappearance of Chinese iron ore buyers.

What happened was a repeat of the 2008 experience when the steel mills of China, perhaps acting under government orders, walked away from the market to solve a problem of overfull stockpiles.

It might have been good business practice by the steel mills but it was a painful experience for Australian iron ore miners and a reminder about who holds the whip hand in all buyer-seller relationships.

The reason for looking back at the 2008 and 2012 crashes is to see the pattern of how a sharp price correction always follows an oversupplied market.

It's a little too early to say that history is about to be repeated, but when you've been twice bitten it would be wise to assume that a third bite is possible, given the poor outlook for steel demand.

If there is to be a third downward leg in the iron ore business it should start to appear soon, because August is the time when China's steel mills take a hard look at the iron ore requirements for the 12 months ahead.

What the mills will be testing is a combination of steel demand and raw material supply; and what they saw last week was an iron ore industry that's starting to deliver the extra tonnes from multiple expansion projects just as steel requirements slow.

Investment bankers who follow the iron and steel sector are divided as to whether a 2008 or 2012 price event will occur this year, though it is interesting to consider a forecast from one bank, UBS, that there will be an over-supply of 155mt of iron ore over the next 12 months.

If correct, several events will be triggered, including:

• a price correction, with the current iron ore price of $US126 a tonne falling back towards $US100/t;
• high-cost producers coming under bank and investor pressure to make deeper cost cuts;
• low-cost producers exerting more pressure on their high cost rivals by 'sweating' their assets to achieve productivity gains; and
• major miners pushing ahead with expansion projects to snatch a bigger market share, leaving less room for small producers while also making life tough for possible new entrants such as Gina Rinehart and her Roy Hill project.

In many ways, the future for iron ore in WA will feel like a trip back in time.

The industry will revert to a point where only the biggest producers with their economies of scale can win, thanks to their advantages of efficient infrastructure backed this time around by new technologies – driverless trucks and trains – that further reduce costs.

It's a sobering outlook, with the next six to 12 months possibly shaping as the last hurrah for the iron ore boom

On the wagon
'Sobering' is not the usual way one would describe the likely outcome of an event normally associated with hard drinking – the annual Diggers & Dealers forum in Kalgoorlie.

This year, however, low commodity prices, low share prices, and a capital drought mean that fear will be the mood-setter this year; replacing greed, which has been the driving force at most earlier forums.

There's not much the organisers can do about the interplay of fear and greed, but they might have put more thought into the compilation of their speakers list, with the two sickest metals – gold and nickel –dominating time at the rostrum.

One estimate of the 44 speakers scheduled to make an appearance over the forum's three days is that 60 per cent are from companies specialising in gold or nickel, commodities that might be important in Kalgoorlie but not in many other places.

No golden glow
There's not much anyone in Kalgoorlie can do about the gold price, and even less about the huge losses being incurred by gold mining companies that are facing the double whammy of reduced earnings and big asset value write-downs.

Newcrest Mining's $6 billion loss reported last month was an early warning of what's happening.

AngloGold Ashanti then chimed in last week with its own $2.8 billion in write-downs, and Barrick Gold is tipped to take a $5 billion impairment charge on one mine alone – the Pascua-Lama project on the border between Chile and Argentina.

There will be much more to come as auditors demand fresh market-linked valuations on gold assets, which are obviously worth much less today than a year ago.


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