08/03/2017 - 13:49

Pressure to build on iron ore

08/03/2017 - 13:49

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OPINION: Whoever wins Saturday’s election must know that state debt is too high.


Pressure to build on iron ore
Upbeat expectations on iron ore seem set to disappear.

OPINION: Whoever wins Saturday’s election must know that state debt is too high.

However, what the next premier might not realise is that hope for a boost to royalty income from the recent surge in iron ore prices could fade as quickly as it arrived, ensuring that the financial cupboard remains bare.

Few investment analysts believe that a price of more than $US90 a tonne for Western Australia’s most important export, and major contributor to the state government’s budget, can be sustained with the price expected to fall later this year.

But none has gone as far as the research team at HSBC, a bank with deep Asian connections, which date back to its roots as Hongkong and Shanghai Banking Corporation.

In a report published late last week, which has significant implications for WA, the bank’s analysts reckon that the iron ore price will collapse to $US50 a tonne within a few months.

If correct, that 44 per cent price fall will take the iron ore price back to the state Treasury forecast in last year’s budget, $US47.70/t, and the windfall royalty win from the unexpected price increase will evaporate, leaving income from that source at around $3.5 billion, the lowest in seven years.

Not everyone agrees with HSBC. Investment bank UBS agrees with the argument that the iron price is likely to fall, but believes the drop will be limited to about $US80/t in the first half of 2017, before slipping to around $US60/t by the December quarter.

Multiple pressures are bearing down on iron ore, including an increase in supply chasing the current high price, full stockpiles in Chinese ports, and plans for mothballed mines to be re-opened in China, India, and elsewhere.

China Hanking Holdings, one of the Chinese miners to shut three mines last year, has unveiled a plan to re-open at least one of the closed mines. Mines in India, also closed when the price collapsed, are being readied for re-opening.

“Iron ore prices are set for a massive fall in the second half of 2017 as re-stocking demand wanes and the market-supply response accelerates,” HSBC said in its report which was headlined ‘When the music stops’.

“Despite an improved outlook for Chinese steel production, we forecast a growing iron ore surplus to 2019.”

The flip from a shortfall of supply to a surplus is bad news for any commodity, but it is particularly bad for a bulk commodity such as iron ore, because of the problem in stockpiling a material that requires a lot of space – unlike metals such as nickel or copper.

“While demand (for iron ore) remains largely stable, supply will increase considerably from here in the second half of 2017,” HSBC said.

“Seasonally stronger supply, mainly from Australia, Brazil and China, is likely to result in 39 million tonnes of additional supply in the second quarter, and another 26m/t in the second half of the year.”

The overall impact of the extra supply is tipped to alter the market from a 10m/t deficit in the first quarter of the year, a gap that goes a long way to explaining the current price of more than $US90/t, to a surplus of 30m/t in the June quarter.

UBS echoes much of what HSBC said but was not so gloomy in its price forecasts.

“Iron ore prices continue to surprise,” UBS said. “But fundamentals are not so tight. Chinese port stocks are at an all-time high, and imports in January were the second highest on record thanks to minimal Australian and Brazilian wet season disruption to date.

A number of factors have propelled the iron ore price above $US90/t, according to UBS. They include strong Chinese steel output, and a preference for high-grade iron ore (from Australia and Brazil) thanks to greater pollution controls and high coking coal prices.

The UBS view of the iron ore market is that the high prices cannot last because it risks large-scale supply increase and new project go-aheads.

HSBC predicts a price reverse to around $US50/t within a few months, just as a newly elected WA government takes office and considers the challenge of reducing state debt.

The fall, when it comes, could be quite sudden, the bank believes.

“The longer it takes for the price to correct, the harder it will likely fall,” HSBC said.

The bank’s major concern is that a price as high as $US90/t is enticing mine owners to re-start production at mothballed projects and for that re-started supply to become ‘sticky’ with operators reluctant to go through another closure process.

“Should incremental supply growth persist, prices may need to fall below the marginal cost of production for an extended period to drive the necessary closures and rebalance the market”, the bank said.

In other words if the forecast fall in the iron ore price is delayed, it could mean lower prices for longer.

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