China's bark could be worse than its bite on iron ore prices: Morgan Stanley

China’s renewed jawboning to curb iron ore prices could be short-lived if past efforts are anything to go by.

Morgan Stanley analysts say iron ore could rise to US$175/t on robust supply-demand fundamentals despite efforts to curb rising commodity prices that caused spot iron ore to fall 9% to US$136/t yesterday.

The Chinese Government got the jitters as iron ore prices soared 70% from lows of US$87/t in November to US$153/t last week.

It seems like recovering Chinese steel demand is behind the moves, with rate cuts in China leading to expectations of stronger infrastructure and property investment after last year’s second half slowdown.

China cut steel output significantly in the second half of 2021 to meet strict emissions targets, but still produced over 1Bt of steel for just the second time after 2020.

But China has blamed false market information from traders, with moves to double transaction fees on the Dalian futures exchange having a chilling effect on prices.

Recovery tends to come within a week: MS

Morgan Stanley analysts led by commodity strategist Marius van Straaten said in a note three Chinese efforts to cause a selldown in iron ore had failed in the past 1.5 years.

“The prince tended to recover within a week as long as the underlying supply-demand fundamentals remained supportive,” they said.

While China successfully reduced out of control thermal coal prices last year, it covers around 93% of domestic demand from local sources.

In iron ore at least 80% comes from overseas, mostly Australia and Brazil.

Its heavy reliance on Australian iron ore at a time when it is in a diplomatic cold war with the Morrison Government is a sense of consternation for Communist Party officials.

MS believes steel output could recover 20% from the 3.5 year lows of it hit in the fourth quarter of last year, “spurred on by the combination of easing environmental restrictions and front-loading of infrastructure stimulus.”

“We therefore expect the price also to bounce back from the current weakness in this particular instance (MSe $175/t 2Q22),” they said.

One point Chinese authorities have made is extraordinarily high port stocks of iron ore in excess of 150Mt, which is around 33Mt or 27% up on the middle of 2021 and 70% held by traders rather than mill owners and miners.

In that context, they’ve said the market is “balanced”. But MS says there could be other explanations for the rise in port stocks.

“However, we think it plausible this could have been a result of the oversupply in 4Q21, rather than large scale hoarding, and that excess inventories should get partially worked off when the seaborne market tightens in 2Q,” they said.

FMG focused on long term relationships

Chinese English language outlet the Global Times, widely regarded as a mouthpiece for the CCP, reported Tuesday that the China Iron and Steel Association had held a video conference with Rio Tinto’s VP of iron ore sale and marketing Simon Farry to discuss its concerns on prices.

FMG CEO Elizabeth Gaines told media after releasing its half-year results the company, which will ship 180-185Mt of iron ore from the Pilbara this year and has a trading enterprise in China, is yet to be approached by authorities.

She said “supply and demand dynamics drive the price.”

“We’re staying very focused on on the things we can control, which is obviously delivering to our customers,” she said.

“And we’ve clearly demonstrated that we’ve increased shipments to our customers.

“So we’ve increased shipments … in line with our long term contracts, and we stay focused on those long term relationships with our customers.”

FMG has seen increasing discounts for its lower grade iron ore products in recent months, seeing its profit fall 32% to a still healthy US$2.8 billion in the first half of FY22.

It will pay a 0.86c per share dividend, equivalent to around 70% of NPAT, expectedly lower than the $1.47 paid last year with spending on its green energy business FFI up and iron ore price realisation down 16% from US$114/t to US$95/t from H1 2021 to H1 2022.

Gaines noted FMG was still making a substantial margin on its iron ore in excess of US$50/t in the latter part of 2021 given its low C1 cost base of US$15.28/t.