Bulk Buys: The discount for low grade iron ore is growing; how long before it is baked in?
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Economic cycles that see low grade iron ore producers compete on price with high grade miners could become a thing of the past as China gets serious on emissions reductions, an iron ore pricing expert says.
Spreads have been rising between high, mid and low grade iron ore fines in the past six months in volatile market conditions, with discounts nearing the levels seen in 2017 and 2018.
While the gulf between prices paid for 58% iron ore fines and 62% benchmark iron ore was as narrow as 11% in late 2020, the differential has blown out to around 40% by the start of this year, according to data from Fastmarkets MB.
On Friday, 62% iron ore was fetching US$128.03/t, with 58% fines going for US$77.21. At US$154/t, 65% iron ore fines were trading at a 17% premium.
Fastmarkets senior price development manager Peter Hannah said traditionally price differentials had ebbed and flowed with mill profitability and coking coal prices.
But he said a structural trend away from low-grade ores was developing.
“Those grade differentials do always tend to be somewhat cyclical. But even so, I’m not convinced that we’re going to see conditions again that really favour low grade prices like we have in the past,” he told Stockhead.
“With China now taking much more of a long term, stricter stance on the environment, and also with a willingness to impose production curbs on mills, rather than seeing margins get crushed, like they have in the past.
“So low grades do very well when mill margins are really low, there’s overcapacity in the system and there’s weak environmental restrictions. And that combination of factors I’m not convinced is going to be seen to the extent in the future as it has in the past.”
The 58-62% differential — which peaked briefly in both 2017 and 2018 at 46% — is near all-time records, with short term factors also at play.
“You’ve got healthy mill profit margins, high coke prices, and seasonal anti-pollution restrictions,” Hannah said. “So mills right now have got both a profit incentive, as well as cost and compliance concerns that are motivating them to moderate their consumption of low grade ores.”
The acceptance of lower ore grades and rapid expansion over the last two decades of China’s steel industry has supported the rise of Australia’s baby major iron ore sector.
FMG, MinRes and Gina Rinehart’s Roy Hill have all filled this niche, while BHP (ASX:BHP) and Rio Tinto (ASX:RIO), while they have attempted to move from fines to higher grade premium products like lump, have seen overall grade declines.
It has posed a serious question for the Australian iron ore producers, especially with the expectation that green steelmaking technologies in the future will favour higher grade ores and concentrates we do not produce in abundance.
For now, Hannah said current prices were seeing low grade ores receive support as a blending product with premium 65% ores.
“These grade differentials mirror each other, and they kind of support each other,” he said. “So mills are always looking at the economic pros and cons of using, say, a mid grade 62% product versus a blend of 65 and 58.
“And you can track that and see if you just use the indices and make a proxy blend of 65 and 58 and compare that to the price of 62, the value in blending high grade and low grade in recent weeks has been higher than it’s ever been historically.
“So I think that some of the price action in the 65, as in the premium ticking up quite sharply in recent days, has been because those low grade discounts have facilitated taking much sharper bids on high grade cargoes and looking to blend those.”
Still, he said established low grade iron ore producers like Fortescue were taking more steps to diversify into high grade products.
“Miners who are in the low grade segment will be looking to optimise their grade profile where they can; obviously Fortescue has invested in Iron Bridge and that will bring some more high grade exposure,” Hannah said.
“All the three you mentioned (FMG, MinRes and Roy Hill) have made efforts to optimise their fines, even low grades, to try and ensure that the grade is as pure as it can be from the ore body they’re working with.
“But it’s worth saying that even if … this structural trend continues and low grade continues to be discounted, these miners will still be thinking about their absolute margin.
“So what does it cost to mine the product and what does it cost to sell and if their production costs are cheap enough, even if the discounts are wide and the low grade prices are not very strong, then they could still probably make pretty good margins.”
For FMG that is around the $14-15/t mark, meaning even at discounts it is making good money. MinRes, which had to reduce low margin production from its Koolyanobbing operations late last year, is under more threat.
But by trimming costs with economies of scale it still sees the opportunity to bring bulk lower grade projects online at a profit, like by developing the 30Mtpa Ashburton hub, which would more than double the mid-tier’s production profile.
Brazil’s mineral rich Minas Gerais province has been struck with torrential rains that have caused Vale to halt production in its southern hub.
Its northern mining hub is still operating and the company says it will not see any impact to its production guidance of 320-335Mt in 2022 because it has planned for the tropical wet season.
“Vale informs that it has partially halted trains service on the Estrada de Ferro Vitória a Minas railway (EFVM) and the production in the Southeastern and Southern Systems to guarantee the safety of its employees and communities and due to the heavy rainfall level in Minas Gerais,” the company said in a statement.
“In the Southeastern System, the EFVM was halted in Rio Piracicaba – João Monlevade stretch, restraining the expedition of Brucutu and Mariana complex’s production, which production was halted. The Desembargador Drummond – Nova Era stretch was also halted, but it is in resumption stage and did not impact Itabira complex production.”
But images have painted a stark picture from the sodden state, where a rockfall in a canyon unrelated to mining operations resulted in the deaths of at least 10 tourists on Saturday, a tailings dam overflowed resulting in the suspension of Vallourec’s Pau Branco mine and iron ore carts sit idle filled with water.
Given the sensitivity around Vale’s production in recent years since the Brumadinho dam collapse in 2019, it is understandable the market would have jitters after seeing Vale suspend operations again.
Vale says it is conducting 24 hour surveillance of its tailing dams in Minas Gerais.
Supply will be closely watched this year. If the world’s two biggest iron ore exporters, Vale and Rio Tinto, again fall short of guidance in 2022, it could bring tailwinds for prices.
Futures have already risen in the day since, with Singapore February futures up 1.97% to US$127.55 and Dalian iron ore up almost 3% yesterday, just one day after a rise in Omicron Covid in cases sent prices lower.
Hannah said the news will send jitters through the market, even though heavy rains are common at this time of the year in Brazil.
“That can impact output but Vale have reiterated that their production guidance for now remains unchanged,” he said. “The rain’s always heavy there but this is, I think, a La Nina year, which means that the weather patterns are a little bit more extreme.
“So that could be a risk factor. And I think just seeing those images, the market may be a little bit nervous over the coming days.
“The wildcard factors at the moment are whether issues on the production side could tighten the market. But also you’ve got another wildcard factor on the consumption side, which is the COVID situation in China with the cases in Tianjin now and it will be interesting to see how those two factors balance out against each other.”
Chinese steel production fell off a cliff in the second half of 2021, hitting levels not seen in four years as authorities ordered mills to curb output.
The main reasons were bids to reduce emissions as China placed greater emphasis on environmental targets over economic growth, the desire to keep skies clear ahead of the Winter Olympics in Beijing next month and efforts to control runaway commodity prices.
That saw near record portside iron ore stocks build up over the second half of the year, with a 205,500t decline reported last week by MySteel the first in several months. Blast furnace utilisation rates are also on the up as restrictions in some steel hubs ease.
Iron ore had hit a record US$237/t in May last year as steel output threatened an annual rate of 1.2Bt. While official figures are yet to be released, China Iron and Steel Association estimates show China turned out ~1.3Bt in 2021, only 35Mt less than the record level in 2022.
MySteel expects crude steel demand to fall 1.2% in 2022 to 970Mt, with manufacturing and infrastructure expected to alleviate a drop in demand from the property sector.
Hannah said if Chinese steel production is more evenly spread in 2022 it would support iron ore demand.
“If the goal is to keep 2022 at the same overall output level of 2021 and maybe 2020, around a billion tonnes, then as long as that is spread a little bit more evenly over the year, and we don’t see the big seesaw like we did in 2021, that should actually provide some upside from here,” he said.
“The maths of it supports the notion that you might see a little bit more of a recovery, but then there’s a more structural expectation of some recovery.
“So a lot of the recent price action that we’re seeing, I think is expectations that policy might shift in China post Chinese New Year and post Winter Olympics to favour a little bit more the growth and stimulus side of things.”
Hannah said there is hope and expectation in the market, but also uncertainty about China’s policy stance after the Winter Olympics.
“The truth is, it’s uncertain, no one actually knows for sure. So if that turns out not to be the case, and things stay as they are, more in this kind of restrictive pattern, then I think some hopes are going to be dashed.”
With iron ore prices on the up, the first week of trade on the ASX has been a good one for the sector.
Of the 41 companies on Stockhead’s watchlist, just 11 ended the week in the red.
At the big end of town, Fortescue Metals Group returned above $20 a share for the first time since September, up 10%.
BHP (+8%), MinRes (+8%), Rio (+6%), and Champion Iron (ASX:CIA) (+10%) saw the good times roll.
High grade iron ore companies were also heavily favoured, with Magnetite Mines (ASX:MGT) up 41% for the week to lead the list.
Up 13% was Akora Resources (ASX:AKO) which had some news to report from drilling at its Bekisopa project in Madagascar yesterday.
Akora said it had produced a 70.2% average iron concentrate grade from Davis Tube Tests on core from drill hole BEKD04 from surface to 38.1m downhole.
It also delivered a 66.1% average fines grade from magnetic separation process trials on composites from the same intersection.
“Bekisopa Central Zone assay and processing trial results indicate the presence of a significant iron formation that should translate into a noteworthy iron resource that has been demonstrated to be capable of producing various high-grade iron ore products,” the company said.
Coal miners have also been buoyant so far this year as a coal export ban introduced by the Indonesian government on New Year’s Day has tightened the seaborne thermal coal market.
There were signs Monday night of the ban easing, with 14 bulk vessels sitting in port given the right to leave once signed off on by mining authorities.
Consuming nations like the Philippines and Japan had issued calls for Indonesia to reverse the ban, designed to avoid a critical shortage on its domestic market, as futures threatened to break the US$200/t mark.
Australian prices for the commodity almost hit US$270/t last year as tight supply sent the market haywire.
In the metallurgical coal market Australian coal continues to be competitive with prices paid for coal in China despite its ongoing blockade from the Chinese market amid trade tensions between the two nations.
Premium hard coking coal FOB Dalrymple Bay Coal Terminal was up US$6.91/t on Monday to US$378.62/t with hard coking coal up US$7.50 to US$330.15/t.
Chinese prices, which were double Aussie rates at one point last year, were trading similarly up US$10.07 to US$370.04/t for premium hard coking coal CFR Jingtang, with HCC up US$9.09 to US$337.44/t.
Stanmore Coal (ASX:SMR) is up 13% over the past week after announcing Friday it had completed its US$625 million debt funding deal to part finance its US$1.2 billion purchase of BHP’s BMC coal mines in Queensland.