The sharp fall in iron ore prices has mainly been a demand-side story, after policymakers in China announced plans to curb 2021 steel production in line with 2020 levels.

The revised targets implied a sharp decline (~12% annualised) in the second half of the year, given robust production levels in H1.

New research from UBS and CBA indicates that production eased back in July. However, the analysts said sharper production cuts are more likely to happen later in the year.

Iron ore prices — a ‘wait and see’ approach

Iron ore prices were steady overnight, with benchmark 62% fines closing 2.8% higher at US$166.40/tonne.

Early indications show that production levels have slowed to start H2. But like many things China-related, there are often a few layers to unfold when assessing policy communications.

In their assessment of the sharp fall in iron ore prices, UBS noted that daily pig iron production fell by 6% in July relative to June.

Major steel producers including Baowu have also signalled an intention to curb production.

“This has resulted in mills de-stocking and iron ore prices falling sharply in a thin spot market,” UBS said.

Looking ahead though, the picture is more complex. While the government has indicated a preference to curb leverage in Chinese property, it’s also maintained support for the country’s infrastructure push.

The net result of that is steel prices have continued rising, even though iron ore prices are falling, UBS said.

In addition, policymakers have also taken a dim view to what they call ‘campaign-style carbon reductions’.

In other words, a top-down approach to reduce emissions in an “orderly” fashion, rather than the individual carbon reduction efforts of local governments.

“This is however expected to mainly target China’s thermal coal, not steel, industry,” UBS said.

Ultimately, UBS expects the focus on curtailing China’s steel production to be more of a Q4 story.

That’s when seasonal demand slows heading into winter, and air pollution comes into focus — “especially ahead of the Winter Olympics in February 2022”, UBS said.

The UBS view was shared broadly by CBA analyst Vivek Dhar, who said this morning that China’s steel production efforts have been “tame so far”, relative to its stated H2 production cuts.

“China Iron and Steel Association notes that most steel mills are taking a wait-and-see approach to output cuts,” Dhar said.

In that context, “mills may potentially keep output steady in Q3 before reducing output in Q4”.

While the demand-side shock has driven most of the recent price action, UBS shares the view of Morgan Stanley that oncoming supply — which increases more gradually — will continue to put downward pressure on prices.

The bank currently forecasts that iron ore prices for benchmark 62% fines will fall back below US$100/tonne by the end of next year.