The iron ore price is in freefall. What happens next?

Iron ore prices slid to their lowest levels since April overnight, as speculation about Chinese steel production cuts delivered a hit to the Pilbara’s big iron ore miners.

Prices fell 7.7% to US$169.30/t according to CommBank, while Fastmarkets saw them down US12.14 to US$171.55/t this morning after a 5.6% drop in Dalian futures on Thursday.

Brazilian 65% fines were fetching US$203.50, having traded for more than US$255/t a few weeks ago.

BHP (ASX:BHP) tumbled from record share price highs, losing 2.28%, while Rio Tinto (-1.69%), FMG (-1.07%), Mt Gibson Iron (-1.9%), Champion Iron (-4.17%), Mineral Resources (-1.21%) and Fenix Resources (-2,32%) all shared in the losses.

But the magnitude of the hit to iron ore demand remains uncertain and experts maintain it is too early to say where steel output and prices will sit in the wash-up.

A $50 fall in iron ore prices over the past fortnight or so has come after weeks of predictions from analysts that the overheated market, which climbed to unprecedented highs of over US$230/t for standard 62% Pilbara fines, was due for a correction.

Production cuts could be walked back: CBA

Those soaring prices came amid a post-pandemic construction boom in China, the world’s largest steelmaker and second largest economy behind the USA, where steel mills turned out 12% more in the first six months of 2021 than they did in a previously record shattering 2020.

China wants to reduce emissions and keep a lid on iron ore prices that have seen it send record export dollars Australia’s way despite a trade cold war that has seen it shun Australian coal, wine and lobster.

But a drop in steel production in the order of as much as 100Mt on an annualised basis could have deep-seated impacts on the Chinese economy and post-Covid stimulus efforts.

“On the one hand, nation wide steel production cuts to reduce emissions are gaining momentum, helping explain the recent capitulation in iron ore prices,” CBA analyst Vivek Dhar said.

“However, there is a risk that these nation wide cuts are walked back. This could come from China’s top decision making body who would likely see nation wide steel cuts as a “campaign style” carbon reduction measure.

“But that’s not the only headwind facing China’s steel output cuts. Policymakers are wary of high commodity prices translating through to higher consumer prices. That has already seen policymakers step in to curb speculation in China’s commodity markets in mid May.”

Steel production cuts starting to ‘hit home’

Fastmarkets Index Manager Peter Hannah told Stockhead today the prospect of steel production cuts, bandied about by the Chinese Government for months, was now “starting to hit home” for iron ore demand.

But he said it would be difficult to see China reach targets of cutting steel production to 2020 levels, which would require a 12 per cent year-on-year reduction in output over the second half of 2021.

“It’s difficult to see it happening quite frankly,” he said. “There’s definitely an ambition.”

“On the face of it it’s quite environmentally driven, the cut is designed to be reducing emissions, but then you’ve just recently you’ve got some mixed messages coming out of Beijing.

“That is kind of creating uncertainty in the ferrous markets, and my feeling is that uncertainty is partly strategic because they don’t need to be super clear cut about exactly what’s going to happen.

“The fear of it, the uncertainty about how much steel might (be) cut is doing the job on at least moderating iron ore prices.”

According to Hannah, the “wildcard” could be the potential spread of the coronavirus Delta strain throughout China which could reduce downstream steel demand.

China walking tightrope on economic growth

While China wants to reduce emissions its politburo also wants to contain inflation and sustain economic growth.

That means it walks a tightrope with efforts to curb crude steel output.

“I think (steel miller) Shagang came out and said some things in terms of we’re going to make some serious cuts,” Hannah said.

“There’s been a couple of other steel makers as well that have said whatever the government says we have to comply with.

“I think the number of needing to reduce steel output by 12-13% is what people are kind of looking at and the mills are saying if we’re forced to do that we’re forced to do that.”

If consumer demand for steel remains strong, China could risk price shocks in raw materials for the construction sector.

“The question is are they actually going to be forced to do that (because) it’s a big hit when all it’s going to do is tighten steel markets downstream in my view,” Hannah said.

“That has been the elephant in the room all the way through this. The price levels we’ve seen have been based on fundamentals because China has been using so much steel in its construction sector, infrastructure, downstream.”

Correction expected, but also moderation: Fastmarkets

Hannah said the Fastmarkets’ analysts have anticipated a “correction” in high iron ore prices for several months, but that the price is expected now to moderate around current levels.

“I need to issue a disclaimer that in my role including pricing I can’t share number forecasts, but I can share what our Fastmarkets research analysts are predicting,” he said.

“They had expected this correction for a number of months, but now that it’s happened, they’re actually not as bearish.”

“They anticipate that a bearish sentiment is bedding in, but the downside may be slightly moderated based on the fact the absolute crude steel output numbers are still very strong historically speaking.”

On the supply side Hannah said major producers like BHP, Rio and Vale were still disappointing on shipments.

“Also this expected or anticipated increase in supply, the iron ore cavalry hasn’t quite been as much as you’d expected,” he said.

“Most of the majors have slightly disappointed on the output numbers in the last quarter and shipments from Brazil in July I think were down year on year.”

“So everyone’s expecting this big flood of iron ore to come from Brazil. It hasn’t happened yet and actually it was down in July.”

Price moderation could be more sustainable in the long term

Fastmarkets’ analysts have a US$175/t average price target on the upcoming December quarter.

Hannah said prices at current levels were more sustainable in the long term.

In some rare cases high grade producers whose products generate a premium from steelmakers like Tasmania’s Grange Resources (ASX:GRR) were making so much money the benchmark price was their margin in the June quarter.

“Our analysts were predicting a US$175/t average in Q4 for 62% grade and a US$200/t average for 65% grade, so they were anticipating this kind of drop but to be reasonably moderate in terms of further downside from here,” Hannah said.

“I think this sort of correction is probably a relatively good thing for the iron ore market long term.”

“Above US$200/t for a commodity that is costing tens of dollars per tonne to produce and deliver was kind of giving the jitters to a lot of people in the industry.”

“You get the political finger waving we’ve seen, on the supply side the major producers are looking at each other thinking is there going to be a bit of a flood in response, thinking is someone going to take the initiative?

“Or even just the prospect of having a lot of new projects, new juniors come into the market and a lot of non-mainstream supply that is going to clear out as and when things correct.”

Hannah said more moderate steel output could avoid a “margin crush” that saw overproducing steel mills reduce their bids on iron ore during the 2015 crash.

“Especially when it’s down to the Chinese steel industry being prudent around their margins and actually maintaining a margin by not overproducing steel,” he said.

“What it does for iron ore, in 2015 is when you get an oversupply of steel production and then margins get crushed, then there’s no bid on iron ore.”

“If (China) avoids a repeat of 2015 by not oversupplying steel, it is almost in the long-term interest of the iron ore suppliers to have a big more moderation in the price”.

Juniors reverse the tide as majors fall

While the iron ore majors had an uncomfortable day on the Australian bourse, sentiment remained high for some iron ore juniors, many of whom posted handy gains.

Macarthur Minerals (ASX:MIO) led the sector with a ~7% rise after announcing a rail haulage deal with Aurizon for its proposed Ullaring direct shipping ore project.

Grange was also up 2.1%, while Tony Sage’s soon to be iron ore exporter Fe Limited (ASX:FEL) was up 4%.

Mindax (ASX:MDX) was also up a touch under 7% after releasing an update on its early stage assets in WA, while magnetite developers Magnetite Mines (ASX:MGT) and Carpentaria Resources (ASX:CAP) were unchanged.

Hannah said if prices drop there may be more hesitancy to finance junior projects, but he noted that in a broader sense the iron ore market and its fundamentals remain historically strong.

“What you might see is a little bit of hesitancy now around financing some of these new projects that maybe would have got going but now people are just a little bit nervous to pull the trigger on them,” he said.

“But there again I think it’s worth just seeing the bigger picture.”

“Average price levels are still super high and the levels we’re at now were all time highs just a few months ago.”

“The theme of the world needing steel, the green steel transition happening is still intact and the important thing is grade really.”

“The world needs more high grade iron ore to produce the steel in a green way that it needs, but there may some nervousness around new investments in light of the magnitude of the falls in recent weeks.”

“The view that now prices have come back to $170-180, that we’re now back at normality, it’s far from it from a historical perspective.”