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Is the iron ore price headed for a crash?

Iron ore prices have slumped in recent weeks, renewing fears that miners will see prices under US$100 a tonne in the second half of this year.

Exports of iron ore from Australia’s Pilbara region are up 20% annually, as our three largest iron ore miners add tens of millions of tonnes of ore to their production. Rio Tinto Limited (ASX: RIO), the second-largest iron ore miner on the planet, produced 66.5 million tonnes from its Pilbara operations in the December quarter, and is targeting full year production of 295 million tonnes in 2014.  That’s around 30 million tonnes more than last year.

BHP Billiton Limited (ASX: BHP) expects to produce 217 million tonnes in the twelve months to June 2014, up from 187 million last financial year. Fortescue Metals Group Limited (ASX: FMG) shipped 31.5 million tonnes in the March 2014 quarter, 53% higher than the previous year, and is aiming to hit 127 million tonnes this financial year.

Brazilian giant Vale, plans to lift exports from 311 million tonnes a year to 450 million tonnes by 2018. Vale’s cost of production is expected to fall to around US$18 a tonne before shipping costs.

Chinese economic data has also been inconsistent, leading to concerns that demand for the steel-making ingredient will fall, as stockpiles at Chinese ports reach near-record levels. Add in India easing bans on iron ore mining in a number of states, and you can see that rising supply and potentially falling demand are both weighing on the iron ore price.

Already analysts and BHP Billiton are calling for lower prices in the second half of this year. They may well be right, although no one has any idea of where the price will fall to. Prices below US$90 a tonne are possible, which would be a massive hit to smaller, higher cost miners like Mount Gibson Iron Limited (ASX: MGX) and Arrium Limited (ASX: ARI).

While the big miners have very low production costs, even a fall to US$90 a tonne will have a large negative impact on bottom line profits, with Rio and Fortescue standing directly in the firing line. BHP has a more diversified asset base, so could weather the storm better and its earnings are unlikely to be hit as hard.

Foolish takeaway

Vale CEO Murilo Ferreira says the iron ore price has a strong floor around US$110 a tonne, and expects the commodity to average around that for the next few years. If he’s right, there may be an opportunity to pick up cheap shares in the iron ore miners, should the iron ore price fall below those levels temporarily.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

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