Could iron ore prices fall to US$20-US$30 a tonne?

Headwinds are rising in the iron ore sector and it means danger for junior iron ore miners

| More on:
a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Thanks to some savage cost cutting, some savvy business deals with contractors and the falling Australian dollar, Australia's junior iron ore miners appear to be generating positive cash flows.

Atlas Iron Limited (ASX: AGO), BC Iron Limited (ASX: BCI), Arrium Limited (ASX: ARI), Mount Gibson Iron Limited (ASX: MGX) have all managed to cut their production costs significantly in the past three years.

Prior to 2013, iron ore miners hardly mentioned their production costs – not surprisingly when they were receiving US$130 a tonne and higher for their product. Even with the Australian dollar trading above parity with the US dollar (~$1.03), the miners were making a motza.

Looking through their quarterly reports, most were focused on ramping up production. Back in November 2011 (PDF), Atlas was even aiming for production of 46 million tonnes per annum in 2017. The miner produced 12.2 million tonnes in the 2015 financial year and appears unlikely to achieve its target.

Downward pressure arrives

But the dramatic fall in the iron ore price that started in 2011 saw the commodity price plunge from above US$180 a tonne down to the current price of around US$52 a tonne. The falling price was due to a couple of reasons. Iron ore miners around the world had rushed to open new production – at virtually any cost – to take advantage of the high prices in 2010 and 2011. That saw massive amounts of supply come on stream.

Chinese steel producers losing money

At the same time, growth in the production of steel – of which iron ore is a major component – had slowed. Chinese steel production grew just 4% in 2012, after a number of solid years of double-digit growth. Steel demand had waned too, impacting on steel prices, pushing them lower. The Nikkei Asian Review said today that a tonne of Chinese steel is cheaper than a tonne of cabbage.

Forbes estimates that the majority of Chinese steel makers are currently loss-making, but very few mills have even considered cutting production, let alone closing. In an effort to make at least some money, Chinese exports of steel have rocketed higher, up 26% this year compared to last year.

China's steel output is falling, albeit slowly – down just 2% in the first eight months of 2015. Earlier this week, South Korea's biggest steelmaker, Posco, reported a quarterly loss of US$582 million.

Steel production peaked?

In April this year, economist Ross Garnaut predicted that China's steel production had peaked, and will fall by more than 25% over the next 15 years to around 600 million tonnes in 2030. BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) estimate it will be around 1 billion tonnes.

The chairman of China's second-largest steel producer, Shanghai Baosteel Group, Xu Lejiang told Bloomberg overnight that the loss for China's steel industry totalled $2.8 billion in the first eight months of the year. Output may eventually fall by 20%, matching the experience seen in the US and other countries he said.

China's steel producers are also feeling the pain from another front. Banks are tightening their lending to the steel sector, including for raw material stockpiles (which includes iron ore).

Supply versus demand

The problem Australia's junior iron ore miners face is that supply is still coming on stream, as we illustrated here. Other sources estimate around 200 million tonnes of excess supply will be added in 2016 – much of it at very low cost. When you have steel production declining but iron ore production is rising, simple economics suggests it can only result in one thing – a lower iron ore price.

Foolish takeaway

For 20 years up to 2004, when China's steel production took off, iron ore had traded consistently below US$20 a tonne. Australia's big miners can ship the stuff to China at around those prices now, so it would take the iron ore price to halve from here to cause them major issues – but it would be game over for the junior miners.

Predictions of an iron ore price near US$40 a tonne early next year appear optimistic in my book. It wouldn't surprise me to see iron ore prices drop to the US$20-US$30 per tonne range within the next year or so.

Motley Fool contributor Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

More on ⏸️ Investing

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest
ETFs

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

Two people in suits arm wrestle on a black and white chess board.
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »

⏸️ Investing

Why Fox (NASDAQ:FOX) might hurt News Corp (ASX:NWS) shareholders

News Corporation (ASX: NWS) might be facing some existential threats from its American cousins over the riots on 6 January

Read more »