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Is the iron ore price set to soar?

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Overnight, the spot iron ore price rose 0.3% to US$42.78 a tonne, its’ fourth consecutive rise.

Since January 13, the commodity price has now gained 8.3%, despite signs that China’s steel production is falling as demand falls.

But the commodity may see some relief from the massive oversupply in the market, with both BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: BHP) backing away from massive production targets.

BHP says it now expects to ship 237 million tonnes of iron ore in the 2016 financial year (FY16), rather than the 247 million tonnes it had forecast earlier. Some of the cut back is due to the tailings dam disaster at Samarco in Brazil. Just a day before, Rio said it expected to produce 350 million tonnes of iron ore in 2016, still up from the 327 million tonnes it produced last year – but lower than market expectations of 355 million tonnes.

However, Rio, as the lowest cost iron ore producer, is still making a decent profit at current prices, and perhaps is being a bit conservative with its guidance – which might help to boost the iron ore price.

Brazil’s Vale currently produces 340 million tonnes a year and is still pushing ahead with plans to produce between 380 and 400 million tonnes in 2017 and between 420 and 450 million tonnes by 2020. Then you also have Gina Rinehart’s Roy Hill mine which has only just begun shipping iron ore, but is ramping up to produce 55 million tonnes within 18 months.

As you can see from the chart below, while steel demand and production are falling, iron ore production is forecast to continue growing rapidly. There’s only going to be one outcome from that – lower iron ore prices in future.

iron ore forecast production

Source: Company reports

Foolish takeaway

As we get closer to reporting season starting in February, investors will have a better idea of the carnage taking place in the iron ore sector, particularly amongst the junior iron ore miners. It’s unlikely to get much better, and the currently rising iron ore price is likely only a temporary reprieve.

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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

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.

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