Analysts at Goldman Sachs have been looking over the iron ore market amid the weakening demand backdrop for the steel making ingredient.
The good news for iron ore producers such as BHP Group Ltd (ASX: BHP), Fortescue Metals Group Limited (ASX: FMG), and Rio Tinto Limited (ASX: RIO), is that the investment bank doesn't expect prices to fall to the levels we saw during the last downturn in 2014 to 2016.
How low will prices go?
Goldman Sachs expects the iron ore market to move into surplus in late May/June on higher Australian and Brazil shipments and lower (ex-China) steel demand.
It suspects this will lead to the iron ore price retracing to US$70.00 per tonne, before rebounding to US$85 per tonne in the fourth quarter on an expected recovery in global steel demand.
Its analysts offered five reasons why this is expected to be the case:
Reason 1. Goldman notes that the market was in a large surplus position (30-60Mtpa) during 2014-2016 due to the ramp-up of new supply from the iron ore majors. Whereas, this time the market was in a deficit before the pandemic.
Reason 2. In addition to this, the exit of high cost iron ore production (from China, SE Asia, India and West Africa) was slow during 2014-2016. It notes that higher cost supply did not return from 2017-2019 despite high prices, and reserve depletion is only accelerating amongst Tier 2&3 producers.
Reason 3. Another reason is that the majors brought on >300Mt of new capacity from 2014 to 2016. However, mining giants Rio Tinto and Vale have been struggling to increase their production in 2019-2020 due to ongoing operational issues.
Reason 4. Goldman also feels that the rise in Induction Furnace (IF) capacity in China that used scrap impacted iron ore demand previously. However, these IFs were phased out from 2016 and have been replaced by large blast furnaces which has boosted iron ore demand.
Reason 5. Finally, in 2014-2015 a policy-driven downturn in the Chinese property market impacted steel and iron ore demand significantly. This time around the Chinese property market is rebounding with improving sales and starts.
Overall, this should ensure that prices remain high and BHP, Fortescue, and Rio Tinto continue to generate significant free cash flows over the next 12 months.
