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Iron ore price drop: China steel overproduction takes industry into a new normal

By Hector Forster in London

August 31, 2012 - The Chinese state-led steel industry launched the first electronic iron ore trading platform in May, just after seaborne iron ore prices were at their highest to date this year at around $150/dry mt CFR China.

Led by the China Iron & Steel Association, the industry wanted to boost transparency and help drive import prices lower, to counterweight the negotiating power of global miners such as Vale, Rio Tinto and BHP Billiton

Whether or not the ensuing China Beijing International Mining Exchange (CBMX) was partly responsible, the objective of lower seaborne iron ore prices has come faster, and down to levels nobody expected.

“The market is moving on its own, it’s nothing to do with the platforms", said a market source close to the CBMX. “Otherwise the Chinese would have done this 10 years ago.”

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The price fall comes despite the highest ever steel output in China over July, which should have helped prop up imports of the steelmaking commodity.

Analysts expect an inventory overhang and possible further destocking to depress steel demand for imported iron ore and coking coal into the fourth quarter.

Platts IODEX plunged to $90.75/dmt CFR China for the main physical benchmark on August 29, piercing analysts’ price forecasts. (See related chart: Iron ore prices drop since April 2012).

The price is half that of some early price calls and comfortably $50 or so below recent consensus for average annual prices in 2012.

Most of the slide has come over the past two months. The 62% Fe fines price tumbled just over 30% [in - delete] since July, as Chinese and global demand for steel weakened.

China’s economic growth stuttered and fears of a hard landing took hold as Chinese purchasing executives continued to indicate lower confidence.

Falling export trade demand, chronic steel overcapacity, a July hike in steel export sales as domestic demand cooled, and local miners seemingly over-producing at an operating loss for the time being-- cited by industry analysts and economists – are likely the main drivers for the iron ore price slide.

“The data’s been disappointing,” HSBC’s chief economist for China, Qu Hongbin, said in an August 28 report. “July export growth dropped sharply and industrial production and bank lending were both lower than expected,” HSBC said.

That followed Q2’s slowest pace of economic expansion in three years, while HSBC’s latest China manufacturing purchasing managers’ index (PMI) deteriorated to a nine-month low of 47.8.

Analysts point to construction, heavy industry and consumer goods sectors as important steel indicators for China.

The aftereffects of monetary tightening last year, as well as coping with worsening external trade demand and boosting steel demand by state-led infrastructure projects are recent focal points.

Ensuring China’s stellar economic growth trajectory is kept intact, and maintaining employment and state tax receipts have all played their part in keeping steel output high.

Shanghai rebar futures have been on a relentless decline over the past few months. Traders shorting as the macro trend took hold, negatively influenced iron ore sentiment.

Volumes in Shanghai for rebar outstripped iron ore swaps clearing at the Singapore Exchange by 16:1 on August 28.

The paradox is that steel output in China, which rose to new record levels in July, remains only moderately off that high, producing at a daily rate of just under 2 million mt earlier in the month.

This should help demand for seaborne tons, especially as high-cost domestic ore is displaced, even with some destocking.

Much of the call on domestic ore is from mines with operating costs well over $100/mt CFR China equivalent, according to analysts led by Colin Hamilton at Macquarie.

Domestic iron ore prices were higher than import tons by around $20/dmt on an equivalent basis in mid-August, based on the bank’s analysis.

Macquarie points out that 280 million dmt of Chinese ore at 62%- Fe is needed to meet current annualized pig iron output of 650 million mt.

Chinese domestic mine costs below current import prices totals only about 150 million dmt while the highest-cost mines are at $150/dmt CFR China equivalent, the research published August 22 shows.

Next page: Domestic iron ore attractive in falling market

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