Thursday, March 26, 2015

Iron ore price saga, once vital for the Aussie dollar, continues | Low-cost miners have their own agenda

Iron ore prices have now reached a six-year low, are at less than a third of their highs, and show no signs of stabilising. That the Aussie dollar is as high as it is, albeit well down from its peak, is a measure of the effectiveness, so far at least, of the Australian policy of transitioning from a mining-led economy to one that is supported by local consumption. Not too long ago the merest hint of a drop in the price of the main component of steel production worldwide would have caused the Aussie to swoon.

Hard commodities, like iron ore, were always going to suffer in the wake of the relative slowdown in the Chinese economy. The drop this time around is extraordinary, however, and is exacerbated by the fact that the world’s three largest producers, Rio Tinto and Billiton of Australia and Vale of Brazil, continue to mine for iron ore at full tilt, just as if there was no price issue at all.

Low cost miners have their own agenda

Before the drop in price the Brazilian company, Vale, built a fleet of the largest ships ever to sail the oceans, as dedicated iron ore bulk carriers. The purpose of this was to greatly increase the efficiency of, and therefore significantly lower, the transportation element of their cost of production, so that they could compete for Chinese business against the Australians, who are geographically much closer to that market, and against indigenous Chinese miners, who are small and less economically viable players.

One of the major risks associated with increasing capacity in large increments, such as when nuclear power facilities are built, or a fleet of super-duper bulk carriers is commissioned, is that the perceived need may have evaporated before they are complete, due to the length of time required to construct them.

That is what happened here. However, Vale, along with Rio and Billiton, have decided to make a virtue of necessity, and are now using their superior cost efficiencies to, as they put it, increase market share, by pumping material into the market regardless of the price implications.  They are not too concerned that one side effect of this policy is devastation for many of their more high-cost competitors. Many of these are in China itself, but now Fortescue, a second-tier miner in Oz, has called for government-imposed price controls to support the price, to the derision of the big boys. Even the government of New South Wales, where much of the state revenue comes from mining and is related to the price of iron ore, is on record as voicing its displeasure at the actions of Rio and Billiton.

This saga will run and run.

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