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By: Andrius Balsys

The iron ore market is experiencing dramatic changes, with its price declining by 32% to US$92.61 since December 2013. The price is declining due to slower-than-expected construction industry growth in China, but mostly due to increasing production of iron ore in the mines of Australia and Brazil operated by BHP Billiton Ltd, Rio Tinto Group and Vale SA (also known as the Big Three).

China is responsible for 45% of steel consumption in the world. The construction industry accounts for over a quarter of total steel demand in China. Consequently, construction industry changes in China have the greatest influence on the demand for steel globally. Chinese economic growth is slowing, therefore growth in the Chinese construction industry is expected to ease to 7% in 2014, compared to 9.3% in 2013. Declining demand is pushing prices even further downwards.

Although the price of iron ore has declined, Chinese miners are not able to operate at an iron ore price below US$100. Up to three times lower iron content in its ore and its small scale of mining operations inflate the costs above the US$100 level. We believe that the Chinese mines with the highest operating costs will be closed down. Such mine closures might cause a temporary price hike in iron ore on the global market until the supply of iron ore from Australia, Brazil, Canada and India can cover any lost supply from China.

Increasing iron ore supply is crushing Chinese mines

The Big Three is increasing its production despite falling iron prices. Australian, Brazilian and Canadian mines manage to keep their costs at an average of US$50 – or as low as US$30 in the most effective mines. Such cost differences occur due to the larger mining scale and the up to three times higher iron content in the ore in comparison to China.

Moreover, the Chinese government’s cuts in the subsidies and investments for inefficient miners of iron ore will further contribute to the falling profitability and lower competitiveness of mines in China. Higher gross profit margins, a desire to regain market share and pricing power will further drive the supply increase from Brazil and Australia, and will continue to push Chinese mines out of business.

The final nail in the coffin of Chinese producers is resumed mining in India. In 2012, the government of India closed many iron ore mines due to investigations into tax evasion and fraud. In 2014, mining operations were restarted. It is expected that production will be back to its original levels by the end of the year. Fully recovered production might add up to 60 million tons of iron to the global supply.

The Big Three will drive the competition race

Although Chinese construction growth in 2013-2019 is expected to see a CAGR of 11%, it will not be able to fully absorb the increased supply of iron ore from the Big Three and India. The oversupply will continue to be a global factor and prices will stay low.

In my opinion, during the coming few years the most expensive iron ore mines in China will be pushed out of business as the average price of iron ore will fluctuate within a range of between US$95 and US$100 in 2014-2016. The market should stabilise at a new price level with a greater market share held by the Big Three and decreasing mining operations in China.

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