The hidden factors impacting the iron ore market

In the period since Chinese New Year, trade in seaborne iron ore concentrates has almost doubled each day and port stocks of high quality ores have picked up, driven by Rio Tinto. This has prompted competitors including FMG, Roy Hill and BHP to once again consider options to enhance the quality of their products.

China’s environmental protection policies have widened through last year, with policies taking effect in different areas and result in a regional restocking after each production cut.

While the environmental protection policy is neutral to the physical market, derivative markets may be prone to over-reaction. The iron ore market in May and June should remain neutral to bearish, however with limited space to fall DCE iron ore has stronger support at 432.5 and has bigger room to rebound, since the absolute value of DCE iron ore is much lower than SGX iron ore swap.

With India expected to produce 170m tonnes of steel in 2019 – 20% of China’s steel production – the two countries dominate iron ore demand and have become two giants in the ferrous market.

Chart 1: Australia, Brazil and India iron ore weekly delivery
Sources from: MySteel, Compiled by FIS

Iron ore deliveries climbed each year and the highs and lows are becoming higher compared to the last few years. The dual national conference in China and the late Chinese New Year have created time lag around steel demand.

Ex-Port Hedland iron ore deliveries to China in March reached a historical high at 34.95m tonnes. In seasonal terms, deliveries tend to grow from January all through the year, reached the highest by Q4, bringing more pressure on the iron ore price in next few months.

Chart 2: Platts 62% IODEX, SGX IOS, DCE IO futures, DCE-Platts Basis and IOS – Platts Basis
Sources: Platts, SGX, DCE, Compiled by FIS

The Chart uses the current-month swap instead of the most active month to see significance of two different basis. In addition, using the raw data instead of standardized data to gain simple or linear relation, avoids skewing. From a historical perspective, the market is going down every time when both DCE and Platts basis move from positive to negative area (as we could find on the small circles on the lower area of the chart).

Over 80% of the time, Platts/IOS spread is below $2. In addition, over 80% of the time, Platts/DCE futures is below $5. According to the divergence and regression feature, the current basis reached a higher level on both a DCE and SGX basis, indicating a continuous fall might happen in near future. In addition, when the Platts-DCE basis crosses above the orange line around $5 – a 20% percentile event – it promises a continuous positive trend of $15-$20. The trading range narrows from $40–90 to $50–80 and $60–75.

Chart 3: Platts 65% – 62%, Platts 62% – 58%
Source: Platts, Compiled by FIS

Miners are more positive on H1 compared to H2. The chart above indicates that current mid-grade iron ore is weaker compared to high grade and low grade, since the large-sized physical trades from March to April, indicate miners are ensuring liquidity and giving up some profit margins. For example, six trades on PB fines were done on April 26, creating the biggest one-day session of seaborne trading.

The supply and demand ratio is sensitive to the same stocking and destocking cycle. If the supply-demand ratio remains stable, the iron ore price should not see a sharp drop. The supply demand ratio normally ranges from the 1.8–2.2 area, and current 1.8 is indicating an area providing support to the price by the end of the year’s destocking period.

Chart 4: Iron Ore Supply and Demand Balance
Sources: from National Bureau of Statistics of China, CISA, DCE, Compiled by FIS

Chart 5: Blast Steel Cost and EAF Steel Cost
Sources: Mysteel, Bloomberg, Compiled by FIS

EAF profit margins have narrowed from 700 yuan to 350 yuan between 2017 and 2018, without including some overheads and labour costs, so that many mills actually have no profit on their balance sheets.

Blast furnaces still return 1300 yuan/tonne profit on producing rebar. The difference is caused by the surging graphite electrodes prices and furnace facility cost. In the long-run, the profit difference between the two types of furnaces should narrow, since EAF will take the place of many Blast Furnaces.

Ends

Commodity Researcher: Hao Pei – HaoP@freightinvestor.com

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