China's quest for cleaner skies drives change in iron ore market

The iron ore market's structural change last year is all to do with the environment, and led by demand patterns in China.

Iron ore with a higher content of iron, Fe, allows a reduction of coal usage in the steelmaking process, lowering carbon emissions. So trade has shifted away from the standard 62% Fe-quality base – the traditional iron ore benchmark product – to a multi-tier market. This includes specialty products that may be tailor-made for specific steel mills, with premiums, penalties and spreads between product values quite the order of the day.

“We’re carving the market up into segments: more and more we’re talking about high and low grade,” said Alex Griffiths, principal analyst, steel and iron ore markets with Wood Mackenzie.

Until late 2016, analysts note, there was no premium for the iron units in iron ore fines with a 65% Fe content. In July last year, with demand for high-grade iron ore soaring, the premium for these units leapt to 37% above the 62% grade price, slipping back to 16% at year-end.  The basic 62% commodity grade no longer calls the shots.

Has iron ore “decommoditized”?  Peter Poppinga, ferrous and coal executive director of Vale, the world’s biggest iron ore producer, says the move reinforces a point he has been making for some time. “Iron ore was never a commodity,” he said on the sidelines of the Vale Day in London early December. What has changed is that “now we’re getting the premium for quality” in a market that has “differentiated itself”, he said.

Structural change here to stay

The structural change is here to stay. At the start of 2018, a year in which governments, companies and the public alike speeded up action to combat climate change, steelmaking raw materials markets were impacted by China’s introduction ofa severe winter cuts regime, curbing sintering, steelmaking and coal usage to cut back on smog  in selected locations  in a “blue sky” policy. This is set to become an annual event.

With new “cleaner” capacity coming on stream, China’s overall crude steel production has nonetheless continued to grow. However, the emphasis on quality in raw materials usage is producing a less carbon-intensive steel, with positive margins emerging due to the more efficient installations.

The cuts dispelled discussions that China was somehow not “serious” about its elimination of polluting steelmaking capacity. In March Beijing was ahead of schedule in its planned elimination of 150 million metric tons capacity between 2016-2020. This followed permanent removal of an additional 140 million mt of mainly illegal induction furnace capacity in 2017. Mergers and acquisitions relocated mills from smog-prone areas. The European Union’s emissions trading market and related controls have contributed to this trend.

China’s cuts reduced the market for the nation’s own iron ore, high in impurities and in cost: at least half of China’s previous 300 million mt plus iron ore mining capacity has left the market for good.  “We forecast an additional 30 million mt of seaborne iron ore imports to China over the next two years, largely weighted towards 2019 and mainly from Vale's S11D,” WoodMac analysts said in a mid-December report, referring to the company’s Brazilian mining megaproject.

The 1.6 billion mt/year seaborne trade is also changing. According to Neelix Consulting mining and metals senior partner Jose Carlos Martins, this market is made up of 500 million mt/year of low-quality, mainly hydrated material, much of which has entered the market over the last ten years from Australian mines, with a high Loss on Ignition (LOI) – a measure relating to ore oxide analysis - and various impurities, with sheer quantities of new capacity production provoking price volatility.

Much of the rest of the market has become a pick and choose affair. Chinese and other buyers are seeking not only higher Fe content but qualities including low alumina, phosphorus and LOI. Alongside the standard benchmark 62% Fe delivered China product, more recently-introduced 58% and 65% standards have gained prominence, in a “proliferation of indexes and premiums,” in a movement set to intensify, Martins said.

Changes to IODEX spec

S&P Global Platts changed its IODEX 62% Fe specification in January to reflect market product realities, increasing the typical IODEX alumina and phosphorus content. Further increases in the alumina and phosphorus contents of Australia-origin ores are considered likely, while higher alumina content in Australia-origin medium grade fines has not been matched by increased supply of low alumina ores from Brazil.

Coinciding with the so-called “flight to quality”, major miners stopped bringing on greenfield capacity expansions of “commodity” or standard grade ores. After a protracted period of oversupply, Citi Research’s commodities research strategist Tracy Xian Liao sees seaborne iron ore supplies may start to decline slightly from 2020. However, prices for the more common grades are not expected to gain substantially even amid lower supplies due to "headwinds from greater scrap supplies," which may also put a cap on coking coal prices, Liao said at a recent London Metal Exchange Focus Day in London.

Ferrous scrap availability is another factor in this year’s structural change: greater scrap arisings as China’s first generation of mass consumer goods reach obsolescence has encouraged the rise of “cleaner” scrap-based electric arc furnaces which do not use coal.

What does decommoditization mean for the market?

1. More investment in iron ore blending: Australia’s Fortescue Metals Group, the world’s fourth biggest iron ore miner, late last year started shipping 60.1% ore blended from a base of its more typical 58% quality ore, to meet demand. This follows Vale’s lead in setting up no fewer than 17 blending stations worldwide. The Brazilian miner is, in effect, “blending all the way into China,” WoodMac’s Griffiths says.

2. More investment in pellet feed production to make pellets, a concentrated high iron content product. Vale sees demand for pellets growing from an estimated 514 million mt worldwide at present to 602 million mt in 2025. Demand for iron ore pellets this year outstripped supply, exacerbated by Brazilian Samarco’s absence from the market since late 2015. This led pellet premiums to inflate and producers including Vale to propose pricing pellet premiums off the 65% Fe  rather than the traditional 62% Fe index. WoodMac reports more than 35 million mt of pellet capacity is proposed to be commissioned within the next 7 years in China, mostly using domestic pellet feed. The closure of Vale's Corrego do Feijao mine in Brazil following the January 25 tailings dam collapse is seen as adding limited upwards pricing pressure on high-grade iron ore.

3. Different parts of the iron ore market will be subject to different pricing and demand pressures. More indices could emerge, for instance for LOI.

4. Major producers will increasingly serve market niches. According to WoodMac’s Griffiths, Australia’s BHP and Rio Tinto will continue to be consistent suppliers of commodity (lower quality) grades, while facing an increasing need to reduce production costs via use of conveyors and driverless trucks. Vale and other Brazilian producers are favored by having naturally high Fe grades, allowing them to offer more “specialist” products.

5. Despite a wide range of iron ore derivatives already traded on China’s Dalian Commodities Exchange and Singapore Exchange, more financial products may enter this market, especially as players may switch from trade to arbitrage, measuring and trading spreads between iron ore products. SGX launched 65% Fe swaps and futures contracts in early December. However, market players including Neelix’s Martins note that it may become less necessary to hedge higher-value or niche products as these may be less susceptible to price volatility than the broader “commodity” grades.