Have the iron ore bears got it wrong?

Commodity forecasting is a difficult business at the best of times. Even the most sophisticated "all-singing, all dancing" supply-demand model cannot account for a myriad of imponderables. These can include weather events and environmental factors, operational outages and disasters, government policy changes (especially in China)—and heavens above, a global pandemic.

Granted, there is always a crystal ball element to price forecasting. But in the case of key steelmaking raw material iron ore, analysts, consultants and industry experts, and often market players themselves, have consistently got the price outlook wrong—typically on the low side.

In fact, from practically the time your blogger started covering the iron ore and steel industry—from Shanghai in May 2008, the month of Fortescue Metals Group's inaugural shipment—he was told: "Don't get excited by all the hype now, there will be a massive oversupply in a few years. Australian and Brazilian expansions, accompanied by millions of new tons from Africa, will swamp the market; scrap will increasingly displace iron ore; and prices will return to their historically low levels."

On the day this blog was written, the S&P Global Platts IODEX 62% Fe benchmark stood at $160.70/mt CFR China, 70% higher on the year before. So much for low prices! Forecasts are not carved in stone, of course, and are subject to revisions as market conditions change and new information emerges. But the consensus continues to be that iron ore prices will fall markedly in coming years. Most analysts see them dropping by roughly $5-$10/mt each year over the next four years, to an average of $95/mt in 2021, $85/mt in 2022, $$75/mt by 2023 and $70/mt in 2024.

At this stage, Platts does not provide a formal iron ore price forecast. This is therefore merely a personal view based on observing the market closely for almost 13 years. But here's why I think an overly bearish outlook on medium-term prices may be wrong:

Firstly, and most importantly, forecasters routinely overestimate how much iron ore supply is coming online...

There is little in the way of meaningful net new supply guaranteed to hit seaborne markets in the next 2-3 years. It is hard to see where the estimated hundreds of millions of tons of new supply over the next few years, built into some projections, are coming from. Yes, there are mine replacement in Western Australia projects (more on this later), and Fortescue's new Iron Bridge magnetite project. Fortescue also has plans to lift capacity at Port Hedland by an additional 20 million mt/year, while BHP has similar plans to increase throughput at the port. But planned capacity and actual production are two different things.

...and underestimate how much crude steel China will produce

Many were skeptical (including this author) when Rio Tinto and BHP routinely trotted out the view a few years back that China would produce 1 billion mt of crude steel by 2025-2030. When Chinese steel output seemed to go into reverse from 2014, the view was that Chinese steel consumption and output had peaked. The party was over! Instead, things took off again in 2016, helped by some capacity reduction and a property construction boom. Bumper profits incentivized Chinese mills to build new capacity and lift output. In 2019, China produced 996 million mt of crude steel and this year the 1 billion mt mark will be breached. As it turned out, Rio Tinto and BHP were 5-10 years too late in their predictions. Platts expects Chinese steel production to keep growing at 1%-2% in the next couple of years. The demand side of iron ore will remain extremely strong - and it won't just be coming from China (see below).

Go deeper: S&P Global Platts Iron Ore & Steel Outlook

There are always operational issues

Despite its increasing sophistication—automated logistics, use of big data, control centers 1,500 km away from the mine site, etc—mining is still essentially about digging holes and transporting material on trains and ships; there are many things that can go wrong along the supply chain. Further, the iron ore hubs of Australia and Brazil happen to be located in regions that suffer cyclones and heavy rains every year. Damage to facilities is not uncommon.

Moving targets are often missed

There's not much point building ambitious volumes into a supply-demand model when companies keep missing their current year targets. In October, Vale said it would reach 400 million mt by early 2023 at the latest. In December, the Brazilian company downgraded its 2020 target from 310 million-330 million mt to 300 million-305 million mt. Rio Tinto has been beset by operational issues this year, and has downgraded its full-year production guidance more than once. In fact, Rio Tinto and BHP have both flagged maintenance work in calendar Q4 as being likely to impact iron ore production. Anglo American Kumba has said annual port and rail maintenance at its South African operations will see it achieve the lower end of its production guidance this year.

The ramp-up of new projects is rarely plain sailing

Following on from the above point, there are a number of significant mine replacement projects due to start in the Pilbara region of Western Australia. Fortescue's new 30 million mt/year capacity Eliwana mine has just produced its first ore. Next year, Rio Tinto will start its new 43 million mt/year Koodaideri mine to keep up its flagship Pilbara Blend product, as supply at older mines is depleted. BHP will launch its new South Flank operation in 2021 that will replace the 80 million mt/year Yandi mine. In other words, a lot of tons of iron ore depend on successful tie-in work, commissioning and ramp-up of new projects. Will the majors maintain overall production and export volumes as new operations are brought online? Given the way the market often freaks out (like right now) at any potential supply shortage, any announced delays could see prices spike.

ESG considerations could see longer project timelines

Quite simply, the iron ore industry cannot afford another Samarco, Brumadinho or Juukan Gorge. It would be hysterical to say such an important industry is in the "last chance saloon" with investors—but the fate of outgoing Rio Tinto CEO JS Jacques shows the level of scrutiny the sector is now under. Investors have walked away from thermal coal, and many are snubbing metallurgical coal. Cleaner sectors have growing investor appeal, which is one reason for the current buzz around hydrogen. S&P Global Ratings includes ESG factors in its criteria for evaluating companies and they are likely to play a larger role over time. Many of the miners have now put in place measures to ensure rigorous consultation with traditional owners and First Nation communities. A more careful and diligent approach to developing and expanding iron ore mines could see longer project timelines.

Demand is not just coming from China

There is a massive amount of new integrated steelmaking capacity planned for Southeast Asia in the next few years. Most of the mooted new projects will probably get no further than the drawing board. But one would have to think some new capacity will be built—especially as the lion's share is being funded by Chinese companies, which could potentially benefit from Belt & Road Initiative borrowing terms. In the meantime, established mills such as Vietnam's Hoa Phat are adding blast furnaces. Over time, the region could pick up any fall in demand for iron ore from China, Japan and South Korea.

A bull more than a bear

Taken together, these drivers point to upward support rather than downward pressure in the iron ore market, in the short-to-medium term at least. But of course, my crystal ball is just as cloudy as everyone else's...