May. 15 2018 — The forces shaping the steel value chain are causing divergence in our expectations for steel and iron ore prices. Much of the strength in the steel market is reflected in headline 62% Fe iron ore prices, yet risks remain to the downside due to ample supply — we have marked our 2018 expectations to market given robust prices until April 20, yet continue to expect a profile of gradually declining prices for the near term. Four themes lead us to form these expectations.
The primary expectation is for stronger, synchronous global growth. Fundamentally, at a macroeconomic level, the world is now on a more robust foundation when considering real GDP growth — the International Monetary Fund noted that economic growth in 2017 was the strongest since 2011, and has revised both 2018 and 2019 figures upwards by 0.2 percentage points to 3.9% apiece. We therefore expect consumer demand within China, and demand for the country's exports, to be firm for the near term — this includes demand for steel-intensive products, which will provide support for downstream finished steel production.
Second, finished steel demand in China increased in March 2018 from already-robust levels. Most relevant is the strength in China's residential housing market — residential floor-space started grew by 12.2% year-over-year in March. We estimate that 54% of China's 752 Mt consumption of finished steel will come from the construction sector in 2018, and this reported strength in the first quarter of 2018 residential data supports our view. We also see strength in general-purpose machinery demand, which continued to grow at 6.8% year-over-year in March as China continues to replace and upskill its aging stock. Industrial production growth of 7.3% in February and Purchasing Managers Indices of 52.0 and 51.0 from National Bureau of Statistics and Caixin sources respectively, also combine to indicate solid steel-intensive economic growth in the world's largest consumer and producer of finished steel.
Third, we observe strength in China's crude steel production rates yet see less strength in pig iron production. If we remove any seasonality, particularly the timing of the Chinese New Year, crude steel production has risen by 5.0% year-over-year to 211 Mt in the first quarter of 2018. However, we note that China's production of pig iron over the first two months of this year was reported by the World Steel Association to be broadly constant year-over-year at approximately 113 Mt.
Data from S&P Global Platts indicates that steel scrap demand has risen recently, with some mills reporting 18% scrap in the blast furnace. We consider these large proportions of scrap employed to be approaching a technical limit and do not see much potential for further substitution of iron units away from iron ore, particularly now that coking coal prices are lower. These technical data points on the specific utilization techniques for Chinese blast furnaces lead us to expect less upside demand potential for iron ore.
Finally, we continue to expect seaborne iron ore supply to grow by approximately 2.2% year-over-year in 2018. Data from the first quarter of 2018 shows that the aggregate quantity of iron ore produced by the world's "Big 3" iron ore miners grew by 2.7% year-over-year to 236 Mt. This was led by Rio Tinto, which grew production 6.9% by adding 5.6 Mt of incremental tonnage compared with the first quarter of 2017; BHP Billiton Group simultaneously added a further 4.9 Mt to first-quarter 2018 volumes. This incremental volume is being added at a time when crude steel production is growing strongly, yet pig iron production is relatively flat — we expect this ample supply of seaborne iron ore to weigh negatively on seaborne iron ore prices for 62% Fe material in the second quarter of 2018.
However, we acknowledge that there is some risk to these expectations, whilst Vale SA has maintained 2018 guidance of "around 390 Mt", the company removed 4.2 Mt from seaborne volumes in the first quarter of 2018. This could see less near-term liquidity in premium-quality seaborne iron ore availability, but we maintain our annual expectations for Vale based on guidance and market reports — it seems more likely that extra volumes will enter the market later this year.
The net effect of these forces is for the steel market within China to continue to tighten and for the global iron ore industry to remain in a modest surplus. We increase our price expectations for 2018 marginally to US$67.1/t due only to strong prices through April 20. This is higher than the S&P Capital IQ surveyed mean of US$63.8/t.
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