Australia takes issue with low iron ore price

It’s the end of the commodities supercycle and iron ore, like many other resources, has bottomed out. Globally, the metal is in oversupply and continues to push prices down – and high-cost producers out.

At about $50 a tonne, iron ore, a key component in steel, has reached lows last seen during the economic recession in 2008, a large comedown after an all-time high of nearly $190 a tonne in 2011.

Australia, the world’s largest iron ore producing country, is feeling the pressure of the plummeting metal price and support is growing for a parliamentary committee to investigate the oversupply and determine whether action needs to be taken.

The largest producers of the metal, BHP Billiton and Rio Tinto, are accused of intentionally flooding the market. Leading the charge against the major mining companies is Andrew Forrest, the chairperson of the Fortescue Metals Group, the world’s fourth-largest iron ore producer.

But Michael Kavanagh, a metals and mining analyst at Noah Capital Markets, said the overproduction and subsequent glut in supply was “very typical cyclical behaviour”. “When commodity prices are high, everyone produces as much as they can. But, inevitably, demand softens and then we go through a rebalancing phase. High-cost producers close and the balance goes up.”

During this kind of phase, the larger companies would often subsidise high-cost operations with revenues from profitable ones.

“We have seen it with Anglo Platinum, and their Bokoni mine and their Rustenburg operations have been cross-subsidised and, inevitably, the small guys get pushed out … It’s market forces basically,” Kavanagh said. “It works on greed.”

Closing up shop
Smaller, high-cost producers have begun closing up shop and, this month the Chinese government introduced tax breaks for iron ore producers.

Peter Major, a mining analyst at Cadiz Corporate Solutions, said: “They always ramp up in the good times. They do it every time, even though there is no investment sense in it and it always ends up destroying returns and costing shareholders huge, irrecoverable losses.

“The only way to survive in mining is to be a ruthless, disciplined, low-cost producer. Period. He who controls his costs best will survive and grow best. Period. The rest are just freeloaders hoping for a once-in-a-100-year commodity boom.

“Politicians, unfortunately, are constantly trying to have more influence on the way the major mining houses operate. But it’s earnings that will be the final arbiter for investors,” Major said.

“Yes, many of these shares are at five- to 15-year lows, because that’s where their earnings are now. People seem to forget that, at the end of the day, it is earnings that drive share prices. Investors are continuing to nail high-cost operations, because their earnings are not going to rise until they cut costs. Period.”

BHP Billiton’s chief executive, Andrew Mackenzie, speaking on Australian radio this week, said an inquiry was unnecessary and would send the wrong signal to international customers about Australia’s commitment to free trade.

“It’s good for the world economy and it’s good for geopolitical harmony when people feel that they can count on Australia for the supply they need to grow.”

Rational strategy
Mackenzie said his company’s strategy was rational, commercial and responsible, with BHP anticipating, and stating on many occasions, that supply growth would exceed demand growth.

He said an inquiry would be an “amazing gift” for Australia’s competitors, given that iron ore was a globally traded commodity, with other major sources of supply in Brazil, South Africa, India and China.

The production costs of Kumba Iron Ore, the largest producer in Africa and the fourth largest in the world, are higher than the likes of BHP and Tinto.

“What happens in the Australian iron ore industry, because of their size, affects the international market and therefore affects us,” Kumba said in response to questions. “We, therefore, follow these events and all market developments. We are sure that the market mechanisms will ultimately result in the appropriate solutions to balance the market.”

Mackenzie said BHP had already deferred growth opportunities of about 180-million tonnes a year in 2012 and felt an inquiry would conclude the global iron ore market was operating according to market principles and no intervention was warranted.

“I am very confident, if an inquiry goes ahead, that we will see this as a well-functioning market, which is in the interests of both customers and suppliers,” he said.

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