Steel demand

This week we have seen some of our miners taking heat, with Kumba Iron Ore in particular really feeling it. Monday saw Kumba Iron Ore down by 8.5%, about 4% of it was due to a dividend, and then a further 5.4% yesterday. Why the huge drop in price? The price of iron ore dropped on Monday by 8.3% to $104.7 per ton, it's lowest in over a year. The spark that started the drop was concerns that the demand for steel from China and by extension iron ore would not be as high as anticipated. Once the price started dropping, it gained momentum due to people using iron ore as collateral for loans, which meant that as the price dropped they had to sell some ore to ensure that their collateral value did not drop too low.


Where is the iron ore price heading in the future? According to BHP Billiton the medium term (the next 5 years) does not look great for the miners, with the growth in supply expected to grow by faster than the growth in demand. BHP expects China's demand for iron ore to keep growing (albeit at a slower rate each year) until about 2025 and at the same time the rest of the world's demand will also grow, the demand will be coming from an expected 1.2 billion people who will urbanise globally by 2030. The extra supply is to cater for the increased demand over the long term, the demand that should push iron ore prices up once the increased supply slows.


From BHP Billiton's point of view, increased supply may result in the price of iron ore dropping over the medium term but it will also result in their unit costs also dropping because they are bringing online low cost supplies. For Kumba Iron Ore, their Sishen mine which is their biggest contributor of Iron Ore has a unit cost of about $35 per ton which is expected to drop to about $33 in 2016 and their second biggest mine, Kolomela has a unit cost of about $24 a ton which is expected to drop to about $20.5 in 2016. If the Iron ore price stayed the same, the increased output as well as the lower unit costs would result in higher profits but with iron ore prices expected to drop, profits will most likely be subdued until demand growth outstrips supply growth.


BHP also point out that as there is a drive to become more environmentally friendly higher grades of iron ore will be needed because it is cleaner to make a higher grade of steel than a poor grade. This didn't sound right at first, but the reason is due to higher grades of iron ore having less impurities. In the case of carbon which needs to be removed, they blow pure oxygen into the molten metal, where the oxygen and carbon join to form carbon monoxide, not a gas that environmentalists want being released. This is good news for BHP and Kumba who are suppliers of high quality iron ore.


In the long term the iron ore assets are still quality assets and there is going to be a demand for what they are selling. Over the next couple of years though, unless there is unexpected demand for iron ore I think that Kumba's share price is going to struggle and BHP who have half their earnings in iron ore probably won't be shooting the lights out. BHP are of course diversified, so many of their other businesses can pick up the slack. Spare a thought for their copper business however.