The potential for recovery of the positions by Kazakhstan suppliers of iron ore in China market, which is limited today by low demand, has all the chances to be realized in the foreseeable future. This is the opinion of Nikolay Filkevich, the project manager of Metal Expert Consulting analytical company.
Kazakhstan ranks among the top 15 largest iron ore miners and producers of iron ore in the world. The leading enterprise of the industry is Sokolov-Sarbai Mining Production Association (SSGPO) JSC, which supplies about two thirds of the total release of concentrate in the country and is the only manufacturer of iron ore pellets.
The role of export for Kazakhstani manufacturers is difficult to overestimate - the iron ore supply to the domestic market traditionally does not exceed 5-10% of the overall volume of commodity shipments of concentrate, sinter and pellets, while the rest is expedited to the metallurgical enterprises of Russia and China.
Over the past two years the iron ore export from Kazakhstan (Chart 1) has undergone some important changes. Total deliveries abroad decreased by twice - from 16 million tons in 2013 to 8 million tons, according to the results of 2015. In addition, all export destinations and segments were subject to reductions, and the supplies of Kazakhstan products most significantly dropped in Chinese market - from 7 million tons to 300 thousand tons.
In order to understand the causes of these changes and estimates of future prospects for Kazakhstan when exporting iron ore, we will consider the situation in the domestic markets of the key importing countries, as well as pricing conditions of ore on the world market as a whole.
According to the results of 2015, the supply of iron ore from Kazakhstan to the Chinese market have fallen to 300 thousand tons, although a few years ago they it not fell below 6 million tons per year. Traditional consumers of Kazakhstan ore are three enterprises of the bordering provinces Xinjiang- Shougang Steel, Baosteel BaYi and Baosteel Aksu.
A key prerequisite for reducing procurement is a drop in demand for ore from the mentioned plants: according to Mysteel, last year the production of steel and iron in Xinjiang Province has declined by 40% - to 7 million tons. Under such circumstances, Chinese steelmakers will prefer to buy locally produced or imported iron ore from Mongolia, which is cheaper for individual consumers compared with supplies from Kazakhstan due to a short transport leg and respectively, lower delivery costs (Chart 2).
Analysis of the actual cost of iron ore transportation demonstrated that across the three companies this value ranged from USD 30 to USD 50 per ton. Accordingly, with an average level of concentrate production cost in Kazakhstan about USD 25/t, a break-even point in the supply of ore to customers in Northwest China equals USD 55/t for comparison: average procurement prices for concentrate in the province of Xinjiang last year totaled about $ 50/t.
It should be noted that the decline in shipments of ore from Kazakhstan is not an only change in the iron ore procurement framework of Chinese metallurgists. Despite the status of the largest global manufacturer of finished rolled products, last year the volumes of consumption of steel products and steel in China reduced by nearly 15 million tons, the main reason being a decline in demand for the metal, caused by the deceleration of growth of Chinese economy.
Throughout 2013-2015, domestic output of iron ore in China in terms of 62% concentrate has fallen from 400 million to 300 million tons, which was a consequence of the closure of many small unprofitable enterprises in mining ore and the purchase of more attractive cheap imported ore from Australia and Brazil. At the same time, the supply of raw materials from Asian countries gradually expanding their own production of steel, significantly reduced.
According to estimates of Metal Expert Consulting, the tendency of reduction of demand for steel products in China may take a few more years and likely to become a cause for further reduction of steel production in the country, which, in turn, will result in reduced demand for iron ore. This may be a “shock therapy” for the whole of the global iron ore market: China consumes around 2/3 of the world's iron ore, and the announcement of a variety of new iron ore projects in previous years was attributable to expectations of further growth in demand for ore of at least by 5% per year. And in the current realities the latter is most unlikely.
However, the completion of reorientation of the originally export-oriented economy of China towards domestic market, closing inefficient plants and reducing overcapacity in the steel industry of China has subsequently become a precondition for the resumption of growth in demand for metal products and recovery of previous levels of iron ore consumption. Thus, the potential for recovery of the positions of Kazakhstan suppliers in the Chinese market, currently limited by low demand for the foreseeable future, has all chances to be realised.
Last year the volume of purchases of iron ore from Kazakhstan Russian consumers - Magnitogorsk (MMK) and Chelyabinsk (Mechel) metallurgical plants amounted to 8 million tons. At the same time, since August MMK is the sole buyer of Kazakhstan ore in Russia.
As you know, Magnitogorsk steel plant does not possess its own iron ore production assets, in connection with which the company buys these products at the local market, as well as imports from Kazakhstan. Currently, a long-term agreement between MMK and SSGPO continues (calculated until the end of 2017), under which Kazakhstan suppliers shall monthly deliver to the plant about 200 thousand tons of pellets and 450 thousand tons of concentrate.
According to estimates of Metal Expert Consulting, favourable prospects of demand for iron ore from Kazakhstan in the Russian domestic market are attributable to the following factors:
1. Geographical proximity. In the context of current low prices for iron ore, the abundance of its offer in the market, as well as the rising cost of transport to Russia (2016 - 9%; from 2017 onwards the RF Ministry of Economic Development suggests indexing railway tariff to inflation) consumers will seek to optimise the procurement, abandoning more costly raw materials. It is obvious that the main opportunity to reduce purchasing prices for iron ore is the selection of a geographically closer supplier, shipping cost from which will be lower. At the same time, the analysis of transportation cost (charts 3 and 4) of iron ore to Magnitogorsk and Chelyabinsk complexes shows that the Kazakhstani enterprise SSGPO is characterised by the lowest value of railway tariff as compared to Russian suppliers.
2. The expected growth in demand for ore in reconstruction of steel production. The specialists of the RF Ministry of economic development, as well as acclaimed analysts (IMF, OECD, EBRD, etc.) are forecasting renewed growth of the Russian economy already from 2017 that will result in the growth of domestic consumption of finished steel products and, consequently, in demand for iron ore.
Iron ore prices
The global ore market's benchmark has traditionally been a spot price of fine iron ore of Australian origin (62% Fe) for the Chinese market. On its basis the quarterly agreements are prepared, and other providers change their pricing policy.
Over the past three years, the price of 62% iron ore in the global market (Chart 5) declined almost threefold, from USD 150/t up to the level of the current USD 50-55/t (CFR China), which for the last time was observed on the market in the year 2003.
Currently the world iron ore market is primarily affected by factors of imbalance of supply and demand. Global iron ore consumption volumes are falling, reflecting the decline in steel and iron production (according to WSA, by 2% in 2015 and by 4% in the first quarter of 2016). At the same time, supply of raw materials from the leading suppliers -Australia and Brazil, by contrast, continues to grow: last year the export of iron ore from these countries increased by 7-8% (+ 77 million tons). It is clear that the growth of supply from Australia and Brazil goes hand in hand with the reduction of supply by companies from other countries, whose iron ore production costs are higher. In particular, this applies to Chinese mining companies, whose support from the State has weakened significantly in recent years, and the cost often exceeds the current price levels. Despite the decline in demand, the world's leading iron ore producers continue to announce plans to increase the sales volumes with a view to increase their market share. In particular, the Australian Rio Tinto intends to raise production by 40 million tons.
In addition to the above factor of oversupply of iron ore, a vital role in reducing of ore quotes was played by strengthening of US dollar against major world currencies (euro, Yen, pound). In particular, only in 2015 it grew by more than 5%.
According to estimates of Metal Expert Consulting, with declining demand for ore from China, the key drivers of growth in global demand for iron ore in the medium term may become the developing countries in Asia (especially India), Africa and the Middle East. At the beginning of this year, the world continues to implement around 40 projects, while other 10 have been announced. Even if we consider only the projects that are currently being implemented, as well as the planned ones with a known date of launch, the total iron ore capacity increase until 2020 exceeds 500 million tons. It is obvious that not all the initiatives will really completed: even the most courageous forecasts of global consumption growth of iron and steel market will not be able to absorb a 50% increment in offer of commodity iron ore in the next 10 years. In such circumstances, first and foremost, the most effective (with the lowest production costs) and investment secured (vertically integrated holdings that are immediately extracted ore consumers) of all projects will be implemented.
Persistent oversupply of iron ore in the world market and further tightening of competition in the sector are the key arguments in favor of a long phase of low prices for ore. Chart 6 presents a consensus forecast for expected changes in iron ore prices in the short and medium term, consolidated by Metal Expert Consulting based on nearly 20 initial reports by industry and investment analysts, published in April-May this year. Consensus forecast, built as the average value for all current projections, involves stabilisation of the prices of ore at the level of USD 47-50/t until the end of 2017 with further strengthening to USD 60/t to the year 2020 by improving market conditions and rising inflation.
Conclusions and recommendations
Summing up, we can draw some conclusions. Firstly, in the short and medium term the surplus of iron ore in the global market is expected to remain, which will not allow prices to return to the previous high levels.
Secondly, the main external shipment direction from Kazakhstan in the coming years will remain Russia, which is stipulated not only by the long-term contract between SSGPO and MMK, but also by one of the lowest levels of transportation costs among all manufacturers of iron ore due to geographical proximity to metallurgical plants of Russian Urals.
Thirdly, in response to the reduced demand for ore in China and the increased share of transportation costs to traditional consumers in Xinjiang Province, a substantial increase in shipments of Kazakh exporters to this market seems unlikely by outcomes of 2016-2017. However, we believe that as demand for iron ore in Chine grows and ore prices on the global market increase, Kazakhstan is able to gradually regain its lost positions in the Chinese market, which until a few years ago accounted for about 50 per cent of total commodity exports from the country.
According to estimates of Metal Expert Consulting, one of the major factors that can enhance the competitiveness of Kazakhstan's iron ore production to foreign consumers, is to optimise the cost of extraction and enrichment of ore. In this issue, the experiences of leading Australian iron ore companies, including Rio Tinto, BHP Billitton and FMG is indicative, as in recent years they have reduced production costs from USD 25-30/t to the current level of USD 15-20/t.
Another recommendation is to reduce the cost of ore transport across the territory of Kazakhstan, which can be implemented by way of railway tariff reduction by government in the export of iron ore, as well as by increasing the efficiency of railway transport of ores through the use of Supersize cars, increase of the train length, reducing the weight of the wagons (to reduce the load on the shaft), etc.
In addition, we see prospects for growth in iron ore consumption in the domestic market. High potential to increase the metal consumption in Kazakhstan, continuing in view of the need for the development of housing, industrial and infrastructure construction determined the growth of steel capacity load. Given the reduction of scrap collection and worsening deficits in the scrap market in Kazakhstan (after entry into the WTO in late 2015, ban on the export of scrap metal from a country outside the Customs Union was cancelled, resulting in a tightening competition among domestic consumers and foreign importers) an alternative type of raw materials for steel production may become hot briquetted iron (HBI), produced from ore. It is not by chan e that SSGPO JSC project for deployment of high-quality HBI production in Kostanay region (90% Fe) with a capacity of 1.8 million tons of pellets per year is among priorities and is introduced by the Government of Kazakhstan into the integrated plan for the development of the MMC before 2019.