MARKETS SPECTATOR: BHP's iron advantage

Could iron ore lift the gloom surrounding BHP Billiton?

Iron ore accounts for about 65 per cent of sales at BHP. The world’s biggest mining company said its annualised iron ore production rate is now approaching 200 million tonnes compared with a 12-month to June 30 forecast of 183 million tonnes.

Iron ore production in the three months to March 31 was up 6 per cent year-on-year and 3 per cent on an annualised basis, according to BHP’s latest production report. Western Australia iron ore achieved “record production”, says the company, for the nine-month period ending March 31. By March 2014 BHP’s annualised production could be up to 220 million tonnes because of the Jimbelbar mine expansion.

Iron ore is currently trading around $US126 per tonne, according to Credit Suisse. Iron ore sales are not just determined by the spot market. Miners also negotiate iron ore sales on a contract basis – that they are loath to disclose – that may or may not be based on the spot price. Credit Suisse forecasts the spot price for iron ore fines this year, cost and freight, will average $US128 a tonne, the same as Citigroup who raised their forecast on Monday from $US120.

BHP, Rio Tinto and Fortescue Metals Group have successfully kept competitors out of China, although a multi billion-dollar mistake by their Brazilian competitors did help their cause. Vale is crying foul because Chinese authorities are not letting their 400,000 deadweight tonne vessels dock at any Chinese port. BHP charters ships. Its costs to rent vessels to carry its iron ore has fallen like a stone. In 2008 the daily rate to hire a 170,000 deadweight tonnes vessel was about $US300,000. Today the same rate is about $US5000 a day.   

The dire predictions of a slump in iron ore prices have yet to materialise. UBS forecasts that in the third quarter this year iron ore prices could go below $US80 a tonne. If BHP’s iron ore production remains as robust as it forecasts and its transport costs and market share remain unaffected along with a better than expected price for the commodity – a lot of 'ifs', admittedly – then the shroud hanging over its stock because of perceived weak Chinese demand may start to lift.

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The price of iron ore is not what we should be looking at, it's all about demand. If demand for iron ore remains stable, then all is well. Australia has the propensity to overproduce, thus shooting itself in the foot. Ask a CEO, if he understands critical mass, if he replies "What is the application" - then get another CEO, who does understand.

I'd read elsewhere about generally plunging rates in global shipping so was interested to read these specific amounts in iron ore miners' costs and that their decline had been even more precipitous. The received wisdom as I understood it why the Australian miners have always had the Chinese market to themselves is nothing more than an accident of geography. From costing a trifle, it's now just a pittance. The additional distance from Brazil to the main Chinese ports added as I remember $20/tonne or more shipping costs. The Valemax fleet was meant to reduce this but surely Vale is still landing some ore in China and elsewhere and is also benefiting from the reduced rates. What is odd is how they can have been so wrongfooted in their dealings with the Chinese that they spend billions of dollars on ships that are now substantively obsolete. A quick Google search lists an article from last June from Caixin Online that provides more in depth analysis on this issue, suggesting not to expect resolution any time soon.