China Commodity Call - Domestic iron ore – all the rage  Macquarie Research,

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China Commodity Call
Domestic iron ore – all the rage
 The combination of robust Chinese pig iron production, lacklustre seaborne
iron ore supply and declining seaborne ore grades has led to a surge in the
use of Chinese domestic iron ore over 2011.
Unusually, domestic iron ore prices have outperformed
seaborne prices
 Historically, higher dependency on domestic iron ore has correlated strongly
with an increasing price premium for imported ore over domestic
concentrates. This year however, the premium for imported ore has actually
contracted with the rise in domestic concentrates. We believe two factors
have driven the relative outperformance of domestic ore prices – tighter credit
conditions and the desire to maximise blast furnace efficiency.
For long product producers, productivity is key
 Profitability, for the long product producers at least, has been extremely good
this year. This has driven a desire to maximise blast furnace productivity, to
ensure as much product as possible can be sold into a strong market.
Historically, this was best achieved by using as much imported ore as
possible but as seaborne grades have declined this year, domestic
concentrates have been a better option – seemingly in the form of pellet.
 One measure of the relative demand for pellets over fines is to compare
pricing for the two products. The chart in fig 5 shows the price premium for
domestic pellets over domestic concentrates (on a dmtu basis) against our
estimates of cash margins for a spot raw material dependent mill in China.
There is a clear correlation between increasing margins and an increasing
pellet premium, with the pellet premium rising to strong levels this year
relative to last.
 The pellet premium has pulled back since the middle of July, in line with
easing steel production and some softening of the demand indicators
(stabilising rebar inventory for example). However, the fact that the premium
remains high relative to history indicates that supply of good quality iron ore is
still tight and that mills are not planning to drastically reduce production from
current levels.
Coal – Looks strong into winter
 Macquarie joined the 2011 McCloskey China Import and Export Forum held in
Beijing this week. Feedback from the conference was quite upbeat in terms of
the thermal coal price outlook for 4Q11.