Iron ore supply outlook ::Coping with delays and cost inflation -:: Macquarie Research

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Iron ore supply outlook
Coping with delays and cost inflation
 We believe iron ore remains undervalued as a commodity, as a combination
of factors is likely to cause the supply side to underperform in the medium
term. As a result, more Chinese domestic ore will be required to balance the
market for longer. Cost inflation in the Chinese mining sector will underpin
spot prices at elevated levels, and the result will likely be a continued period in
which the cost curve is steep, prolonging the strong cash generation which
makes iron ore such an attractive sector.

We consider the market heavily undersupplied in 2011
 The robust growth in iron ore demand in recent years has strained seaborne
supply to the limit; and, as with many other commodities, China has mobilised
its own resources in order to prevent raw material availability from becoming a
bottleneck to economic growth,. This material is typically low grade (Fe levels
which simply would not be mined anywhere else) and thus high cost.
 Of the 300mt (62% basis) of ore production in China at present, we estimate
only 100mt would be present in an equilibrium market environment, and thus
one could say that the iron ore market is undersupplied by about 200mtpa.
Plenty of supply prospects out there, but also plenty of
barriers to timely delivery
 The big questions surrounding the supply side of the iron ore industry remain
whether the vast number of prospects can be delivered on schedule and
when this supply will start to weigh on the market price. In our view, while still
exhibiting robust growth in the coming years, seaborne supply will continue to
underperform expectations.
 Common themes are apparent through the iron ore supply chain in explaining
the difficulty in bringing new projects to market. A combination of spiralling
capital intensity, infrastructure barrier to entry, financing issues and lack of
control over project execution risk continue to push project timescales further
into the future. Furthermore, issues such as grade depletion and legacy costs,
common across the mining sphere, are also prevalent in iron ore.
Prolonged need for Chinese domestic ore makes the top
end of the cost curve crucial for future price levels
 With seaborne supply struggling to deliver, we think in excess of 300mtpa of
Chinese domestic ore (62% basis) will be needed to balance the iron ore
market through 2013, before new projects erode this requirement. While such
volumes are required, the market remains critically tight, and iron ore is likely
to trade at a level to make even the marginal tonnages viable to extract.
 Moving forward, two crucial factors are at play. From 2012 onward, slightly
less Chinese domestic ore should be needed to balance the market each
year. However, the amount that is left in the market is inflating at a very fast
rate, likely to be around 6% per annum (mining inflation in China has been
running close to 20% pa for the past couple of years). Therefore, we see the
spot price being well underpinned by the cost structure of Chinese domestic
ore at around $150/t in 2015 – well above market expectations.