Another Consequence Of China's 'Ostrich' Economics: Iron Ore And Coal Set To Plunge Further

Tyler Durden's picture

The impact of unsustainable production in Chinese Steel-making plants, to avoid the inevitable employment consequences, has created a 'glut'. This excess inventory will need to be worked through before spot Iron Ore (and Coking Coal) prices can stabilize.

Morgan Stanley believes the sharp raw material price declines since mid-July followed a collapse in Chinese steel prices and aggressive margin compression. This was the result of continued weakness in demand and the over-production of crude steel, reflected in rising producer inventories. This is in turn has resulted in aggressive thrifting of raw material purchases. More recently, the price declines have accelerated with Chinese re-bar and HRC prices reaching 33-month lows.

In their view, prices of steel making raw materials can recover in 4Q 2012 and in 2013, but spot prices for both iron ore and coking coal first have to fall below the marginal cost of seaborne (not Chinese) production to  drive out the short-term supply overhang. In addition, Chinese steel mills have to complete finished product and raw material de-stocking to stabilize both steel and raw material prices (if they are ever allowed to). Iron Ore prices could fall 17% further before this 'stabilization' and spot coking coal over 8% from current levels.

Spot Iron Ore and metallurgical coal prices...

Where will prices stabilize?

Our best estimate of where spot prices for iron ore and hard coking coal might bottom-out in this environment is one in which prices reflect levels that are below the marginal cash cost of the true seaborne market, not sellers of distressed or displaced cargoes in this environment, the price has to reflect a level that drives the seaborne sellers out of the market, albeit temporarily. At the same time, as the spreads between domestic and international prices widen (especially in the iron ore market), prices at levels below true seaborne marginal cost should also become sufficiently attractive to beleaguered Chinese mills to finally entice them back to the market, albeit on a small scale until steel prices stabilize. At the time of writing, with spot prices for 62% Fe fines CFR into North China at US$99.40/dmt, Australian net back prices on the IODEX platform for a capesize cargo, with an 8.03% moisture adjustment, are US$94.32/t, while Brazilian net backs are at US$82.60/t with a 9.0% moisture adjustment.

The global seaborne iron ore cost curve (ex-China), 2012

Worst case scenarioprices could overshoot below the seaborne marginal costs of around US$92/t DMT CFR. We think the true seaborne market (which excludes China domestic production) is driving current prices. Given that there could be as much 4Mt of displaced cargoes trying to find immediate buyers in this environment, we believe there is a possibility prices could overshoot on the downside.

Based on data from CRU Consultants, we estimate that on a business or cash equivalent basis, the 90th percentile of seaborne suppliers (ex-China) as a proxy for marginal cost is US$79/t on a FOB wet metric tonnes basis for two small Australian producers. At current spot freight rates and an average moisture content of 8%, this equates to an implied CFR price of US$92/t, some 7.7% below the current spot.

To highlight the very short-term risk of prices overshooting even below this level, we have assumed a potential further downside risk of 10% below this indicated price level, suggesting a possible floor in the price around US$82-83/t cfr North China for 62% Fe fines. At this level, prices would have fallen to the 86th percentile of current true seaborne costs, a level 16.9% below the current spot price.

Interestingly, at today’s spot price, the 4Q 2012 midpoint price is at US$93.25/dmt CFR DMT North China, slightly above the estimated level of the seaborne marginal cost. On the same basis of a potential overshoot 10% below estimated seaborne marginal cost, spot hard coking coal prices could fall as low as US$150-155/t fob North Queensland, indicating further potential downside of 5.2-8.3%.


Source: Morgan Stanley

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francis_sawyer's picture

Does anyone know where the love God goes when the waves turn the minutes to hours?

LetThemEatRand's picture

Fellas it's too rough to feed 'ya.

fonzannoon's picture

sometimes i think it's a sin when feel like i'm winning when i'm losing again

Manthong's picture

.. she’s a good old boat and she’ll stay afloat in the toughest gales and keep smiling.

Well, With the Baltic Dry Index down 59% YTD and the fleet over-capacity, they can ship all that excess steel and coal just about anywhere for a song.

Whatta's picture

fella's its been good to know ya...

FoxMulder's picture

The wind in the wires made a tattle tale sound
and a wave broke over the railing

MisterMousePotato's picture

The church bell chimed 'til it rang 29 times for each man on the Edmund Fitzgerald.

MisterMousePotato's picture

p.s. This article reinstilled in me my sense of utter inadequacy so common when I first stumbled across this website two or three years ago. Does anyone actually have any knowledge or proof that Tyler Durden really is human? Every sentence is a masterpiece.

Hayek FA's picture

The sea was angry that day, my friends

Vampyroteuthis infernalis's picture

That POS known as China can only get away with centralized planning so long. Rot in hell commies.

Fish Gone Bad's picture

China poisoned pets and children with melamine in case anyone forgot ...

Element's picture



"... Iron-ore below $120 a metric ton is a “short-lived” situation, ..."



In early 2009 China was screaming about $60 iron ore, demanding it be dropped to ~$37.

Input costs are currently way too high so cutting supply to maintain price is still not going to be stable either, it will just really piss-off Asia, cause it to sink further, at a time when it needs a lower price.

The Australian dollar is also way too high which means our exports push inflation into Asia.  It hurts us and hurts all our trading partners, so no side wins from this, and no one wants it.  So a collapse in AUD would be a huge and very welcome development indeed.

Oil is also much too high, and has been for a long time now, so inflation is driven harder again.

Consequently a serious trade spasm within Asia is inevitable in that situation.  Maintaining elevated prices of iron ore by reducing production is a destructive short-term response.  

What surprises me most is that it's has taken this long to occur!  I expected this sort of response last year, but it's taken a fall-off in European demand for it to occur, which tells me China and Asia was fairly resilient.

The bonus is it is going to rationalise miners and prod them back to efficiency.  It will also force China reconsider its consumption habits, and maybe avoid follow on spikes.

chump666's picture

...and the HFTs are all over the ASX200.  Nanex go check it out, probably the worst algo churning you'll see.

otto skorzeny's picture

Coal companies won't give up the ghost. Don't get me started on NG dogs like debted-up CHK

Cursive's picture

Nothing like a planned economy to create huge resource misallocation.

ekm's picture

I have said it, I say it and I always will say. Buying and Storing raw materials is NOT consumption. It comes to a point that nobody wants to store any longer.

Same thing with crude oil. Buying and storing crude oil is NOT consuption. Crude is going back to $40, faster than an eye blip, as soon as people owning storage will not accept delivery any longer (same as for iron ore) and the cargos will have to be dumped into the SPOT market.

I know Zerohedge disagrees with this, but hey, life is tough, suck it up.

akak's picture

Your thesis might hold some water if the combined world stockpiles of those commodities were more than a fraction of annual world production. 

Yes, the dishoarding and cessation of stockpiling could and would lead to a decline in prices, but nothing on the order of >50% for an extended or indefinite period (say greater than one year).  While that may be significant in the trading pits, it is just a blip in the broader world economic picture.

ekm's picture

Good points.

There is a difference between World Production and World Consumption. I think stockpiling is quite a high fraction of world consumption.

I'm not sure about how low and for how long would iron ore stay low, but for crude oil, knowing that is the absolute basic resource of western civilization, I'd say it won't stay at $40 for longer than 6 months, probably 3 months.

akak's picture

I was mainly aware of those facts by discovering a number of years ago, somewhat to my surprise, that the ONLY commodities of any significance which have an accumulated aboveground (refined) stockpile of greater than one year's worth of annual production are silver and gold, with anywhere from 5 to 20 years for silver, and approximately 60 years for gold.

ekm's picture

Gold is totally different, silver a little bit less different.

There's no massive brand new amounts of gold being extracted. Hence, it's so easy to manipulate gold in any direction. It can be easily stored while still being extracted and refined.

As far as oil is concerned, nobody is interested in shutting down oil rigs everywhere in the world for a long time due to a huge overhand of oil in storage. It will come to point that OPEC itself will advocate (secretly) an oil dump, otherwise they'd have to fire people for working at rigs at those countries.

I am not sure about silver though, since silver is 2nd most important resource for the western civilization. No electronics without silver, different from gold, 55% of it has crucial industrial use. That's why silver is more important target for manipulation to keep the price low.

Stuck on Zero's picture

The big stockpiles will be in scrap iron and steel.  Even if all iron ore shipments seize scrap steel will keep a slow econom going for a long time.


ekm's picture

How low is low? Your opinion...........

fonzannoon's picture

ekm if china hoardes all these materials and then revalues the remninbi against the dollar sending it rocketing up does that not send crude skyrotecking for the US?

ekm's picture


China can't skyrocket rmb vs dollar since they are have already over production of anything and suffering deflation. If they revalue by a lot it will get worse in China. Korea very calmly is dumping Kias and Hyundays in France and Frech got wind of it and got pissed since Renaults and Peugeots are not getting sold.


I can't see how revaluing rmb vs dollar could affect crude oil price. Please, explain.

fonzannoon's picture

i would and i had a broader thought that i wanted to ask u about but i have a 2yr old that is preventing me from thinking straight. have a good night fellas will try this again later

ekm's picture

Well, thx for 'wanting to ask me sth'.

If you want to better understand China, this link is mandatory to watch. US Army Chief of Staff.


SafelyGraze's picture


Oil gets pumped out of the ground in Africa, or someplace, then we refine it down, dig another hole, bury it again in a strategic petroleum reserve and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.


dexter bland's picture

Iron ore and coal are falling fast because they are much more difficult and expensive to store (bulkier by value). We have seen with copper, even aluminium they can just keep piling it up in warehouses without running out of space, and the price holds up because there is no visibility into demand and people are still buying it as a "store of value". Oil likewise. PMs are the ultimate in that regard (in small quantities that you don't have to hire guards for).

Who knows when these will correct to close to a marginal production cost? If they do it won't be because they run out of space, or because of the supply/demand fundamentals. But just because paper traders decide its time to start shorting.


SamuelMaverick's picture

smarten up ekm,  the producers of commodies arent complete morons. Oil and gas producers shut down production of wells when the prices tank, and get them back online when the prices surge.  All the while smart traders figure the time lag for both as it affects the price.

ekm's picture

Correct for the western countries.

Incorrect for the poor OPEC countries. They cannot afford to shut down anything.

Russian ISDA MA's picture

What about the Hedge Funds building sythetic CDO's exposed to the Chinese and HK Property markets?  Same way they did it here, but on Asian exchanges.  Take a look at this entry and explore the rest of the blog...You'll see CDO "managers" doing "casino projects", and unexplained cash flows....all connected to chinese REIT!

Think John Paulson was duped in Sino Forest?  Think again...Hes connected to Stanley Ho in more than 1 way...and that is how they are laundering the shorts for the chinese market.


euphoria's picture

From someone who works there, the Queensland coal mining industry is cutting a lot of costs at the moment with a lot of contractors being put off and expansion plans put on hold/suspended. A 'wait and see' approach seems to be the current state of affairs at the moment, at least for the next few months. Early 2013 the industry could look a lot different (read smaller). Mining investment drives Australias GDP, if plans get canned/put on hold (Case in point Olympic Dam in SA) the flow on effects to the supporting industries of manufacturing/freight/logistics etc will severely hurt the Aust economy. With so many people leveraged to the hilt over here, look for this to flow through to leveraged assets (read housing). $AUD over parity to the US$? Unless there is worldwide money printing and a massive injection to China to continue this ponzi charade for a little longer we will be lucky to see it over $0.50 to the US.

chump666's picture

Australia is in big trouble.  Thanks to easing from the lunatics at the ECB and Fed, oil inflation is eating into company profits as operational costs increase.  Now, Australia will probably crash hard from their over geared housing market and mining boom going bust, so if the RBA cuts and the AUD tanks further it WILL take out the short end Aust bond market that was a safe haven.  Not now.  Inflation, hard landing in China will devastate the Australian ecomomy.


Element's picture

Last time that happened we got a gargantuan boom 9-months later that fed into Asia, as a low AUD, low oil and low commodity prices made bulk industrial inputs extremely attractive.  The NET result was no recession, not even an enduring down-turn, and a massive rise in exports orders and foreign investment.

The sharper the fall the more vigorous the bounce that immediately follows, no point denying that.

And you forget, the Commonwealth has next to no public debt again and a nearly balanced budget.  Canberra definitely will do this again, because even in a global depression they have paid down almost all the past stimulus, and approximated balanced books again, while the actual highly productive economic activities (profitable revenue-raising investment), occurring on the ground, grew at a genuinely frenetic pace since mid-2009 to present.

So it would not just be unmerited, but unwise to assess or presume that this situation going to fall in a heap, any time soon.  At worst it will stagnate, and it's momentum attrite, while everyone else lingers in an economic ruins for a few years.  Asia and its secular demand is not going away, the trend just gets bigger.

MisterMousePotato's picture

I tried to give you both a green arrow and a red arrow because, well, I'm not sure. (Turns out you can only do one or the other, but at least you can switch them back and forth to your heart's content.)

While I cannot see anything specifically in your post to disagree with, nonetheless, it seems *simplistic*, shall we say?

I mean, can anyone really think that Aussie real estate is not in a (HUGE) bubble? Or that it's preeminent industry (mining) is falling off a cliff?

Maybe it is short term. Who knows? But i kinda think not ... based, not on Oz data or wishful thinking, but what we're seeing out of China, Europe, U.S., etc.

Or does anyone really think that Argentinia is going to replace U.S. demand for iCrap?

Element's picture

Understandable, but keep in mind I've been reading Steve Keen for a long time and am well aware of the situation in RE and mining.  I'm just saying that this is most likely what'll happen as the transient hits shake-out, and yes, it's simplistic.

economicfreefall's picture

Well holiday season is coming up in India...they seem to stack a more yellowy metal though.

It seems, however, that high price levels have not really dampened retailers' seasonal buying moodin the run up to the festive season that kicks off this week in India. Bulk purchases for marriages continue, with most retailers stocking up and individuals buying smaller items of gold jewellery.

rosiescenario's picture

How much Aluminium has Goldman got stockpiled????

Lloydie's picture

Still think that no analysis of iron ore prices is complete without the inclusion of the global demand for steel.  As I understand it Europe is shutting down and iron ore is being redirected by Vale to China.

SafelyGraze's picture

steel demand skyrockets with gov order of a hundred thousand combat boots



msjimmied's picture

What was China's thinking? Earlier, I came away with the impression that they saw commodities as a store of value, they stockpiled all the metals and oil etc etc, they could get. At some point, everything else is going to go kaplooey, and they are will have enough to stoke their engines of production to take over the world. Much like how we're sitting on PM's. Did they misjudge how long kick the can can last? Hell, I know we all shame in that, but it's gotta hurt. I just hope they don't use their ire to channel the frustrations of their worker ants, we have enough pissed off worker ants of our own. It would be good to remind all worker ants that the enemy is not other worker ants, but the fat drones up above. Anarchy in the Hive is called for. 

LMAOLORI's picture




Not going to go kaplooey already is. If you think the U.S. is a Ponzi China has us beat by a landslide empty cities, the banks are even worse then ours.  Chinese Elites have looted them and fled. They also used stimulus spending to keep up their exports that caused inflation.  China put price controls in place on food it was so bad. The stimulus couldn't fix the core problems of reduced demand. Since China's economy was built on low paid slave labor the serf's couldn't afford to buy enough domestically.  When the serf's wanted higher wages China started outsourcing to even lower wage countries like Malaysia, Vietnam, the Phillipines.  Try that Anarchy in China and you will be dead. 


Chinese Manufacturing Is Crashing

China’s stimulus headaches




China's industrial profit dips, puts stimulus in focus

Bo Xilai and China’s corrupt secrets

The Macroeconomics of Chinese kleptocracy


squexx's picture

I'm sure there is no shortage of golden colored tungsten bars in China!

Richard Chesler's picture

Chinese Steel.

An Oxymoron.




Barometer's picture

"Wise man not invest in overcapacity" H Hendry