Iron Ore or Not

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he decline in iron ore prices over the last decade correlates with the fall in China’s economic growth. China produces as much steel as the world combined at around 800m MT and the key component of steel are the properties of iron ore, namely hematite (Fe2O3) and magnetite (Fe3O4). With the supply demand out of sync this is feeding through to increased spare capacity, low rates of utilisation, low profitability and capital returns.

With a fall in demand, many of China’s steel producers have been burdened with heavy debt commitments with increased caution by state owned banks with regards to lending to steel companies. Chinese banks are struggling with increasing non-performing loans, exceeding $301 billion and accounting for 2.15 percent of total bank lending. Banks in China therefore ought to increase stress tests and pursue greater risk analysis.

Even with the fall in China’s demand for growth, the supply or iron ore remained subservient to the China’s bloated industry leading to the price of iron ore dipping just below the US$40. In 2016, prices have crept up cautiously with low marginal producers exiting the market and cancelled projects, leading to returning to a point of equilibrium.

Demand for Chinese steel in the US also faces troubles. The majority of steel in the US is made from iron and scrap metal — a process which requires much less energy than the production of iron and steel products from iron ore. With the real likelihood of import taxes on imported steel, it is widely expected that the market will remain in backwardation.

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