China crackdown on steel output hits iron ore

Analysts say recent sharp falls in iron ore prices are likely to continue in the second half of the year.

Analysts say Beijing is likely to maintain pressure on China’s mills to reduce steel production. Picture: Bloomberg

Analysts say recent sharp falls in iron ore prices are likely to continue in the second half of the year amid increasing supply combined with China’s efforts to curb steel output to lessen pollution.

The benchmark iron ore price has fallen about 30 per cent from a record high of $US233 a tonne in May.

The steelmaking ingredient lost a quarter of its value in the past three weeks as steel mills including Baowu – China’s biggest – fell in line with Beijing’s desire to cut production in the second half.

China’s government has said it wants 2021 steel production to be in line with that in 2020, implying a 59 million tonne curtailment in the second half of the year, according to UBS.

“We are cautious on iron ore prices in the medium term as supply is lifting and demand is moderating,” said UBS analyst Myles Allsop.

He expects iron ore prices to stabilise by September, before falling to about $US100 a tonne next year, implying more than 50 per cent loss of value from the peak.

China appears to be enforcing its target of steel production being flat year on year in 2021, implying crude steel production will fall 59 million tonnes half-on-half to 502 million tonnes in the second half, he says.

“The 10-day CISA data shows daily pig iron production is down about 6 per cent in July versus June (and) key steel producers including Baowu have also announced plans to cut production,” Allsop says. “This has resulted in mills destocking and iron ore prices falling sharply in a thin spot market.”

Morgans Financial analyst Adrian Prendergast cautions that the share prices of the big iron ore miners are likely to come under pressure as they trade ex-dividend. “We still view the value downside vs big dividend return as a trade-off that on a total return basis is skewed to the downside for the big iron ore miners.”

Prendergast notes the iron ore miners have shown a diminishing ability to carry their dividends as the iron ore cycle has progressed.

In February, shares of the three majors lost more than three times the amounts of their dividends in the month after going ex-dividend.

“With more signs of the iron ore cycle slowing, we see a similar risk this dividend season,” he says.

“In particular for Rio and BHP, which have both outperformed iron ore prices over the last month, while FMG’s share price has trailed its bigger peers.”

The benchmark iron ore price has fallen about 30 per cent from a record high of $US233 a tonne in May. Picture: Bloomberg

Rio Tinto fell $8.88 or 6.9 per cent to $120.26 on Thursday after trading ex-dividend $7.59 plus franking credits giving a total “grossed-up” dividend of $10.86.

Investors “looking to lighten positions opportunistically in the big miners should consider waiting to see their full-year results, but then trim before these stocks go ex-dividend”, Prendergast says.

Spot iron ore prices crept up to $US166.40 on Wednesday but futures were down on Thursday.

CBA mining and energy commodities analyst Vivek Dhar says Chinese steel output cuts so far are relatively “tame” as steel mills take a wait-and-see approach to the demands of policymakers, but in his view they may cut output sharply in the December quarter.

Global seaborne iron ore shipments rose just 2 per cent for the year to date, but are expected to rise in the second half as demand moderates, potentially adding to the downward pressure on benchmark prices from China’s attempts to curb pollution.

“We note iron ore exports have not yet lifted materially from Australia or Brazil although producers’ guidance – mainly Rio and Vale – implies supply will lift about 60 million tonnes half on half in 2H21,” Allsop says.

“We expect the China’s steel curtailments to be targeted in 4Q when demand slows seasonally and air pollution is in focus – especially ahead of the Winter Olympics in Feb 22 – and as a result we expect prices to stabilise in Sept/Oct before continuing to fall back below $US100/t in 2022.”

Higher steel prices may make it difficult for China to reduce output as steel margins can impact crude steel output from blast furnaces, says ANZ senior commodity strategist Daniel Hynes.

He notes that, after peaking at $US900/tonne in late 2020, steel margins turned negative in February, causing a fall in output, before Chinese steel makers took advantage of a rebound to over $US1500/t by raising output in the June quarter.

“Beijing is likely to maintain pressure to reduce steel production if steel prices stay high,” he says. “With China’s plans to limit production to last year’s level, we see output falling by 11 per cent in 2H21. This may result in 87 million tonnes of iron ore demand loss.”