Viewpoint: Iron ore holds up despite headwinds

Iron ore prices have fared well in the face of collapsing steel demand and prices, despite widespread blast furnace production reductions and outages.

The Argus ICX 62pc index was $83.55/dmt cfr Qingdao today, up a touch from $81.35/dmt on 10 February, the first day of business after the lunar new year holiday period.

During China's two-month-plus lockdown, which started on 23 January in the Wuhan region, iron ore rose as high as $91.35/dmt despite reduced steel output.

Scrap under strain

Global scrap prices, conversely, came under sustained pressure in March, taking the ratio between the two primary inputs towards historical lows.

Argus' headline HMS 1/2 80:20 cfr Turkey assessment shed $68/t over March, falling from $275/t to $207/t by the end of the month on the back of weaker steel demand and falling rebar prices.

The ratio between scrap and iron ore, unadjusted for Fe unit, fell to 2.5:1 at the start of April, much lower than the typical historical average of 4. It has nudged up a touch since, as dwindling collection rates have boosted Turkish import prices, which have risen by $32/t, to $239/t cfr, in the last four business days alone. But the ratio still looks historically low at 2.92 as of yesterday.

Turkey is the price setter for global scrap — as the biggest seaborne buyer with a preponderance of scrap-fed electric arc furnaces — just as China is the price-setter for iron ore, with its reliance on blast furnace production. As a result the ratio between the two inputs is a good barometer of the respective cost bases of both steelmaking routes, and can point to potential future price direction; the comparatively low ratio could suggest scrap has further to bounce, or ore room to drop. Where the ratio blows out, EAF mills can opt to procure blast furnace-based semi-finished steel, or other metallics. Where it shrinks, blast furnaces can flex up scrap charge.

The ratio is something of a blunt metric, not accounting for regional disparities; the Chinese market is up and running after its Covid-19 shutdown, which could support iron ore, while Turkey is exposed to the weakening European market. Turkey is also far behind on the virus curve, which could see it reduce production in the coming weeks.

Chinese domestic scrap prices have fallen sharply in the past week, with private mill Jiangsu Shagang cutting its No.3 HMS purchase price by 280 yuan/t ($40/t). This is its lowest price since April 2018.

The iron ore forward curve is in backwardation, highlighting the relative strength of current spot prices, but it is milder than some would expect: Argus assessed the second-quarter curve at $77/dmt today, and third quarter at $74.75/dmt, compared to $83.55/dmt spot index today.

Sticky ore leads to margin squeeze

This surprising strength in iron ore has seen blast furnace margins squeezed for global producers.

Fob China hot-rolled coil (HRC) was trading at a premium of just $194/t over blast furnace raw material costs today, according to Argus data: the benchmark fob China HRC index has fallen by $90/t since the start of February, whereas iron ore is up marginally, at a time when global mills are throttling back output because of tanking demand. Turkish mills are currently pushing up their offers as a result of rising scrap costs, while longs prices fell more slowly than scrap over March, providing some theoretical margin.

The appearance of Atlantic pellets in the Chinese market as suppliers shift away from Europe — where blast furnace output is being rapidly curtailed — is heightening direct charge supply. Chinese market participants expect more Atlantic pellet spot sales to China as measures aimed at reducing the spread of Covid-19 stall European steel demand and keep pig iron production low. Over 20mn t of blast furnace capacity has been idled or not restarted because of the virus, not accounting for furnaces being run at reduced rates; the vast majority are at reduced utilisation, with some, such as Tata Steel, operating furnaces at technical minimums of around 60pc.

But the circular nature of the Chinese iron ore market, where mills often become sellers as they offer contractual volumes in the spot market, means there is less desire to see lower prices.

The concentration of volumes with larger trading firms also means that any sharp decline in prices will translate to losses in the portside market where these seaborne volumes are eventually traded. And while seaborne iron ore supply is set to rise amid steel capacity cuts and the idling of blast furnaces across regions, port stocks in China are still not even close to levels seen in the first quarter of last year following the January 2019 Vale dam accident, which disrupted supplies globally.

Mills in China and the rest of the world place significant value on maintaining their relationships with miners and few will push too hard for lower prices, not wanting to risk being caught out in the event of disruption in supply.

Japan's biggest steel maker Nippon Steel is cutting work hours for employees to cover any increase in operation costs rather than seek any substantial discount in raw material prices, as it weathers a sharp drop in steel demand.

There are also sources of supply tightness. Earlier this month, Vale revealed that 27 of its 125 structures failed to receive stability certificates from Brazil's National Mining Agency. But it remains to be seen how long iron ore prices can face up to market headwinds. A sharp enough drop in Chinese domestic steel prices and subsequent narrowing of margins could well pressure Chinese importers to seek lower iron ore prices.

And Chinese mills are facing intense competition from Russian and Indian mills looking to offload volumes in a weak market. Indian sellers have again been aggressive into southeast Asian markets, and are returning to other export markets such as Europe.

By Siew Hua Seah and Colin Richardson