Very bullish for iron ore in 2008, not so for 2009

Implications: Contract prices likely to soar in 2008 Rising supply and weaker demand may lead to weakness in 2009

Analysis: Spot Indian iron ore prices are currently around $175/tonne cif China. For those Chinese mills paying contract prices for Australian iron ore of $52/tonne fob, even a $30/tonne freight rate means they are getting a bargain. Everyone knows this and the only question is whether price increases for iron ore in the 08 contract are up 25% or higher.

I want to focus on 2009, because while the consensus is for further price gains then, I think the market will look very different this time next year.

Firstly, Chinese iron ore demand will slow in 2008. For the last five years, Chinese steel output has been able to grow faster than demand as Chinese steel initially replaced imports and then started to export. However, the imposition of export tariffs (likely to be extended) means that exports will be at best flat in 2008 compared to 2007 and could be lower. That means that steel output will rise in line with domestic demand - probably around 12-13% if you take the average of the last 2-3 years. This is significantly lower than the 20% plus steel output growth of the last few years. As a result, iron ore import growth will slow - our number crunching suggests a still large increase of up to 100m tonnes (raising the total to around 500m tonnes).

The problem is, we expect output growth to be more than 100m tonnes. In Australia, BHP Billiton is adding 20m tpy of capacity under Rapid Growth Plan 3, Rio Tinto is adding 40m tpy of capacity at Yandicoogina and others, while has a further 30m tpy at Hope Downs coming on late in the year or early 2009. Fortescue Metal Group has 55m tpy of capacity coming on at some point during the year, even if it is delayed. In Brazil, MMX will sell at least 15m tpy additional material as it starts its mines, while CVRD plans an additional 25m tpy of sales. CSN is also planning 15m tpy of extra sales. Kumba of South Africa will have an additional 10m tpy extra for sale, and a whole host of junior Australian, Brazilian, Chilean and North African miners will add around 20m tpy of capacity. A back-of-the-envelope calculation makes that around 200m tpy of extra sales in the market.

Can this additional material go elsewhere. Not really. European demand may be up 2-3% - possibly an additional 5m tonnes, and the same for Japan. Other Asia may take an additional 2-3m tonnes, while the Middle East could take up to 10m tpy. North America is essentially supplied internally.

Even if some of this capacity is delayed until later in the year, it will definitely be developed in 2009 and there are a whole host of other new mines coming on in at that point. The visibility of the market and the dynamics will have turned this time next year.

What about the consolidation of the iron ore industry you say. Well, 2008 will see the emergence of 2 new significant players. FMG and MMX will be in a position to sell more than 50m tpy each in 2009, and both intend to go to more than 100m tpy by 2011. CVRD wants to add another 100m tpy of capacity at least by 2012 from 2008. It may be willing to negotiate price in 2009 in order to ensure volume sales.