Base Metals Forecast: Sharp Steel Slowdown, Iron Ore Overcapacity

UNCTAD recently released a report forecasting a 15% decline in global steel demand, which comes after a 1.4% decline in 2008. While most of the world is expected to experience sharp declines in demand, even China is expected to see a 5% decline, though in 1Q09 China still eked out 0.8% of demand growth.

The global contraction in demand has resulted in extremely low May 2009 capacity utilization levels of 43%, 49%, and 55% for the steel industries in the US, Europe, and Japan. Again, even China, despite its growth, was recently about 78% utlization as per the UNCTAD piece, and via other sources is expected to see capacity utilization in the 70% range this year due to over-expansion of steel capacity.

What do the YTD data vs. forecasts tell us? We haven't seen the worst yet out of China. The UNCTAD report implies that most of the 5% decline in Chinese demand should be weighted towards the second half of 2009. The worst is yet to come from China in terms of steel demand, and keep in mind UNCTAD takes note of Chinese government stimulus plans. Falling capacity utilization forecasts for YTD vs. full year 2009 imply the same.

On the iron ore front, falling steel demand is butting up against iron ore production capacity growth and current under-utilization. Also, in terms of seaborne trade volume, despite the potential for smaller high-cost-basis mines in China to shut down (increasing the need for imported ore), seaborne iron ore trade is indeed expected to decline along with lower global, and particularly Chinese, steel demand. Clarkson sees seaborne trade volumes falling back to 2007 levels, as shown below.

For iron ore in general (seaborne or land-shipped), one particular UNCTAD chart really captured the problem ore pricing faces over the next few years, shown below. Essentially, new ore production capacity additions will outstrip new demand by a wide margin. While the demand estimate they use might be a bit too conservative, particularly if Chinese demand rebounds well, say in late 2010, the supply/demand gap is large enough to accommodate even a pretty substantial upside surprise in terms of steel demand for 2009 - 2011. Nevertheless, one feasible way to close this gap would be if a sizable amount of Chinese ore production shut down due to high costs, and do so very rapidly, faster than UNCTAD has put in their numbers. It's a bit of a long shot. Net-net, while iron ore is becoming increasingly controlled by only a few players (Vale (VALE), Rio-Tinto (RTP)/BHP), despite recently higher ore prices amid contract negotiations, I wouldn't be too bullish on iron ore over a 2-year horizon even if major players can use their high market share positions to support pricing a little bit.

Comments

[Rohan C. Pease:]

China steel production in June on an annual basis is on track to beat output from 2007 or 2008. Momentum is still on the iron ore producers.

Jul 10 03:07 PM

[Rohan C. Pease:]

Your UNC TAD data is backward looking, steel markets require to be forward looking.

Jul 10 03:09 PM

[Vincent Fer...:]

Rohan, I don't quite understand you. We refer to UNCTAD forecasts... forecasts are forward looking. They FORECAST lower steel demand in 2009 vs. 2008.

Jul 13 03:10 PM

[Rohan C. Pease:]

From Rio Tinto's earnings conference call it looks as if those FORECASTS are a bit flawed. Goldman Sachs conference call with head of commodities Jim Oneil spoke a couple months back about the increased growth in China and how that will buoy golbal GDP in the second half of 2009 and into 2010. Every week that passes by confirms that fact. Long Vale and FSUMF shares.

Jul 15 04:24 PM

[Vincent Fer...:]

That's fine if you believe their forecasts will be wrong. But you initially implied we were looking backwards, at historical data. Also, while fair to question the UNCTAD report, I wouldn't put too much confidence in Rio management... keep in mind its iron ore negotiation time... and also... the company has proven itself to be horribly managed! They were caught completely off guard by the recent downturn.

Jul 16 05:15 PM