According to the company’s website news release on February 21, 2023, in the first half of financial year 2023 iron ore prices (62%, CFR, Argus) traded their narrowest range since the second half of financial 2020. The 62% index ranged between $79/dmt and $120/dmt, averaging around $101/dmt. Half–on–half average prices were –28% lower than the second half of financial 2022. The average lump premium was US$0.13/dmtu in the first half of financial year 2023, exactly half of the average achieved in financial 2022.
Six months ago, we recounted the surprising decline in Chinese port stocks that occurred over the first half of calendar 2022. The series of developments that led to this unexpected outcome, were: (1) elevated BF utilisation in China despite weak profitability, as scrap shortages and energy issues hindered the EAF fleet (2) lower than expected aggregate seaborne supply from low–cost majors (3) lower than expected aggregate seaborne supply from junior and swing suppliers, including India.
These conditions did not feel sustainable, and they were not. Voluntary cuts in BF production emerged very early in the second half of calendar 2022, as loss–making deepened on weak downstream demand and elevated coke prices. That set off a multi–month phase of downward price pressure. Deepening pessimism on housing, the zero–COVID situation and the global economy, plus uncertainty as to how the authorities would pursue the zero–growth mandate for steel in the latter months of the year, all played their part in driving prices down to the lower end of the real–time cost support range, which we estimated was $80–100/t.
Sentiment began to turn from November, as policy U–turns on property developers and zero–COVID saw market participants upgrading their views on the performance of the steel value chain in calendar 2023. In what seems like the blink of an eye, the iron ore price was almost 60% higher in early February 2023 versus its $79/t low, fittingly recorded on Halloween.
Moving to differentials, the average lump premium (LP) of $0.13/dmtu in the first half of financial 2023 was the lowest since the first half of financial 2021 – which some readers may recall was a phase of “profitless recovery” from the original shock of COVID–19. Fewer mandated restrictions on sintering, rising lump supply, weak overall steel mill profitability and elevated coke prices all impacted on LP dynamics. In the fines space, differentials to the 62% index for the 65% and 58% indexes narrowed across the first half of financial year 2023 (i.e. lower premiums for higher grades, smaller discounts for lower grades), in line with the deterioration in steel margins and the consequent move by mills to procure lower cost raw materials on average. Beyond these fundamental drivers, lower–grade products received additional support when India introduced export tariffs, thereby removing some supply from this suddenly desirable quality bucket.
The feedback loop between Chinese steel margins and lower–grade differentials is one of the major watch points for benchmark 62% pricing in calendar 2023.
How so? The swing suppliers who balance the market tend to be lower grade producers. While their traditional cost base changes slowly, their incentive price to continue shipping is not fixed – it fluctuates daily based on two things over which they have little or no control (1) the size of the discount that market participants currently ascribe to their products, and (2) freight netbacks from CFR to FOB, which can be considerable for, say, a Brazilian junior selling into North Asia. At times, freight and differentials can move in the same direction, at speed, and real–time cost support – the level at which the swing producers cease to earn an operating margin – can change very quickly. That is why we tend to identify a range for real–time cost support, rather than providing a single number.
There was a live illustration of this recursive dynamic operating to the downside just a few months ago, with lower freight and smaller discounts dragging the incentive price of swing producers down to the bottom of the recent range of $80–100/t, with prices ultimately bottoming at $79/t. Earlier in the pandemic, the reverse was true, with elevated steel run–rates in China, buoyant steel margins, elevated freight and large discounts for lower–grade producers combining to lift real–time cost support to the $120–130/t range. In this regard, it is important to note that discounts cover a very wide range, with the potential to blow out to around –40% or more when operating conditions are propitious for steel makers, and freight rates are even more volatile than underlying commodity prices.
With spot iron ore trading above $120/t CFR in the early part of calendar 2023 with China steel margins still negative, Capesize freight rates near record lows and lower–grade discounts still narrow, the above discussion is far from academic.
In the medium to longer–term, as described in our steel decarbonisation blogs (episode 2 and episode 3 in our Pathways to Decarbonisation series) higher quality iron ore fines and direct charge materials such as lump are important abatement sources for the BF steel making route during the optimisation phase of our three–stage Steel Decarbonisation Framework. In China of course, the BF–BOF route represents roughly 90% of steel–making capacity, with the average integrated facility being just 11–13 years old. BHP’s South Flank project, which achieved first production in May 2021, will raise the average iron ore grade of our overall portfolio by around 1 percentage point, in addition to increasing the share of lump in our total output from around one–quarter to around one–third.
Our analysis indicates that the long run price will likely be determined by the all-in cost base of the least competitive seaborne exporters (higher narrow cost, lower value–in–use) in either Australia or Brazil. That assessment is robust to the prospective entry of new supply from West Africa, and China prioritising the accelerated development of its domestic resources. This implies that it will be even more important to create competitive advantage and to grow value through driving exceptional operational performance.
