Understandably the Australian producers that will benefit from the pricing spike have no stomach for gloating.
The tragic tailings dam accident in Vale’s Brazil operations that forced it to shutter operations and caused the sudden supply shortage, and the resulting boost in the ore price, is horrendous. The death toll from the January 25 disaster has stretched well above 100 with scores more victims unaccounted for and feared dead.
Initially commodities experts judged the supply shortage would be short lived — a view that is being revised as the fallout from Brazil cascades.
The history of a tailings dam disaster at a Brazilian Vale/ BHP joint venture, Samarco, provides an illustration of how lengthy the process can be.
The Samarco facilities affected by its 2015 disaster have not yet re-opened.
The politics from the Brazilian side are becoming clearer. This government is taking an even more conservative approach to its response — taking more supply out of the market while it assesses other Vale operations.
And this explains why since the initial reaction to the Vale disaster, the supply of iron ore has further tightened and the price of the metal has continued to rise.
As ANZ commodities expert Daniel Hynes says: “It raises the stakes around the safety issues in Brazil».
This week headlines were made when CBA commodity analyst Vivek Dhar predicted iron ore prices could reach $US100 a tonne this week.
At this point there are plenty of other commodities experts expecting prices to eventually hit the magic $US100 mark. But they see the price coming back over time to around $US80.
Early estimates are that the disasters could see about 40 million tonnes of iron ore leave the market.
Once adjusted for additional mine suspensions and a ramp up in Vale’s production from other mines it appears that there might be a supply shortage.
As far as the demand side is concerned — this is all about China. And this also is something of a wildcard.
Conventional wisdom says that growth in demand is falling — but at a rate that probably still sees a slightly panicked response to such a large chunk of supply leaving the market.
For example ANZ’s Hynes estimates the growth in 2019 will fall to around 2.5 per cent. Just how quickly iron ore prices stabilise depends on the supply response from others.
Our big producers are running at close to full capacity but other previously non-economic producers from Australia and even China will be looking to reopen mothballed mines and begin production if prices remain elevated.
In the meantime the price spike has been an unexpected bonus for Australia’s big three producers.
And this is being reflected in their stock prices. BHP has moved up from $32.80 at the start of the year to $36.27 and Rio is now trading over $92 from its starting point this year of $76.65. Fortescue’s share price has jumped from $4.52 to $6.20.
Analysts have been revising upwards their expectations for the miners. Citi, for example, has Rio’s 2019 calendar year earnings before interest, tax, depreciation and amortisation (EBITDA) lifting by 44 per cent. For BHP and Fortescue Citi sees their 2020 financial year EBITDA rising by 19 per cent and 71 per cent respectively.
Fortescue is receiving additional upside because its lower grade iron ore product has risen proportionately more as the price gap between high grade and lower grade product has narrowed.
This trend had begun even before the Vale tailings dam disaster as the profits from Chinese steel mills had come under pressure.
But the supply shortage has only increased the demand for lower grade iron ore as Chinese mills scramble for steel production ingredients.
Neither the big Australian iron ore producers nor the government that relies on revenue from their tax contribution can factor longer term gains.
Still, as much as the dynamics of this market are uncertain they are also enormously important.
Elizabeth Knight comments on companies, markets and the economy.