Iron ore is about steel production. According to the Department of Industry, it takes an average 1.4 tonnes of iron ore to produce one tonne of steel.
Steel is used for a variety of industrial purposes but the biggest is construction, which accounts for 50% of demand.
China is the elephant in the steel room. In 2017, it accounted for 45% of world steel consumption and 49% of total production. It was also responsible for 67% of global iron ore imports in 2016.
2017 was a much better year for steel production than many forecast. According to the World Steel Association, global production was up 5.2% for the 11 months to November.
China was a big contributor to global growth in both steel consumption and production. Its steel production grew 5.2% in the 11 months to November. This was supported by infrastructure spending designed to stimulate economic growth.
Several months ago, China moved to cut production in outdated and illegal steel mills in order to protect the environment over winter. The result was to improve steel margins and profits for the remaining mills. This improved profitability led to an increase in overall production. The official numbers may also have inflated growth as production from some of the illegal and now closed production went unreported.
For iron ore, all this produced a much better year than most anticipated at the start of 2017.
China’s imports were up 4.9% and the volume of Australia’s exports was up 2.3% for the 11 months to November.
As the chart below shows, the average spot price for the benchmark 62% grade imported into China rose 21% to $US 70.35
For both mining companies and the Australian economy, this translated into a double whammy. Higher prices and increased sales volume.
The Department forecasts that things will come back to earth in 2018.
This is mainly because it believes China’s steel production will be a little lower, as environmental controls become a more permanent feature of the policy landscape.
While China’s lower production will be offset by growth in other places like India and Japan, the net result will be to see growth in global steel production, fall to a negligible 1%
China’s iron ore imports are expected to remain steady but this will not be enough to sustain the current iron ore price because export volumes from Brazil and Australia will continue to grow.
High steel margins are supporting the market now but the Department sees this declining in the second half. Its forecast is for iron ore to be down an average 18% in 2018
The key variable in these forecasts is Chinese steel production and demand. If it does not fall, the iron ore price will do much better than the 18% decline forecast by the department.
The market sees a better outcome with the big rally in mining stocks driven by a co-ordinated global growth theme. The testing time may be towards the middle of the year. By then, the rebound from China’s winter shutdowns should be over. If the Department’s more bearish forecast for iron ore is going to be correct, prices should be on the way down by then.