The recent rally in bulk commodity miners will end in tears. Iron ore has risen to $60 per tonne from a bottom of $37 in December, with leveraged mining stocks more than doubling from recent lows. We expect falling Chinese steel demand and rising Chinese steel scrap availability to cut iron ore prices by half. Shares of several heavily indebted producers are likely to fall by more than 50%. Our long-run forecasts are $30 per tonne for iron ore, versus the consensus of $55, and $75 per tonne for metallurgical coal, versus the consensus of $110.
Investors have finally embraced the reality of peak China steel demand, but most still underestimate how far demand will fall. Consensus sees Chinese steel use stabilising around 700 million tonnes, down modestly from a peak of 765 million tonnes. We expect demand to fall to 650 million tonnes by 2020 and 630 million by 2025 as faltering construction activity outweighs consumer-oriented growth. Rising scrap steel availability is a significant, but longer-term, threat.
Data scarcity and difficulty projecting scrap availability make it tough for investors to gauge the timing and magnitude of the risk. Leveraging academic work on the life cycle of steel products, we project China's domestic scrap supply to more than double by 2025, feeding greater electric arc furnace production and displacing iron ore and met coal demand.
In total, falling steel demand and rising scrap availability will reduce China's iron ore demand by 150 million tonnes over the next 10 years, more than the total consumption of Japan, the world’s second largest iron ore buyer. Iron ore and met coal miners look overvalued as a group. We see 50%-plus downside risk in shares of Anglo American, CSN, Fortescue, Teck Resources, and Vale, as large exposures and hefty debt burdens will magnify the impact of falling iron ore and metallurgical coal prices.
Where Will the Iron Ore Price Go?
Our long-term forecasts lie well below consensus. We expect mid-cycle iron ore prices of $30 per tonne, far below prevailing spot of $60 and consensus of $55. Similarly, we forecast long-term met coal prices of $75 per tonne, versus spot of $90 and consensus of $110.
Lower Chinese steel consumption and rising EAF substitution drive our below-consensus demand outlook for iron ore and met coal. Together, these two factors drive a decline in Chinese iron ore demand of 150 million tonnes, greater than the total demand of Japan, the world’s number-two consumer, and nearly equal to output from the world's fourth-largest iron ore miner, Fortescue.
We've long been bearish on Chinese steel demand, but not bearish enough. Our updated bottom-up forecast suggests consumption will decline to 650 million tonnes by 2020 and 630 million tonnes by 2025, led by weak construction demand. While demand from transportation and consumer durables should grow, their small contribution is far outweighed by construction declines. The machinery end market should see fairly anemic growth, owing to the drag from construction.
A scrap age looms, with Chinese electric arc furnace substitution set to displace huge quantities of iron ore and metallurgical coal. Sector-level asset-life analysis suggests China's steel scrap supply will more than double by 2025. Scrap supply growth will accelerate beyond 2025 as buildings and other long-lived steel-containing assets approach end-of-life.
Much of China’s domestic iron ore and met coal supply is likely to prove resilient. The remaining highcost private producers exposed to seaborne competition should cease production, but we doubt seaborne volumes will displace domestic mine supply in China's interior. We estimate that "inland" mines, which have a transport cost advantage over foreign suppliers, comprise roughly half of China's iron ore production and more than three fourths of its coal production. State-owned mines propped up by supportive local governments and favorable credit access will be especially difficult to displace.
Low-cost expansion will far outstrip demand growth, displacing higher-cost supply and pressuring prices. Additional supply chasing scarce demand will entrench the industrywide race to the bottom on costs. In iron ore, we expect the largest six miners to add 200 million tonnes of low-cost supply through 2025, equivalent to 13% of 2015 seaborne supply.
This would force a similar amount of supply cuts, as it greatly outstrips the flat seaborne iron ore demand that we anticipate over the same interval. In met coal, Mozambique and Mongolia will add 29 million tonnes through 2025, over which time we expect seaborne demand to contract by 31 million tonnes.
What Does this Mean for the Miners?
The cost curves for iron ore and met coal have flattened and shifted lower, owing to cost cuts, producer currency depreciation, and lower freight rates. For the major producers on our coverage list, costs have fallen by an average of 38%, or $18 per tonne, since 2014. We expect further cost improvements as the biggest miners ramp up production of higher-quality assets and spread fixed costs across greater volumes.
We see 50%-plus downside risk in shares of Anglo American (AAL), CSN, Fortescue, Teck Resources, and Vale, as large exposures and hefty debt burdens magnify the equity implications of lower long-term iron ore and metallurgical coal prices.
