Paul Gray - Wood Mackenzie - Iron ore: readjusting capital investment to the new reality

Iron ore: readjusting capital investment to the new reality.

Paul Gray

Principal Iron Ore Market Analyst

November 2014

Strategy with substancewww.woodmac.com

2

Agenda

1. What do we mean by “a new era” for iron ore?

2. Supply response: the story so far.

3. Implications for project development.

4. Winners and Losers in the “new era”.

3

0

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100

120

140

160

180

200

Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14

TS

I 6

2%

Fe

, U

S$

/t, C

FR

Ch

ina

How did we get from $130 to $80?Six major corrections since 2008

The world pre-2013:� Just when you thought it was over …… the price kept

bouncing back!

� Seaborne supply was constrained by a falling India and a

stagnant Brazil.

� China could comfortably absorb all the additional seaborne

supply (and grow its own domestic production).

The world since 2013:� Sharp rise in seaborne supply (mostly Australia).

� Chinese policy reforms - starting to have a real impact on

steel and hence iron ore requirements.

� Growing realisation we have entered an “era of excess

supply capability.” Negative sentiment.

Source: Platts - SBB

Start Event High Low Days Avg Daily Drop ($/t)

1 Jul-08 Global f inancial crisis 177 59 76 1.55

2 Apr-10 Euro sovereign debt crisis 187 122 56 1.16

3 Aug-11 China - liquidity squeeze #1 179 119 49 1.21

4 Apr-12 China - steel margin squeeze 149 87 100 0.63

5 Jan-13 Looming structural oversupply 159 111 106 0.45

6 Dec-13 Actual structural oversupply? 140 77 240 0.26

4

How did we get from $130 to $80?This year’s big story.

Supply:

Australian majors ramping up:

» based on investment decisions made several years ago with a long term view.

Lagged response from high cost suppliers:

» But closures are now happening!

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Q1-12 Q2-12 Q3-12 Q4-12 Q1-13 Q2-13 Q3-13 Q4-13 Q1-14 Q2-14 Q3-14

Year-

on

-Year

ch

an

ge,

millio

n t

on

nes

Chinese Demand Australian exports

Th

e g

reat

iro

n o

re d

isco

nn

ect!

Chinese demand / Australian supply – diverging paths!

Demand:

Chinese property sector recession:

» declining demand from residential property sector (non-res is now the main driver),

» offset by higher exports of steel products.

Hot metal production growing slower than crude steel.

Muted recovery ex-China:

» imports up 2% this year, but still below 2007/08 peak and the outlook is deteriorating!

5

Global steel outlook to 2020

168200

144159

2000 2007 2014 2020

EU-28

Fragile recovery underway, no return topeak levels. High costs and large glut of idled capacity. 120

108 100 107

2000 2007 2014 2020

USA

Strong demand from auto and potential recovery in non-res construction. M&A activity increasing and capacity being added.

21

4453

68

2000 2007 2014 2020

Middle East

Geopolitical risks. Import reliance decreasing as new EAFs being added.

16 22 27 32

2000 2007 2014 2020

Brazil

Demand at a standstill due to underlying economy issues. Challenging investment environment and utilization rates low.

Apparent consumption of finished steel, Mt,

6

Global steel outlook to 2020 (continued)

2440 42 50

2000 2007 2014 2020

Russia

125

408

709810

2000 2007 2014 2020

China

76 8167 67

2000 2007 2014 2020

Japan

28

51

74

98

2000 2007 2014 2020

India

2744

6986

2000 2007 2014 2020

ASEAN

Plenty of potential! But, many issues to overcome for both demand and supply to deliver.

Slower growth as economy shifts focus. Excess capacity will remain an issue for domestic and international markets!

Export competition and demographics will not support growth.

Sanctions impacting an already slowing economy, declining investment.

Apparent consumption of finished steel, Mt,

Strong demand growth, and many steel projects underway. Chinese exports willpressure domestic mills.

7

Chinese peak steel - 15 years away (hot metal <10yrs)

What do we mean by “a new era”?A longer term perspective on Chinese steel.

Source: Wood Mackenzie

Crude steel production peak:999Mt in 2029

0

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400

600

800

1000

1200

2000 2005 2010 2015 2020 2025 2030 2035

Ch

ina:

ste

el

& h

ot

meta

l p

rod

ucti

on

(M

t)

15% pa 2% pa 0% pa

2003 - 2013 2014 - 2020 2020 - 2030

Hot metal production peak:885Mt in 2023

Hot metal peaks sooner than steel then drops faster (scrap effect)

“China is forecast to

reach around 1Bt of

crude steel production

by around 2030”

Rio Tinto, Oct 2014. “We expect China’s crude

steel production to peak

at 1.0-1.1 Bt in the early

to mid 2020s and plateau

through to 2030”

BHP Billiton, Oct 2014.

8

China has accounted for 95% of growth in global trade since 2000.

Global imports: 90Mtpy for the last 5 years, 40Mtpy for the next 5 years, then shrinking further!

Source: GTIS, Wood Mackenzie, Iron Ore Market Service

What do we mean by “a new era”?Implications for seaborne trade in iron ore.

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1980 1985 1990 1995 2000 2005 2010 2015(f) 2020(f)

Glo

bal seab

orn

e i

mp

ort

s (

millio

n t

on

nes)

non-China China

-150

-100

-50

0

50

100

150

200

2000 2005 2010 2015(f) 2020(f) 2025(f) 2030(f)

Seab

orn

e T

rad

e in

Iro

n O

re :

y/y

ch

an

ge (

Mt)

China RoW Total 5-yr avg.

Forecast .......

9

Agenda

1. What do we mean by “a new era” for iron ore?

2. Supply response: the story so far.

3. Implications for project development.

4. Winners and Losers in the “new era”.

10

� Additional 150-170Mt required by 2020.

» Driven by 1.8% trend growth in hot metal.

» But imports will grow faster due to the “displacement effect”

» China’s IO import dependency rises to 85%.

� Strongest demand for direct charge feed.

» Rising lump and pellet ratio in BF (falling sinter rate).

� Risks?

» Chinese supply proves more resilient to low prices?

» To what extent can Chinese cut costs?

Chinese imports to rise by over 300Mt, while domestic supply shrinks by 140Mt.

Source: Wood Mackenzie

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

0

200

400

600

800

1000

1200

1400

1600

2000 2005 2010 2015 2020

Ch

inese C

on

su

mp

tio

n o

f Ir

on

Ore

(M

t)

Domestic supply Imports Import ratio (RHS)

Supply response: the story so far (China).Forecasting China’s future iron ore requirement.

11

Source: Wood Mackenzie

NB: Average cost for 2013

Tibet

Xinjiang

Qinghai

Inner Mongolia

Gansu

Sichuan

Yunnan

Jilin

Heilongjiang

Hunan

Hebei

Hubei

Guangxi

ShaanxiHenan

Anhui

Jiangxi

Shanxi

Guizhou

Fujian

Liaoning

Guangdong

Shandong

Jiangsu

Zhejiang

Chongqing

Ningxia

Hainan

Beijing

Tianjin

Shanghai

120°0'E

120°0'E

90°0'E

90°0'E

50°0

'N

50

°0'N

30

°0'N

30°0

'N

Source: Wood Mackenzie

0 800 1,600km

Iron Ore Mine

Key Producing Area

Contestable Region

Other Region

Contestable market

Production capability: 311 Mtpy

-SOE: 132 Mtpa; Private: 179 Mtpa

Average total cash cost: $99/dmt @62% Fe

Whole China

Production capability: 427Mtpy

Average total cash cost: $92/dmt @62% Fe

� Contestable market:

» Where Chinese domestic supply competes with seaborne supply.

» Over 300 Mtpy capability.

» All coastal provinces; Hubei, Anhui, and Jiangxi (where transportation cost along the Yangtze is comparable to road/rail in other coastal provinces.

» Shanxi, Jilin and Henan where concentrate is sold to coastal regions - mines in these provinces compete directly with seaborne supply.

Supply response: the story so far (China).Defining Chinese contestable supply.

� Non-contestable market

» Inland provinces beyond the reach of imports.

» Relatively price inelastic due to transport cost.

» Over 100 Mtpy capability.

» Key regions: Sichuan and Inner Mongolia.

» Few if any price related mine closures.

12

Supply response: the story so far (China).China cost curve: private mines along the coastal belt dominate the top end.

Contestable vs non-contestable supply China 2014 US$/dmt 62% equivalent cost curve

Source: Wood Mackenzie Iron Ore Cost Service

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50

100

150

200

250

300

350

400

2000 2007 2014 2021 2028 2035

Ch

inese i

ron

ore

su

pp

ly (

Mt)

Non-contestable market

Contestable market

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Source: Wood Mackenzie Iron Ore Market Service

2013-2020: +250Mt• Majors expand.• Juniors close.• Medium quality

reserves.• Infrastructure in place.• Close to market.

2013-2020: +125Mt• North: high grade DSO.• South: low grade itabirite.• Stringent licensing and

environmental control.• Far from market.

2013-2020: +3Mt• Medium quality .• Lack of infrastructure

(water?).• Far from market.• Expansions on hold.

2013-2020: +8Mt• Variable quality reserves;

difficult mining.• Small scale start-ups.• Infrastructure ok.• Focus on Mid-East – DR-

pellets/pellet feed.• Projects delayed.

2013-2020: +9Mt• Large resources but isolated! • Challenging mining conditions.• Lack of infrastructure.• High capital cost.• Far from market.• Projects on hold.

2013-2020: ?• Ebola: Sierra Leone,

Liberia, Guinea.• Lack of infrastructure.• Lack of finance.• Political risk.• Far from market.• Most projects delayed

or cancelled.• Operating assets

under pressure!

2013-2020: flat• Medium/high

quality reserves.• Rail constraints.• Political risk.

2013-2020: -10Mt• Med/High quality

reserves (Odisha).• Severe constraints on

development!• Political risk.• Net importer?

2013-2020: -20Mt• Variable quality

reserves.• Rising domestic

demand will take precedence.

• Export duties?

2013-2020: -20Mt• Russia & Ukraine.• Variable quality reserves.• Vertically integrated.• Rising domestic demand

(in long term)?• High cost exports.

2013-2020: -35Mt• Philippines, Malaysia,

Indonesia.• Low quality reserves.• Small scale production.• Export restrictions.• Rising domestic demand .• Exports now falling .

2013-2020: -7Mt• Low grade taconite

reserves.• Competition from

Canada• Rising domestic

demand (DRI)?

Strong growth

Moderate growth

Decline

Supply response: the story so far (ex-China).

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Source: Wood Mackenzie

Global cost curve: CFR China Global margin curve: CFR China

Supply response: the story so far (ex-China).Over 120Mtpy has negative margins, after sustaining capex.

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$/t

marg

in m

inu

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usta

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Million tonnes

Australia Brazil RoW

-30

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0

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100 200 300Million tonnes

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Agenda

1. What do we mean by “a new era” for iron ore?

2. Supply response: the story so far.

3. Implications for project development.

4. Winners and Losers in the “new era”.

16

Implications for project developmentPost 2020/25 prices will need to rise to induce new supply.

Source: Wood Mackenzie.

Implied “supply gap” >200Mtpy by 2035.

� Medium term: seaborne trade “cushioned” by China “displacement effect”.

� Long term: China effect starts to work in reverse. Falling hot metal and rising scrap = lower requirement for imported ore.

� But mine depletion and demand growth ex-China means a theoretical “supply gap” emerges post-2020.

� Incentive price analysis indicates higher prices required to induce investment.

0

500

1,000

1,500

2,000

2,500

3,000

2000 2005 2010 2015 2020 2025 2030 2035

Millio

n T

on

nes

Operating Closed Highly Probable

Probable 2014 2020

Consumption

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Implications for project developmentThere’s no shortage of (potential) projects – but who’s going to fund them?

Our project list has total (theoretical) capacity of 1.6 billion tpy!

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Implications for project developmentLarge capital hurdles, low prices and slowing demand = less projects reach fruition!

Source: Wood Mackenzie.

The “best” projects are held by the majors.

� Australia accounts for half of all “highly probable” and “probable” projects.

� Brazil ~20% share. This number has fallen since we “downgraded” numerous projects from “probable” to “possible” status.

� West Africa - project potential scaled back significantly. Much depends on Simandou!

� The “Big 4” producers control 70% of all projects rated “highly probable” and “probable”.

0 100 200 300 400

Australia

Brazil

W.Africa*

Other

Potential additional capacity by 2030

Highly Probable Probable

*includes 100Mt from Simandou.

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Implications for project developmentConventional analysis suggests few new mega-greenfields will be developed.

Source: Wood Mackenzie.

Project capital intensity.

Capital Intensity:

Magnetite vs Hematite:� Magnetite = $180/t (in reality closer to $250/t!)

� Hematite = $160/t.

� Almost twice as many magnetite projects but their average size is much smaller.

Greenfield vs Brownfield:� Greenfields ~$190/t� Brownfields ~$120/t

The “new era” means less mega-greenfields.0

100

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400

500

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2012 2014 2016 2018 2020

Cap

ital

inte

sn

tiy (

US

$/t

on

ne)

Planned year of first production

Additional capacity

Avg. greenfield

Avg. brownfield

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Agenda

1. What do we mean by “a new era” for iron ore?

2. Supply response: the story so far.

3. Implications for project development.

4. Winners and Losers in the “new era”.

21

Winners and losers in the “new era”(1)

Major seaborne suppliers – winners!

Source: GTIS, Wood Mackenzie.

Australia – the big winner! A more consolidated industry structure.

29%38%

52%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2000 2010 2020

% s

hare

of

glo

bal ir

on

ore

exp

ort

s,

by c

ou

ntr

y

other

India

S.Africa

Brazil

Australia

57%

45%35%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2000 2010 2020

% s

hare

of

glo

bal ir

on

ore

exp

ort

s,

by c

om

pan

y

other

Vale

FMG

BHP

RIO

22

Winners and losers in the “new era”(2)

Chinese importers – winners then losers!

Source: GTIS, Wood Mackenzie.

China’s iron ore “import bill” peaked in 2011.

Medium term:� Volume up

� Price down� US$ value of imports down.

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2000 2006 2008 2010 2012 2014F 2016F 2018F 2020F

Valu

e o

f C

hin

ese i

mp

ort

s o

f ir

on

ore

: U

S$ B

n

Higher volume offset by lower price.

Long term:� Import bill rises again driven by growing

reliance on high grade imported feed.

� Will China persist in its quest to raise captive overseas ownership of iron ore?

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/201

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/201

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/201

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/201

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/201

4

Iron ore & coal spot prices, Jan 2013=100

Iron ore fines 62% Fe, CFR Tianjin, USD/dmt Coking Coal, FOB Australia, USD/t

Winners and losers in the “new era”(3)

Integrated mills win versus EAFs (for the time being)……

1.0

1.5

2.0

2.5

3.0

3.5

05

/0…

05

/0…

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/1…

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/0…

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/1…

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Scrap to iron ore, Fe unit ratio

Source: Platts-SBB, Wood Mackenzie

0

100

200

300

400

500

600

700

Turkey EAF - 2013 Turkey EAF - 2014* China BOF - 2013 China BOF - 2014*Lo

ng

pro

du

cts

-to

tal

op

era

tin

g ca

sh c

ost

s, U

S$

/to

nn

e

Iron Ore Coal Coke Scrap

Other Metallics Gas Electricity Labour

Other Overheads Credits

Source: Wood Mackenzie*Data based on September spot prices for iron ore, coal and scrap

$262

$437

Raw materials prices have crashed...

Yet scrap has been slow to adjust.

Chinese integrated mills – more competitive.

24

Winners and losers in the “new era”(4)

Seaborne suppliers of high quality concentrate/pellet/sinter feed – winners!

Source: Wood Mackenzie.

China’s rising import dependency for pellet feed.

0%

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30%

40%

50%

60%

0

50

100

150

200

250

2000 2005 2010 2015 2020

Pellet feed imports. CAGR: 2014-20 +11.2%

Pellet feed domestic supply. CAGR: 2014-'20 -2.4%

Import dependency (RHS)

� Forecasting strong Chinese demand for imported pellet feed.

� Partly demand driven (environmental pressure on sintering; rising pellet rate).

� Partly supply driven (pellet feed projects targeting the Chinese market).

� IO pricing will move in favour of higher grade products with lower impurities.

25

Winners and losers in the “new era”(5)

Seaborne suppliers of high quality concentrate/pellet/sinter feed – winners!

Source: Wood Mackenzie.

Pellet feed premium expected to widen.

� The past: pellet feed / concentrates traded at a discount to sinter fines.

� The future: pellet feed should command a bigger premium to reflect Fe grade differential, lower impurities, and implied “grinding premium” over concentrates.

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Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14

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$/t

on

ne

Pellet feed to iron ore differential

Pellet feed 65% Fe

Iron ore fines 65% Fe

Source: MySteel

26

Summary of the Wood Mackenzie iron ore view.

Key theme: displacement of high cost Chinese iron ore – the driver of seaborne demand and prices.

Demand: slower not lower. Chinese “peak steel” 15 years away (“peak hot metal” <10 years away).

Supply: becoming more concentrated (in every sense!). Few mega-greenfields will reach fruition.

Prices: medium term - remain under pressure, support ~$80/t CFR. Long term – prices need to rise!

27

Disclaimer

� This presentation has been prepared for the Informa Americas Iron Ore Conference, Rio de Janeiro, November 10-11, 2014. The presentation is intended solely for the benefit of the Conference attendees and its contents and conclusions are confidential and may not be disclosed to any other persons or companies without Wood Mackenzie’s prior written permission.

� The information upon which this report is based comes from our own experience, knowledge and databases. The opinions expressed in this report are those of Wood Mackenzie. They have been arrived at following careful consideration and enquiry but we do not guarantee their fairness, completeness or accuracy. The opinions, as of this date, are subject to change. We do not accept any liability for your reliance upon them.

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