Iron Ore: Coming back to earth
About the author:
- Author name:
- By Adrian Prendergast
- Job title:
- Senior Analyst
- Date posted:
- 07 August 2021, 4:00 PM
- Sectors Covered:
- Mining, Energy
- So far 2H21 is shaping up as expected, with the robust demand conditions that supported strong June half results proving difficult to sustain.
- Trying to avoid its economy overheating and progressing environmental ambitions, China has cut export rebates on steel products and limited H2 output.
- China is battling the largest outbreak since COVID-19 began, with the Delta strain being encountered in a large number of provinces and threatening growth.
- We remain cautious on our iron ore coverage given what we see as potential for further downside to benchmark iron ore prices.
China steel activity takes a hit
Staggering first half steel production growth of c12% faces some fresh headwinds early in the second half. Clearly interested in preventing its economy from overheating, and also pursuing environmental targets, China has moved to slow steel activity.
This has come in the form of some tightening of stimulus, the scrapping of rebates on exports of a number of steel products, and a limit imposed on steel producers to hold second half production in line with 2020 levels. This directly moves to slow the pace of steel activity, which will also help China in its attempts to reduce emissions.
Meanwhile China is also battling the largest COVID-19 outbreak since the pandemic began. Having registered its first Delta strain case just a month ago, there appears to now be growing case numbers across 16 Chinese provinces. We will soon learn how effectively China can defend against this new strain, a task that could be made more difficult if some media reports are accurate on the lack of efficacy of Chinese vaccines against the new COVID-19 mutation.
The moves by China to directly slow steel activity could see a rapid tapering of iron ore demand growth, particularly if scrap steel usage holds up, while the fresh COVID-19 risks could more significantly undermine base steel consumption in 2H21 and heading into 2022.
What’s happening with supply
Weak June quarter operational results from Rio Tinto (ASX:RIO) and Vale were a surprise, and in our view puts pressure on 2021 guidance for both big miners. In Vale’s case we are watching its September quarter volumes closely as we move into the seasonally stronger (drier) output period.
It continues to reassure on the risk profile of some at-risk tailings dams. A less optimistic six-month outlook for RIO, with the December half being a critical period for bringing on replacement mine capacity (90mtpa) while it also grapples with broader operational under-performance in part from labour constraints.
We continue to recommend caution with iron ore price risk outweighing the appeal of strong company fundamentals. In the case of BHP Group (ASX:BHP) and RIO we maintain HOLD ratings with their dividends filling some of the valuation gap.
Maintain REDUCE rating on Fortescue Metals Group (ASX:FMG), which we expect to keep under-performing on its larger iron ore price sensitivity and growing discount on low grade iron ore.
Figure 1: Share price performance (Jan-21 = 100)
Source: Morgans Financial, Company
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