More Bad News for Oversupplied Iron Ore Market

The lifting of ban on iron ore mining in the Indian state of Goa is not good news for the oversupplied iron ore market.

Apr 24, 2014 at 8:07AM

Last week, mining giant BHP Billiton (NYSE:BHP) lifted its iron ore production outlook for the fiscal year ending on June 30, 2014. Rival Rio Tinto (NYSE:RIO), meanwhile, reported record iron ore production for the first quarter. Brazilian miner Vale (NYSE:VALE) is also targeting annual output of over 360 million tons. Even as mining giants are increasing supplies, there is a sharp slowdown in China, the world's biggest consumer of the bulk commodity. The supply/demand mismatch is likely to keep iron ore prices under pressure going forward. Additionally, supplies could rise even more as India's Supreme Court lifted a ban on iron ore mining in the state of Goa.

Miners increasing supplies
Even as iron ore prices have fallen sharply this year amid slowdown in China, miners have been increasing iron ore production. BHP Billiton recently lifted its iron ore production outlook for the fiscal year ending June 30, 2013 by 5 million tons to 217 million tons. The Anglo-Australian miner lifted its outlook after reporting a 1% sequential and 23% year-over-year increase in iron ore production in the March quarter. BHP's iron ore production in the March quarter totaled 49.6 million tons.

Rival Rio Tinto said that its March quarter production rose to a record 52.3 million tons. However, the first-quarter production fell short of Street estimates of 54.7 million tons.

Iron ore supplies are set to rise as miners continue to boost production. However, a slowdown in China would mean that demand is not likely to keep up pace. As a result, the iron ore market is expected to see a significant glut. Meanwhile, supplies could rise even more as India's Supreme Court has lifted a ban on mining in Goa.

Ban lifted
On Monday, India's Supreme Court lifted an 18-month ban on mining in the state of Goa, which is India's third-largest iron ore mining state. The ban was imposed back in 2012 in order to curb illegal mining in Goa. Although the ban has finally been lifted, the annual output has been capped at 20 million tons. Prior to the ban, Goa's output totaled around 45 million tons, with much of it exported to China where demand at the time was strong.

However, Goa produces low-grade iron ore, whereas in the wake of anti-pollution measures steel mills in China now prefer high-grade iron ore from Australia. Also, production is not expected to resume immediately due to the monsoon and regulatory issues. Still, the lifting of the ban means that more supplies are likely to be added to the iron ore market at a time when there is already increasing supply from mining giants such as BHP, Rio, and Vale.

The Roy Hill project in Australia, which is likely to come online in 2015, will add further to global supplies. Meanwhile, a rebalancing Chinese economy would mean that the country's iron ore demand will never reach the level seen in the previous decade. Not surprisingly, the outlook for iron ore prices is bearish.

Price outlook remains bearish
Iron ore was the best performing commodity in 2013; however, the bulk commodity has already fallen sharply since the start of this year on concerns over a supply glut and a slowdown in demand. Morgan Stanley expects global seaborne iron ore supply to exceed demand by 79 million tons this year. The surplus is expected to double to 158 million tons in 2015.

Given that such a significant supply glut is anticipated over the next two years, iron ore prices are expected to remain under pressure. As I have noted in previous articles, mining giants such as BHP, Rio, and Vale will remain profitable even if prices fell below $100 per ton. However, lower prices will hurt mining companies' cash flows and affect their plans to cut debt levels. 

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Varun Chandan Arora has no position in any stocks mentioned. The Motley Fool owns shares of Companhia Vale Ads. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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