Back in March, George Economou, CEO of DryShips (NASDAQ:DRYS), stated in an interview that lower global iron ore prices would increase China's reliance on imported iron ore. With China accounting for 70% of the world's iron ore imports, and considering that importation of iron ore is the leading item in the dry bulk trade, most eyes in the shipping industry are fixated on this market to foretell their future. Evidence is mounting that everything is about to unfold just as Economou envisioned.
Iron ore prices crushed
Spot iron ore prices have fallen recently to below the pivotal $100 per ton mark. This is thought to be the key price level at which the "majority" of Chinese mines cannot operate profitably, and would face shutting down if prices don't improve. Foreign miners are stepping up their supply, which has caused the price to drop more than 27% to a 20-month low. This is what Economou described back in March as an upcoming "game changer" for DryShips and the industry.
The result has been a 21% rise in Chinese imports for the first four months of 2014, compared to the same time last year. By all accounts, that's just getting the beginning -- domestic mines take some time to close and come offline, so an increase in imports looks inevitable. According to the National Development and Reform Commission, production costs within China can be as high as $145 per ton depending on a mine's location. Relying on domestic ore is obviously not viable, so China will require an increase of iron ore imports just as DryShips had forecasted.
According Jose Carlos Martins, head of Vale's ferrous metals division, as reported by Reuters, "For the first time in 10 years, supply is greater than demand." The result is that Chinese steel mills are cutting back on iron ore contracts and going with spot rate pricing as they anticipate further declines in iron ore prices ahead.
On top of all this, Beijing has been undergoing an "antipollution campaign" which dampens demand for domestic iron ore. DryShips has been promoting this stance as well. Economou said, back in that March interview, "Imported iron ore pollutes the environment much less than the Chinese domestic iron ore," and that "the government has been cracking down on environmental neglect."
According to that Reuters story, Chinese steel mills are "confident that beaten-down prices are unlikely to rebound amid the first global ore surplus in 10 years." Despite this, "Miners such as Vale, Rio Tinto and BHP Billiton are boosting production even faster." It doesn't sound like domestic Chinese miners have any realistic hope in the current climate. The global market is about to get flooded with cheap, high-quality, seaborne iron ore.
DryShips and other shippers no doubt can't be more pleased. According to Australia's Bureau of Resources and Energy Economics, iron ore shipments from the main producers in Australia and Brazil will continue to jump up another 40% or more by 2017, reaching a staggering 1.27 billion tons.
All of this is again in line with what Economou stated in the most recent DryShips conference call in May. He said, "[The] expected iron ore production [that will] come on line within the next three years will increase transportation demand and put further pressure on iron ore prices effectively displacing some of the expensive and lower quality domestic Chinese production."
As usual, keep a close eye on whether iron ore prices continue to stay depressed or even fall further. As news of greater mining production in Brazil and Australia and lower mining production in China picks up, investors will likely see shipping rates shoot upward.
Nickey Friedman has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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