DJ From Iron Awe to Iron Gore -- Barron's Asia By Thomas...

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    DJ From Iron Awe to Iron Gore -- Barron's Asia By Thomas Streater The blue skies of Beijing that greeted world leaders gathered for APEC are no more. By the time the dignitaries had jetted into Brisbane for the Group of 20 Summit, China's capital had once again been enveloped by choking smog as the cogs of Chinese industry were shifted out of neutral and back into high gear. The return of the smog was meant to herald better news for the global iron ore industry. The hope was that as China revved up manufacturing activity, especially at steel mills, it would lead to a rebound in the price of the steel making ingredient. Wrong. Instead, iron ore prices have plumbed a fresh five-year low around $70 a tonne and ratcheted up the miners' pain. UBS warned earlier this week that it was now or never for China's steel mills to restock iron ore. After the latest round of bloodletting, it may seem to be more 'never' than 'now'. It's been a bloodbath for iron ore stocks. Australia's Fortescue Metals Group (FMG.AU), controlled by billionaire Andrew Forrest, was smashed nearly 8% lower on Wednesday as analysts zeroed in on the heavy debt load shouldered by the world's fourth largest iron ore producer. BHP Billiton (BHP.AU) and Rio Tinto (RIO.AU), which together with FMG dominate production from the Pilbara region of Western Australia, were also sold down. The cause of the iron ore miner's discomfort is a problem the industry should be well accustomed to - supply and demand. In this case, the big licks of shareholders cash invested in massively expanding iron ore production have come back to haunt the industry. A massive wave of supply has swamped the market at a time when China's demand for iron ore has waned. The latest data on Chinese property prices, which showed prices fell in 69 out of 70 cities in October, was another reminder that the halcyon days of $180 a tonne seen in 2011 are long gone as China shifts its economic model away from a reliance on resource intensive fixed asset investment. The industry is also having its logic for running their mines at full bore tested by socialism with Chinese characteristics. The theory was that by running their low cost mines at a maximum capacity and pressuring prices lower that would force high cost producers in China out of the market. Wrong again. With an eye on employment and social stability, China's high cost mines continue to feed ore to steel mills and high cost tonnes have not exited the market as quickly as expected. Citi notes that about 70% of China's iron ore production is controlled by subsidiaries of steel mills. The Australian miners, plus Brazil's Vale, have also felt the cool chill of Beijing's credit tightening. Stricter credit standards have stymied the ability of smaller mills to finance imports of iron ore. Despite the gloom, there is the possibility that iron ore miners may find some relief. The last two months of the year have traditionally been a strong period for the commodity. The onset of winter crimps production in China, while the cyclone season that accompanies summer in the Pilbara weighs on production from the trio of Australian miners. That would be a relief for FMG, with Credit Suisse estimating that every $4 a tonne increase in the iron ore price could add AUD1 to the company's valuation. The miners have also embarked on a self-help program. Cost cutting is the name of the game as the heavyweights of the industry seek to push their costs as low as possible. BHP Billiton and Rio Tinto are looking to sweat their 'tier one' assets, which have long lives and low costs, even harder. Rio Tinto's operations are exemplary in terms of costs, with iron ore pulled out of the ground at a cash cost of around $20 a tonne in the first half of the financial year. The company's "Mine of the Future" program is driving down costs of production through the use of autonomous, or unmanned, trucks and trains. BHP Billiton has plans to drive down costs at its Western Australia iron ore business by 25% to less than $20 a tonne over the medium term. But the chasing of lower costs may just incentivize more production. But longer-term plans to add yet more tonnes to the market have drawn widespread criticism. A vocal critic has been Ivan Glasenberg, the billionaire chief executive of commodities producer and trader Glencore (GLEN.LN). He has accused BHP Billiton and Rio Tinto of "killing the super-cycle" by adding to the iron ore glut. That said, having acknowledged an interest in acquiring Rio Tinto, it plays into Glencore's hands to talk down the iron ore price - and Rio Tinto's share price. However, Glasenberg is not a voice to be ignored when it comes to dealing with supply gluts. Glencore last week unveiled plans to suspend production at its Australian coal operations for three weeks. At $60 a tonne, thermal coal is fetching half what it did three years ago. Glencore's action will remove five million tonnes of output. What makes the move surprising is Glencore claims all the mines it is temporarily closing are profitable. Glasenberg has decided to show leadership by taking tonnes out of the market to support prices, rather than continuing to run his operations at full speed, add more supply to an oversupplied market, and hurt coal prices, and his bottom line, further. It's a lesson in resource economics that BHP Billiton and Rio Tinto may want to take on board. With earnings under pressure, there is no doubt shareholders may start asking why more tonnes are being mined and shipped. It's then a question of who may blink first in cutting supply. --- Email: [email protected] --- Comments? E-mail us at [email protected] Subscribe to WSJ: http://online.wsj.com?mod=djnwires (END) Dow Jones Newswires
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