21 August 2013
Americas/United States
Securities Research & Analytics
Iron Ore Cost Curves
Connections Series
Global Update and a Closer Look at China
We expect the iron ore price to move lower in coming years as new projects
from Australia and Brazil hit the seaborne market. As this happens, investor
attention is likely to focus on the cost curve, and the role it plays in supporting
the iron ore price. This report explores the subject in some detail.
Exhibit 1: Global Cost Curve, 2013 Estimate
Red=Consensus 2013 price, Blue=Credit Suisse 2013 price, Grey=Credit Suisse 2012 cost curve
160
Equity Analysts
Nathan Littlewood
416 352 4585
Paul McTaggart
61 2 8205 4698
Matthew Hope
61 2 8205 4669
Ivano Westin
55 11 3701 6318
Liam Fitzpatrick
44 20 7883 8350
James Gurry
44 20 7883 7083
Neelkanth Mishra
91 22 6777 3716
Semyon Mironov
7 495 662 8510
Trina Chen
852 2101 7031
Fixed Income Analysts
Marcus Garvey
44 20 7883 4787
Andrew Shaw
65 6212 4244
US$ per dry metric tonne
140
The Credit Suisse Connections Series
leverages our exceptional breadth of
macro and micro research to deliver
incisive cross-sector and cross-border
thematic insights for our clients.
120
100
80
60
40
20
0
0
100
BHP.AX
200
CLF
300
400
FMG.AX
500
KIOJ.J
600
700
800
900
1000 1100 1200 1300
Million tonnes per annum
RIO.AX VALE.N China
Other Reported Cash Cost (FOB)
All-In Cash Cost (FOB)
All-In 62% IODEX equiv (CFR)
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities
Research estimates.
Perhaps the most differentiated section of this report is our analysis of the
Chinese domestic cost curve. We provide reason for investors to query
consensus thinking on Chinese volumes, and demonstrate the importance of
considering domestic freight from a cost curve perspective.
Our Rest of World analysis identifies ~140mtpa of existing supply which would
be uneconomic by 2016 at $90/t; however, we believe that the economics of
'Big 3' expansion tonnage from Australia and Brazil is robust at, or even slightly
below, the same $90/t level. Please refer to our separate equities report for a
discussion of specific stocks.
If the supply side behaves rationally, then consensus price forecasts correlate
pretty well with our cost curve model over 2014-2016, but our own price
forecasts cut well into the 80-90th percentile of the cost curve. We demonstrate
how one’s view on China can generate 2016 price expectations anywhere from
$76 to 119/t based on cost curve support.
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of this report. Investors should consider this report as only a single factor in making their investment decision.
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21 August 2013
Table of Contents
Summary
Global Iron Ore Cost Curve Review
Three sections to this report
Commodity Price Implications
China
Summary
Questioning the price elasticity thesis
The Freight Barrier
The Grade Debate
China's Cost Base is Price Elastic
A Closer Look at Freight
Impact of a Larger and Lower Cost China
Rest of World
Existing supply
Growth projects
Cost Curves
Appendices
Definitions
Standardization of Key Assumptions
China Iron Ore and Steel Production by Province
Authors & Contributors
Iron Ore Cost Curves
3
3
3
4
6
6
6
8
11
12
13
17
18
18
19
21
27
27
28
29
30
2
21 August 2013
Summary
Global Iron Ore Cost Curve Review
This report provides an update of the Credit Suisse Iron Ore cost curve, which we first
published in December 2012 (click here). Our new forecasts are based on our analysts'
latest company models. As a reminder, we feel our approach to building an iron ore cost
curve is a little different to others due mainly to the adjustments we make for realized
pricing (applied as a cost offset). Both the December 2012 report and the Appendix to this
report discuss our methodology and underlying assumptions in a little more detail.
Exhibit 3: 2016 curve (China: 360mtpa, incl domestic
freight)
freight) – ROW cost support doesn't kick in until $77/t
Blue = CS price fcst, Red = consensus price, Black = demand
Blue = CS price fcst, Red = consensus price, Black = demand
160
160
140
140
120
120
US$ per dry metric tonne
US$ per dry metric tonne
Exhibit 2: 2016 curve (China: 250mtpa, excl domestic
100
80
60
40
20
100
80
60
40
20
0
0
0
100
200
BHP.AX
300
CLF
400
500
FMG.AX
600
700
KIOJ.J
800
900 1000 1100 1200 1300 1400 1500 1600
Million tonnes per annum
RIO.AX VALE.N China
Other
Reported Cash Cost (FOB)
0
100
200
BHP.AX
300
CLF
400
500
FMG.AX
600
700
KIOJ.J
800
900 1000 1100 1200 1300 1400
Million tonnes per annum
RIO.AX VALE.N China
Other
Reported Cash Cost (FOB)
All-In Cash Cost (FOB)
All-In Cash Cost (FOB)
All-In 62% IODEX equiv (CFR)
All-In 62% IODEX equiv (CFR)
Source: Company data, Credit Suisse Securities Research &
Analytics and Commodities Research estimates.
Source: Company data, Credit Suisse Securities Research &
Analytics and Commodities Research estimates.
Although we've not explored the impact of FX in this report, it is clearly an important driver
of iron ore economics at the moment, and something a lot of investors are asking us about.
All of the curves we present are based on our 'base case' macro assumptions (refer
Appendix) but our model does allow us to test spot, or any other scenario. Please contact
your Credit Suisse sales person for data requests.
Three sections to this report
This report has three sections:
(1) China: We test consensus thinking on China price elasticity, and demonstrate why
China could be a i) much larger and ii) much lower cost producer on a long term basis
than the consensus thesis currently suggests. Our scenario analysis explains how we
could generate a 2016 cost curve which looks more like Exhibit 3 than the 'regular'
cost curve shown in Exhibit 2.
China may be bigger, and
lower cost, than current
consensus thinking
suggests
(2) Rest of World: Our global analysts' cost estimates have been leveraged to review
tonnages in our S/D model which are at threat in a $90/t price environment (current
CS long term view). We split this into i) growth and ii) existing supply. The most
material 'growth' projects from our S/D model are from Australia and Brazil, and these
projects generally have robust economics at, or even slightly below, $90/t. We believe
the 'Big 3' will keep building. Perhaps the more interesting finding is that we have
~140mtpa of existing ROW supply, which based on current estimates is uneconomic
in a $90/t price environment.
(3) Cost Curves: For each year (2013-2016) we show the cost curve with and without the
Chinese domestic freight cost adjustment (mentioned above, and discussed in further
detail below). Our estimates are all provided on a nominal basis.
Iron Ore Cost Curves
3
21 August 2013
Parallel 'Equity Implications' report
Parallel to the cost curve report you are currently reading, we have also published a global
equity implications report today entitled 'Iron Ore Equities: Equity Implications of our
Cost Curve Update', containing our top picks in the space, highlighting our most
differentiated calls, and discussing how our cost curve analysis impacts the individual
companies.
Parallel 'Equity Implications'
report for sector top picks
Commodity Price Implications
Exhibit 4: Credit Suisse Iron Ore price forecasts relative to consensus range and mean
140
US$/t (62% IODEX)
130
120
110
100
90
80
Q4 13
Q1 14
Q2 14
Q3 14
2013
2014
2015
2016
Source: Bloomberg, Credit Suisse Commodity Research estimates
Perhaps the most differentiating feature of this report is the analysis we have done on
Chinese domestic freight costs. This analysis is discussed in detail below, and the
potential impact is summarised above in Exhibit 2 and Exhibit 3.
Exhibit 5: Cost curve intercepts using 'regular' curve
Exhibit 6: Cost curve intercepts using 'adjusted' curve
(ignores China domestic freight)
(includes China domestic freight)
170
170
157
150
130
128
118
110
157
150
124
108
94
86
90
130
119
98
110
93
78
76
70
114
102
89
90
106
93
101
92
79
76
89
76
70
50
50
2013
100th percentile
CS fcst
2014
2015
90th percentile
Consensus fcst
2016
75th percentile
Source: Company data, Credit Suisse Securities Research &
Analytics and Commodities Research estimates
2013
100th percentile
CS fcst
2014
2015
90th percentile
Consensus fcst
2016
75th percentile
Source: Company data, Credit Suisse Securities Research &
Analytics and Commodities Research estimates
Exhibit 5 and Exhibit 6 summarise the commodity price read-throughs on each of these
two cost curve scenarios:
■
In our view, the consensus price (red line) seems to fit pretty well with our 'adjusted'
cost curve. This scenario requires uneconomic excess supply in China and elsewhere
to turn off in a disciplined and orderly fashion, thereby avoiding a supply surplus.
■
If the supply side behaves rationally, then the Credit Suisse price deck is probably too
bearish. The Credit Suisse price deck implies deep cuts into the top end of the cost
curve, that provide a more dramatic signal for excess supply to shut down. Depending
on the cost curve model used, our price deck over the next few years cuts as far down
as the 80-90th percentile of the cost curve.
Iron Ore Cost Curves
4
21 August 2013
In our view, the most important question iron ore investors should be asking is whether or
not China's domestic volume will be price elastic. This will have more impact on your LT
view of pricing than mulling over 'Big 3' ramp up profiles.
China's domestic supply is
should be investors' focus
If the answer is 'yes, entirely', then
■
Chinese domestic supply falls to 120-126mtpa (from CSe 360mtpa in 2013, 62%
equiv)
■
There's only 10-20mtpa of excess ROW supply in our model, and
■
The 2016 cost curve support sits at $101-119/t, depending on your view of Chinese
costs
But if the answer is 'no', then:
■
Perhaps Chinese domestic supply stays flat at current ~360mtpa
■
There's around 260mtpa of excess ROW seaborne supply by 2016, and
■
The 2016 cost curve support sits at around $77/t, for the highest cost non-China
supplier
The correct answer lies somewhere in between. Exhibit 7 might assist with framing these
questions and their commodity price implications.
Yes
No
Do you believe that China's
domestic supply is price elastic?
Exhibit 7: Where does iron ore cost curve support sit in 2016?
Do you believe we ought to net domestic freight off Chinese mine gate costs to
generate a China cost curve?
Yes
No
■ Cost curve support is at $101/t
■ Cost curve support is at $119/t
■ Chinese production falls to ~126mtpa ■ Chinese production falls to ~120mtpa
(62% equiv)
(62% equiv)
■ ROW excess supply of less than
■ ROW excess supply of less than
20mtpa
10mtpa
■ Chinese curve support remains at $119/t, as above
■ However if China is price inelastic ROW cost curve support is more relevant, and
this doesn't kick in until $77/t
■ Chinese production remains at 2013 levels of ~360mtpa (62% equiv)
■ ROW excess supply of roughly 260mtpa
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities Research
estimates.
Although there is no end to the desk top analysis we can do on this subject and the range
of scenarions we can create, there is really only one conclusion we can have absolute
conviction on…
The supply side will not behave rationally
■
Although our excel model might forecast the 'perfect world', game theory suggests that
many sub-economic producers will continue to use shareholder capital to oversupply
the market.
■
This will depress pricing for the entire market, and we would not be shocked to see
short term price fluctuations down to as low as $50/t at some point in the next 2-3
years.
■
Unprofitable supply will continue to operate for much longer than it should. Labor
commitments, infrastructure commitments, and supply contracts all complicate the
game theory decision making process.
Iron Ore Cost Curves
All we know for certain is
that the supply response will
not be rational
5
21 August 2013
China
Summary
With contributions from:
The consensus thesis on Chinese domestic iron ore production says that it is highly price
elastic, and longer term Chinese domestic supply shrinks and makes way for growth from
the first and second quartile (mainly Australia and Brazil).
Scott Chui - China Capital
Goods Research (Hong
Kong)
The objective of our 'China' section below is to i) show that there are a number of reasons
why investors should query the price elasticity thesis, and ii) illustrate the impact that a
non-price elastic China can have on the cost curve and hence iron ore pricing (i.e. how to
get from Exhibit 8 to Exhibit 9).
Wenzhe Zhao - Global
Strategy research (New
York)
Exhibit 9: 2016 curve (China: 360mtpa, incl domestic
freight)
freight)
Blue = CS price fcst, Red = consensus price, Black = demand
Blue = CS price fcst, Red = consensus price, Black = demand
160
160
140
140
120
120
US$ per dry metric tonne
US$ per dry metric tonne
Exhibit 8: 2016 curve (China: 250mtpa, excl domestic
100
80
60
40
20
100
80
60
40
20
0
0
0
100
200
BHP.AX
300
CLF
400
500
FMG.AX
600
700
800
900 1000 1100 1200 1300 1400 1500 1600
Million tonnes per annum
KIOJ.J RIO.AX VALE.N China
Other
0
100
200
BHP.AX
Reported Cash Cost (FOB)
300
CLF
400
500
FMG.AX
600
700
800
900 1000 1100 1200 1300 1400
Million tonnes per annum
KIOJ.J RIO.AX VALE.N China
Other
Reported Cash Cost (FOB)
All-In Cash Cost (FOB)
All-In Cash Cost (FOB)
All-In 62% IODEX equiv (CFR)
All-In 62% IODEX equiv (CFR)
Source: Company data, Credit Suisse Securities Research &
Analytics and Commodities Research estimates.
Source: Company data, Credit Suisse Securities Research &
Analytics and Commodities Research estimates.
Questioning the price elasticity thesis
This time last year most industry watchers were focused on the idea of "Chinese cost
curve support" and why the iron ore price could never fall below $120/t. Iron ore
subsequently fell to $87/t, and while there was some volume response from China in 2012,
the '$120/t floor theorists' have been notably absent in 2013.
210
120
180
100
150
80
120
60
90
40
60
20
30
Monthly domestic Chinese
production (mt)
140
0
Jan 09
Iron Ore (US$/t)
Exhibit 10: Chinese domestic iron ore production and 62% IODEX
0
Jan 10
Jan 11
Volume
Jan 12
Jan 13
Iron Ore
Source: Bloomberg, TSI, Credit Suisse estimates
Iron Ore Cost Curves
6
21 August 2013
At the extremes, we have seen estimates for long term Chinese domestic supply ranging
from 200mtpa up to 550mtpa – i.e. a 350mtpa spread. One's view on China's domestic
industry is comparable in magnitude to 100% of Vale, the world's largest iron ore producer.
We'd suggest that an analysis of China's domestic iron ore industry is more relevant to
forming a view on the long term commodity price than debating bullish/bearish scenarios
for Big 3 ramp up.
Reasons why investors should question China's price elasticity
We can see a number of reasons to question the traditional Chinese price elasticity thesis:
■
The freight barrier. Although most iron ore investors are accustomed to thinking
about mine to port rail costs and seaborne freight, we are surprised that Chinese
domestic freight doesn't get as much attention. The cost of freight in China does
however 'shelter' a large portion of the domestic industry (~160mtpa of 62% equivalent
supply comes from inland provinces), effectively creating a barrier to entry for import
competition.
■
The Grade Debate. Statistical evidence to support a price / production relationship is
weak, and we hypothesize whether China's observable grade depletion trend could in
fact be a reversable trend. If so, mining at higher grades will structurally change the
shape of the cost curve as we know it today.
■
China's cost base is price elastic. Although we think the price elasticity of Chinese
volumes is low, a look at regional cost structures shows that the price elasticity of
China's cost base is probably one of the highest in the world. 40% of the China cost
base is a function of the iron ore price. As prices move lower, these price-linked costs
will decrease.
Reasons to question the
consensus thinking on
China
Each of these topics is discussed in more detail below.
A more comprehensive analysis of this subject would also look at the growing importance
of captive SOE supply. Although the ownership structure of the iron ore industry is a little
different to that of steel, steel investors will be well aware that when it comes to China a
lack of profitability is not sufficient to see excess capacity removed. China does not always
behave as a market based economy.
Iron Ore Cost Curves
7
21 August 2013
The Freight Barrier
Iron Ore growth has been inland, not along the coast
It is well known that over the past 5 years China's steel industry has been moving towards
the coast (Exhibit 11). Less well known, but an equally relevant trend in our view, is that
growth across China's Inland iron ore provinces has outpaced that of coastal provinces.
The consequence of this inland iron ore growth is that Coastal provinces now only
contribute ~55% of domestic supply, down from over 70% just a few years ago.
Exhibit 11: Percent production from Coastal provinces
volumes
100%
75%
Contribution from Coastal
Provinces
Exhibit 12: YoY growth in coastal / inland iron ore
70%
80%
65%
60%
60%
40%
55%
20%
50%
45%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Iron Ore
Steel
Source: Bloomberg, Credit Suisse estimates
0%
2005 2006 2007 2008 2009 2010 2011 2012 2013
-20%
Coastal
Inland
Source: Bloomberg, Credit Suisse estimates
Iron Ore investors should appreciate the importance of freight when understanding mine
economics. While many of us are quite used to making freight adjustments between the
mine and port, or the port (FOB) and the customer (CFR), most investors neglect to
consider freight and logistics costs at the customer end of the supply chain.
Ignoring freight costs within China is akin to assuming that the entire country fits on the
head of a pin. In our view, an understanding of China's domestic freight industry is critical
to understanding the longer term competitive dynamic between imported and domestic
material. Consider the following illustrative example:
Imagine 'Mine A' which has mine gate costs of $150/t and typically services a local steel
mill. Due to being located thousands of kilometres inland, transport costs between Mine A
and the nearest port are say $100/t.
■
Traditional thinking would suggest that in a $90/t CFR world our $150/t mine is $60/t
out of the money, and we'd take it out of our S/D model, but
■
For imports to actually compete with, and displace, Mine A their delivered cost is 90 +
100 = $190/t (Exhibit 13). In other words Mine A is actually $40/t in the money (190 –
150).
Alternatively, if we wanted to accurately depict the economics of competing supply on a
CFR (coastal) basis, we could remove the same $100/t freight cost to get a CFR
equivalent cost for Mine A of $50/t (Exhibit 14). Again, this puts Mine A $40/t in the money
relative to our $90/t imports.
The $100/t freight example above is just an example and actual costs are actually
considerably lower. At the end of this section we develop a province by province freight
cost model and show what the cost curve looks like with / without this adjustment (i.e. we
replace the $100/t with proper estimates for each province).
Iron Ore Cost Curves
8
21 August 2013
Exhibit 13: We ought to add freight to imports
Exhibit 14: Alternatively remove freight from domestic
costs if you want to create a CFR (coastal) cost curve
200
200
150
150
100
100
50
50
0
0
Mine A
Transport
Imports, CFR
Source: Credit Suisse estimates
Mine A
Transport
Imports, CFR
Source: Credit Suisse estimates
Demographic Considerations
Although China's demographic landscape is well understood by most, we will briefly recap
for the benefit of those less familiar:
■
GDP per capita in the inland provinces is generally a fraction of that observed along
the coast (Exhibit 15), and we'd suggest that it is the inland provinces where much the
urbanization / GDP catch up opportunity resides within China.
■
Remember there are two ways to urbanize a country; you can take the people to the
city, or the city to the people. Cultural ties to the land and willingness of the population
to migrate are beyond the scope of this report, but might also be relevant to a more in
depth analysis of this subject.
■
Steel / iron ore is a high tonnage industry, and it is often not economic to transport
these materials over thousands of kilometers, so if the population growth is inland,
then the optimal location for the steel mill and the iron ore mine is inland as well.
Clearly there are some geological considerations here though, which we touch on over
page.
Our Demographics Research team recently published a piece titled 'Chinese
Demographics – Labour mobility, migration, urganisation and reforms' (click here) which is
worth a look too, and was the source for the below charts.
Exhibit 15: GDP per capita by province (2011 RMB pp)
Exhibit 16: Population by province (2011)
Source: NBS, Credit Suisse Demographics Research
Source: NBS, Credit Suisse Demographics Research
Iron Ore Cost Curves
9
21 August 2013
Geological considerations
■
Globally, iron ore is dominantly related to banded iron formation (BIF), which is
essentially repeated thin layers of iron and silica one on top of the other. BIF is
exclusively found in ancient Precambrian rocks (and mainly formed in the time period
of 2500 to 1800 million years ago – the Archean and early Proterozoic eons). BIF will
not be found in younger rocks. Hebei, Shandong and Jilin Provinces have BIF along
the Northern China Platform, and this is the major centre of iron ore production and
exploration in China. Coincidentally, this iron ore province is also proximal to the
coast. The pink 'Archeozoic' areas in Exhibit 17 illustrate the exposures of ancient
rocks that can host BIF.
Exhibit 17: Geological Map of China
Source: China Geological Survey
■
Other less voluminous, but useful iron ore in China is found in skarn deposits, which
are small but high grade. These are widespread, and being high grade will be widely
exploited.
■
Thirdly there are the magmatic deposits exemplified by the mighty iron–titaniumvanadium Panzihua deposit in Sichuan. Panzihua is billions of tonnes in size and
mined by a number of companies for all three minerals.
Given the importance of Panzihua and the BIFs for China’s iron ore production, we likely
already know the locations of Chinese iron ore mines which will be in operation 5 or even
10 years from now - as they will be defined by geology, and not demographics.
We'd be surprised if iron ore production from China's Inland provinces will be decreasing
as we look forward. Our broad assumption is that inland mines are servicing inland steel
mills, and for various reasons it can be difficult for imports to penetrate these markets in
volume. We estimate that over 160mtpa of China's 360mtpa (62% equivalent) domestic
supply (45%) is coming from these inland provinces at the moment, so any conversation
about China's price elasticity longer term should arguably be constrained to coastal
volumes. Of the ~200mtpa being produced along the coast, a large portion will be SOE
owned and a large portion will have better costs than imports. For the same reasons that
Iron Ore Cost Curves
10
21 August 2013
the steel industry hasn't responded to a lack of profitability, coastal iron ore mines may not
respond to a low price environment either.
The Grade Debate
Historical analysis suggests that China's domestic ore tonnes mined are somewhat price
elastic (Exhibit 18). Perhaps unsurprisingly given our comments above, there is a higher
degree of price elasticity (slope of the trend line) for coastal provinces than there is inland
provinces.
Exhibit 19: Contained Iron against Iron Ore Price
15.0
Ore Volume (mt)
60
50
40
30
20
y = 0.1216x + 22.227
10
50
75
100
125
150
Iron Ore Price 62% IODEX
Inland
175
Contained Iron Volume (mt)
Exhibit 18: Ore Volume against Iron Ore Price
70 y = 0.1539x + 37.482
12.5
y = 0.01x + 8.4792
10.0
7.5
5.0
y = 0.012x + 4.6374
2.5
50
200
75
100
125
150
Iron Ore Price 62% IODEX
Inland
Coastal
Source: Bloomberg, TSI, Credit Suisse estimates
175
200
Coastal
Source: Bloomberg, TSI, Credit Suisse estimates
There is another adjustment that can be made to this data however. Rather than just
looking at crude (as reported) ROM tonnes (Exhibit 18), we can adjust for contained iron
(i.e. grade) as well, as per Exhibit 19. Although the low correlation coefficients don't really
change much, the interesting thing about Exhibit 19 is that the price elasticity is far lower.
In fact it is pretty close to zero (again, we are referring to the slope/gradient of the trend
line here).
80
50%
40%
120
30%
160
20%
200
10%
0%
240
Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan
03 04 05 06 07 08 09 10 11 12 13
Grade % Fe
62% IODEX US$/t
Source: Bloomberg, TSI, Credit Suisse estimates
2.2
0
2.0
300
1.8
600
1.6
900
1.4
1,200
1.2
1,500
1.0
Gold Price - INVERTED
40
60%
62% IODEX - INVERTED
Implied domestic ore grade
commodity price
70%
Exhibit 21: Global gold grades and commodity price
Average Global Gold Grade (g/t)
Exhibit 20: Chinese domestic iron ore grades against
1,800
1992
1997
2002
Grade g/t
2007
2012
Gold Price $/oz
Source: Wood Mackenzie, Credit Suisse estimates
The data seems to suggest that as the price of iron ore fluctuates, the ore tonnes change,
but the contained iron does not. We suspect this observation may be the aggregate effect
of a number of drivers:
■
Low grade / high cost mines enter the market on an opportunistic basis when prices
are high, dragging down the average head grade across the country.
Iron Ore Cost Curves
11
21 August 2013
■
To the extend possible, mine plans are modified to exploit lower grade/high cost
tonnes when prices are high and the mine can remain cash flow positive.
■
On a longer term basis, we could also be observing a deliberate reallocation of mining
resources from high to low grade mines in response to price.
Similar price / grade relationships can be observed in most other commodities. Exhibit 21
illustrates the point with gold.
Just like any other iron ore region we've no doubt that depletion plays a part, but
remember China is one of the largest iron ore producers in the world. The country holds
billions and billions of tonnes in iron ore resources. Given that the average head grade
from the Pilbara has fallen by perhaps 1 percent over the past decade, it seems
improbable that China's multi-billion tonne resource base has fallen by 15-20% over the
same period. The grade/tonnage curve simply can't be that steep.
If part of China's observed grade trend can be reversed, then costs are likely to fall. A
mine that extracts ore at say 15% ROM (run of mine, i.e. unprocessed ore) and produces
a 64% Fe concentrate for cash costs of say $120/t, could produce the same 64%
concentrate at $70-80/t if it was mining 25-30% ROM ore.
We do not capture the impact of a changing grade profile in our cost curve. Our numbers
essentially assume grade is kept flat.
China's Cost Base is Price Elastic
Not only could a change of mined grade have a favorable impact on Chinese production
costs, but we think that in an absolute sense a lower price environment will do the same.
Exhibit 22: Cost Structure break down, by country
100%
80%
60%
40%
20%
0%
Australia Brazil Canada China
Guinea
India
Liberia Russia
Sierra
Leone
South Ukraine
Africa
Mining Costs ($/tonne)
Processing Costs ($/tonne)
Transport Costs ($/tonne)
Pelletising Costs ($/tonne)
Port Costs ($/tonne)
Overheads ($/tonne)
USA
Royalty and Levies ($/tonne)
Source: Wood MacKenzie, Credit Suisse estimates
According to Wood Mac estimates, roughly 40% of China's average production costs are
associated with 'overheads, royalties and levies'. We consider most of this likely to be a
derivative of the commodity price. 40% price-linked costs is higher than any other country
in the world except maybe India, with the global average being closer to 20% (Exhibit 22).
We suspect that a lot of this 40% represents 'price participation' on behalf of the
authorities, much of which is likely opportunistic in nature and likely to reduce as prices fall
and margins reduce. Anecdotes from China iron ore mine visits include people standing on
the side of the road charging a toll to truck drives because they know they can afford it.
When the price falls the truck driver can't afford the toll, and the person on the side of the
road goes away and does something else.
Simply put, the cost structure of the Chinese iron ore industry is probably one of the most
price-elastic iron ore cost structures in the world. If you believe iron ore prices are
lowering, you should expect all-in Chinese costs to more lower as well. For the purposes
Iron Ore Cost Curves
12
21 August 2013
of our cost curve model we do not capture any of this cost elasticity. For conservatism, we
in fact model 5%pa inflation on Chinese costs.
A Closer Look at Freight
The previous few pages have hopefully given readers cause to see why longer term China
might not only be a bigger producer, but also a lower cost producer than consensus
thinking suggests. Not only do we expect Chinese production costs to fall much more
quickly than ROW putting more supply back in the money, but further we feel that the
relevance of price in determining Chinese production decisions (elasticity) is overstated.
China is not a market-based economy.
The following section illustrates the potential cost curve impact of our domestic freight
discussion above. Carrying on from the $150/t Mine A example with the $100/t freight
costs, the following section actually derives provincial level estimates for both.
Estimating the impact of domestic freight costs
Exhibit 23: Chinese freight transport, by mode
Exhibit 24: Chinese 'Metal Ores' transported by rail
400
100%
350
80%
300
60%
250
40%
200
150
20%
100
0%
1970
Railway
1980
1990
Highway
2000
Waterway
2008
Air
2012
Pipeline
Source: Company data, Credit Suisse Equity Research (18 June
2013)
50
0
1992
1995
1998
2001
2004
2007
2010
Source: CEIC, Credit Suisse Equity Research (18 June 2013)
Although Waterway and Highway freight has taken significant market share from rail over
the past few decades (Exhibit 23), we suspect that rail remains the main method for
transporting iron ore over long distances given that:
■
Rail is significantly faster than water
■
Highway / trucking is the main method used over short distances, but over longer
distances its costs are likely prohibitive.
Trucking is used extensively in Shanxi and the western part of Hebei, and our China team
estimate this could cost as much as $10-20/t.
Iron Ore Cost Curves
13
21 August 2013
Rail costing model
With the help of our China Industrials team we've built a simple Chinese rail cost model, as
summarized below.
Exhibit 25: Chinese Rail Freight costing model
Haulage
Distance
km
50
100
500
1000
Base rate 1
(variable)
Rmb/t Rmb/t/km
13.8
0.28
13.8
0.14
13.8
0.03
13.8
0.01
Construction fund
surcharge
Rmb/t Rmb/t/km Rmb/t Rmb/t/km
3.77
0.08
1.65
0.033
7.53
0.08
3.30
0.033
37.65
0.08
16.50
0.033
75.30
0.08
33.00
0.033
Base rate 2 (fixed)
Electrification
surcharge
Rmb/t Rmb/t/km
0.60
0.012
1.20
0.012
6.00
0.012
12.00
0.012
Loading/unloading
Total
Total
Rmb/t Rmb/t/km Rmb/t Rmb/t/km US$/t US$/t/km
22.4
0.45
42.22
0.84
6.90
0.138
22.4
0.22
48.23
0.48
7.88
0.079
22.4
0.04
96.35
0.19
15.74
0.031
22.4
0.02
156.50
0.16
25.57
0.026
Source: China Ministry of Railway, Credit Suisse estimates
Over short distances, the loading/unloading costs associated with rail are likely to make
trucking more attractive, however on a pure operating cost basis rail looks more attractive
for haulage in excess of 100km.
th
Exhibit 26: China Railway Map, from 12 Five Year Plan
Source: Chinese Ministry of Railways
The Three Gorges dam and lock system allows penetration of imported ores all the way up
to Chongqing in 10kt vessels. BHP.AX does in fact sell its seaborne marketing into
Sichuan province via this route.
We don't have a waterway cost model, but it is our understanding that barging costs are in
the order of $0.02 per tonne km. Nominating the mode of transport might therefore be
relevant for capacity/volume based analysis, but for our high level economic based
analysis the comparable costs mean that we do not need to differentiate between the two.
The final step in our domestic freight cost analysis is to estimate distances.
■
Rather than getting lost in the detail, we've done this on a provincial basis by
considering the most likely port option for each province. Clearly in some cases there
are multiple options, and for some of the larger provinces there would be significant
Iron Ore Cost Curves
14
21 August 2013
variance from one side of the province to the other, but the averages we've used are
summarized in Exhibit 27.
■
Exhibit 26 is the Ministry of Rail map from China's 12 th year plan, and so far as
possible we've tried to keep 'googlemaps' routing consistent with rail routing.
Exhibit 27 combines our estimated distances with our freight costing model (Exhibit 25) to
generate a $/t rail cost / net back estimate for each province. Were imported material to be
competing with domestic material in each of these provinces, the below seems to be a
reasonable assumption regarding potential routing. This final freight column below has
been removed /netted off our mine gate cost estimates in the scenarios which follow.
Exhibit 27: Chinese domestic freight costs – Credit Suisse estimates
Province
Anhui
Beijing
Fujian
Gansu
Guangdong
Guangxi
Guizhou
Hainan
Hebei Low/Mid
Hebei High
Heilongjiang
Henan
Hubei
Hunan
Inner Mongolia
Jiangsu
Jiangxi
Jilin
Liaoning Low/Mid
Liaoning High
Qinghai
Shaanxi
Shandong
Shanxi
Sichuan
Xinjiang
Yunnan
Zhejiang
Mean (volume weighted)
ROM 2012 Output (Mt)
46
20
14
11
22
4
1
6
184
347
5
15
23
8
92
2
19
17
25
129
2
12
154
81
163
29
26
2
Port
Shanghai
Tianjin
Quanzhou
Qigdao
Guangzhou
Zhanjiang
Zhanjiang
Basuo
Tianjin
Tianjin
Dalian
Rizhao
Liangyungang
Xiamen
Tianjin
Shanghai
Xiamen
Dalian
Dalian
Dalian
Tianjin
Rizhao
Qingdao
Tianjin
Rizhao
Tianjin
Zhanjiang
Shanghai
Distance (km)
470
140
200
1,830
50
330
880
50
334
334
935
575
840
870
620
150
690
690
360
360
1,720
1,000
100
550
1,750
3,200
1,100
170
571
Freight (US$/t)
15
9
10
43
7
13
24
7
13
13
25
17
23
23
18
9
20
20
13
13
40
26
8
17
41
70
28
9
17
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities Research
estimates.
The same data is shown in Exhibit 28, and in the Appendix to this report we have a map of
China which shows both iron ore and steel production by province.
Regarding Exhibit 28:
■
The diagonal lines illustrate the divide between material which is economic and
material which is not (based on the freight net back from coast) at $80, $100 and
$120/t. y axis value less x axis value = grey line.
■
On a 2013 basis, our methodology implies that 36% / 129mtpa of Chinese domestic
tonnage is uneconomic at $100/t, 49% / 177mtpa at $90/t, and 70% / 251mtpa at $80/t
■
A more comprehensive analysis of this subject would look at ownership structures (i.e.
SOE v private) and raw material switching costs for the steel mill. As any steel analyst
will tell you, just because an industry is unprofitable in China doesn't mean it will cease
to produce.
Iron Ore Cost Curves
15
21 August 2013
■
Also recall our earlier discussion of cost elasticity. To demonstrate the sensitivity to
costs, consider a scenario where the entire Chinese industry were capable of lowering
their cost base by 20%. The volumes quoted above become 0.5% / 2mtpa at $100/t,
2% / 9mtpa at $90/t, and 37% / 132mtpa at $80/t.
Exhibit 28: Chinese provincial iron ore production
Bubble diameter represents production (mtpa), and 80/100/120 lines indicate the theoretical
divide between tonnage which would be economic, and tonnage which is not
180
$120
$100
Mine Gate Cost (US$/t)
160
$80
140
120
100
80
60
40
20
0
10
20
30
40
50
60
70
Estimated freight net back, from closest port (US$/t)
80
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities Research
estimates.
Mine verse Steel Mill net back?
■
We have 'netted back' the China domestic freight costs based on the mine location,
and not the steel mill location. Readers would be right to query whether this is the best
approach, given that it is the steel mills' location which determines the clearing price
for iron ore and it is at the steel mill that the imports v domestic raw material battle
takes place.
■
Our broad assumption is that inland mines are servicing inland steel mills. Exhibit 11
shows that there is only a 7% difference between the volume of iron ore produced by
coastal provinces (53%) and the volume of steel produced by coastal provinces (60%).
Therefore using a steel mill rather than iron ore mine net back would only change our
overall freight overlay by 7%, which we consider less than our forecasting error.
In the next section of this report we use our in house model to demonstrate how the above
concepts may impact the cost curve.
Iron Ore Cost Curves
16
21 August 2013
Impact of a Larger and Lower Cost China
Using our 2016 cost curve as a case study, we set out four basic steps:
■
Step 1 / Exhibit 29: start with a 'regular' iron ore cost curve (in which domestic freight
costs are ignored). We've used the Credit Suisse 2016 estimates as a case study. The
Step 1 data is repeated on Step 2 – 4 charts as a grey outline.
■
Step 2 / Exhibit 30: Adjust Chinese domestic production for domestic freight costs –
i.e. net them back to a CFR equivalent cost
Exhibit 29: Step 1: Start with a 'regular' 2016 cost curve
Exhibit 30: Step 2: Adjust China Cost base for domestic
(ignores China domestic freight)
freight
160
160
Cost curve support at $120/t
Cost curve support at $100/t
140
120
US$ per dry metric tonne
US$ per dry metric tonne
140
100
80
60
40
20
120
100
80
60
40
20
0
0
0
100
200
BHP.AX
300
CLF
400
500
FMG.AX
600
700
800
900 1000 1100 1200 1300 1400 1500 1600
Million tonnes per annum
KIOJ.J RIO.AX VALE.N China
Other
0
100
200
BHP.AX
Reported Cash Cost (FOB)
300
CLF
400
500
FMG.AX
600
700
800
900 1000 1100 1200 1300 1400 1500 1600
Million tonnes per annum
KIOJ.J RIO.AX VALE.N China
Other
Reported Cash Cost (FOB)
All-In Cash Cost (FOB)
All-In Cash Cost (FOB)
All-In 62% IODEX equiv (CFR)
All-In 62% IODEX equiv (CFR)
Source: Company data, Credit Suisse Securities Research &
Analytics and Commodities Research estimates.
Source: Company data, Credit Suisse Securities Research &
Analytics and Commodities Research estimates.
■
Step 3 / Exhibit 31: Instead of shrinking Chinese supply to 250mtpa (as per our
existing S/D model), keep it flat at 360mtpa (CSe 2013, 62% equivalent).
■
Step 4 / Exhibit 32: make room for the extra 110mtpa of Chinese domestic material by
removing 200mtpa ROW supply
Exhibit 31: Step 3: Keep Chinese production flat at
Exhibit 32: Step 4: Remove excess ROW supply to
360mtpa (rather than reducing to 250mtpa)
balance supply with demand
160
160
Cost curve support at $100/t
Cost curve support at $120/t
or $77/t for ROW
140
120
US$ per dry metric tonne
US$ per dry metric tonne
140
100
80
60
40
20
120
100
80
60
40
20
0
0
0
100
200
BHP.AX
300
CLF
400
500
FMG.AX
600
700
800
900 1000 1100 1200 1300 1400 1500 1600 1700
Million tonnes per annum
KIOJ.J RIO.AX VALE.N China
Other
Reported Cash Cost (FOB)
0
100
200
BHP.AX
300
CLF
400
500
FMG.AX
600
700
KIOJ.J
800
900 1000 1100 1200 1300 1400
Million tonnes per annum
RIO.AX VALE.N China
Other
Reported Cash Cost (FOB)
All-In Cash Cost (FOB)
All-In Cash Cost (FOB)
All-In 62% IODEX equiv (CFR)
All-In 62% IODEX equiv (CFR)
Source: Company data, Credit Suisse Securities Research &
Analytics and Commodities Research estimates.
Source: Company data, Credit Suisse Securities Research &
Analytics and Commodities Research estimates.
Clearly there are some fairly significant implications to ROW iron ore supply and the
commodity price here:
■
The 'regular' cost curve (Step 1) suggests cost curve support at $119/t, but
■
Our adjusted cost curve (Step 4) doesn't show ROW support until we get to around
$77/t for ROW. If China is price inelastic then the top of the China cost curve at $120/t
is irrelevant.
Iron Ore Cost Curves
17
21 August 2013
Rest of World
The 'Rest of World' section of this report is split into two sections:
■
Existing supply. We look at supply/demand surpluses in the next section of this
report, but we've leveraged our cost curve to demonstrate how much of the tonnage
currently in our S/D model which is out of the money under various pricing scenarios.
We can see around 375mtpa of 2016 supply which is out of the money at $90/t iron
ore, 140mtpa of which is ROW/ex-China.
■
New projects. The new project tonnage estimates, dominated by Australia and Brazil,
appear fairly robust. Our analysis has involved a review of 465mtpa of 'growth'
capacity, for which we have looked at outstanding capex, anticipated operating
margins, and from the two derived an estimated ROI. This analysis suggests that the
economics of most Australian and Brazilian growth projects appear fairly robust, even
at price levels slightly below $90/t, however by the time we get down to around $70/t
the volume of economic expansion tonnage does fall off quite quickly. Our separate
titled 'Iron Ore Equities: Equity Implications of our Cost Curve Update' discusses
individual companies and their expansion projects in a little more detail – and should
be read in conjunction with the below.
Existing supply
Exhibit 33: Existing GLOBAL supply which become UNeconomic in 2016
Existing supply UNeconomic (mtpa)
400
Although we can see why
the market focuses on
'$120/t' we query whether
this is really a 'floor'
350
300
250
$105 - 115/t appears to be a more
notable resistance level
200
150
100
50
0
135
130
China
125
Australia
120
115
110
105
62% IODEX (US$/t)
North America
Brazil
100
95
90
Europe
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities Research
estimates.
Our 62% IODEX normalized cost curve provides a convenient tool with which to assess
the economics of existing supply. In a theoretical world, 'out of the money' supply from
ROW should turn off in an orderly fashion and prices should stabilize at the top end of the
cost curve. As we noted earlier though, about the only thing we can be sure of here is that
the real world will not operate the same as our theoretical world.
Exhibit 33 and Exhibit 34 illustrates the existing 2016 supply volumes from our S/D and
cost curve models that becomes uneconomic at various pricing points.
Although we can see why the market has become emotionally attached to $120/t level, as
discussed earlier in this report we feel that the manner in which China will respond to this
pricing level has been over stated. A more significant 'cost floor' based on our modeling
exists within the $95-110/t range. Within this range almost 120mtpa of existing ROW
Iron Ore Cost Curves
18
21 August 2013
supply becomes uneconomic across Australia, North America and Europe. By the time we
get to $90/t, we see just over 140mtpa of ROW supply which is out of the money.
Capacity which is uneconomic (mtpa)
Exhibit 34: Existing ROW supply which become UNeconomic in 2016
160
140
120
100
80
60
40
20
0
110
105
Australia
100
62% IODEX (US$/t)
North America
95
Brazil
90
Europe
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities Research
estimates.
All of our cost analysis is done on a CFR China basis. Although the intent is to create a
consistent and level playing field in order to compare economics globally, this approach is
arguably a little unfair to European producers. Very little European supply actually makes it
all the way to China, and although the economics don't look very appealing when we add
a hefty freight charge to 'normalize' it to China, the economics are far more attractive when
the actual freight costs (for local delivery) are used.
Most of the 59mtpa uneconomic European supply shown in Exhibit 34 (CFR China basis)
actually is economic when delivered into local markets. The same logic might apply to
some of the Brazilian and North American supply too.
Growth projects
Our analysis of growth projects has involved a review of around 25 global iron ore
projects.
For
each
project
we
consider
incremental
supply
added,
outstanding/uncommitted capex, and anticipated operating margins. The margin divided
by the (outstanding) capital intensity is then used to calculate a pre-tax ROI for each
project.
By applying a 25% ROI hurdle, we generate Exhibit 36.
■
Australian and Brazilian growth forecasts generally appear robust at, or even slightly
below, $90/t. This is supportive of the long term thesis on iron ore; which says that the
Big 3 (BHP, RIO, Vale) will continue to add capacity displacing more and more of the
third and fourth quartiles.
■
Australian and Brazilian growth economics start to look shaky at $70-80/t, but this is
below our current LT price forecast.
■
This very crude analysis says that Africa (Simandou) needs >$100/t iron ore to
generate a 25% ROI.
■
India and European growth projects are a 'drop in the ocean' relative to the tsunami
impact of Australia and Brazilian growth.
Iron Ore Cost Curves
19
21 August 2013
Exhibit 35: Market share of Top 3 and Top 10 producers, by commodity
Lead
Thermal
Gold
Silver
Zinc
Top 3
Metallurgical
coal
Top 10
Copper
Nickel
Aluminium
Iron Ore
(total)
Platinum
Iron Ore
(seaborne)
Palladium
100
90
80
70
60
50
40
30
20
10
0
Source: Wood Mackenzie, Company data, Credit Suisse Securities Research & Analytics
We expect iron ore to remain an oligopoly. Although we are confident that Big 3 growth
projects will happen, we are less confident on the timing. The oligopoly can (and will) hold
back supply in order not to flood their own market. The game theory discussions which
take place at board meetings must be fascinating…
New supply which is Economic (mtpa)
Exhibit 36: New supply growth generating >25% ROI
500
450
400
350
300
250
200
150
100
50
0
70
75
80
Australia
85
90 95 100 105 110 115 120 125 130
62% IODEX (US$/t)
Brazil
Africa
Europe
India
Source: Company data, Credit Suisse Securities Research & Analytics
Iron Ore Cost Curves
20
21 August 2013
Cost Curves
The third and final section of this report provides an update of our annual cost curves.
Coverage and Commodity Price Implications
Our cost curve model has an estimated 91 - 94% 'coverage' of our supply/demand model.
The 6 – 9% shortfall is tonnage which we can see fairly easily in various trade data
sources (and hence include in the S/D model), but which we have been unable to
confidently estimate costs for.
Exhibit 37: Cost Curve coverage
2013
2014
2015
2016
mt
360
1,211
1,571
320
1,381
1,701
300
1,500
1,800
250
1,603
1,853
Cost curve target
Cost curve actual
Cost curve coverage
Uncosted tonnes
mt (dry)
mt (dry)
%
mt (dry)
1,497
1,362
91%
134
1,620
1,488
92%
132
1,714
1,608
94%
107
1,765
1,647
93%
118
Demand
World Steel Production
China Steel Production
mt
mt
1,575
755
1,634
779
1,683
806
1,730
833
Seaborne demand
China Domestic Production (62%)
Total demand
Total demand (scaled for CC coverage)
mt
mt
mt
mt (dry)
1,205
360
1,565
1,352
1,295
320
1,615
1,408
1,348
300
1,648
1,468
1,436
250
1,686
1,493
Excess supply
mt (dry)
10
81
140
154
Supply
China Domestic Production (62%)
Seaborne Supply
Cost curve target
mt
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities Research
estimates.
Given that we are missing 111 – 139mt of supply from our cost curve model in any given
year, in order to show a 'demand' line on our charts we've had to scale our raw demand
numbers by the cost curve coverage factors (91-94%) as shown above. This 111 –
139mtpa of uncosted supply is pretty important to understanding the supply response in
coming years. By 'scaling' our demand number to match our 91-94% coverage, the implicit
assumption is that this uncosted tonnage is distributed evenly across the cost curve. The
reality, we suspect, is that most of it would reside within the third and fourth quartiles.
Through 2013 – 2016 we can see 6 to 148mtpa of excess supply, which will obviously cut
into the top end of the cost curve. In a theoretical world, this excess 'out of the money'
tonnage would turn off, and price would stabilize.
Exhibit 38 and Exhibit 39 summarise the commodity price read-throughs on each of these
two cost curve scenarios:
■
In our view, the consensus price (red line) seems to fit pretty well with our 'adjusted'
cost curve. This scenario requires uneconomic excess supply in China and elsewhere
to turn off in a disciplined and orderly fashion, thereby avoiding a supply overhang.
■
If the supply side behaves rationally, then the Credit Suisse price deck is probably too
bearish. The Credit Suisse price deck implies deep cuts into the top end of the cost
curve, that provide a more dramatic signal for excess supply to shut down. Depending
on the cost curve model used, our price deck over the next few years cuts as far down
as the 80-90th percentile of the cost curve.
Iron Ore Cost Curves
21
21 August 2013
In our view, the most important question iron ore investors should be asking is whether or
not China's domestic volume will be price elastic. This will have more impact on your LT
view of pricing than mulling over 'Big 3' ramp up profiles.
China's domestic supply is
should be investors' focus
If the answer is 'yes, entirely', then
■
Chinese domestic supply falls to 120-126mtpa (from CSe 360mtpa in 2013, 62%
equiv)
■
There's only 10-20mtpa of excess ROW supply in our model, and
■
The 2016 cost curve support sits at $101-119/t, depending on your view of Chinese
costs
Exhibit 38: Cost curve intercepts using 'regular' curve
Exhibit 39: Cost curve intercepts using 'adjusted' curve
(ignores China domestic freight)
(includes China domestic freight)
170
170
157
150
130
128
118
110
157
150
124
108
94
86
90
130
119
98
110
93
78
89
90
76
70
114
102
106
93
101
92
79
76
89
76
70
50
50
2013
2014
100th percentile
CS fcst
2015
90th percentile
Consensus fcst
2016
2013
75th percentile
Source: Company data, Credit Suisse Securities Research &
Analytics and Commodities Research estimates.
100th percentile
CS fcst
2014
2015
90th percentile
Consensus fcst
2016
75th percentile
Source: Company data, Credit Suisse Securities Research &
Analytics and Commodities Research estimates.
But if the answer is 'no', then:
■
Perhaps Chinese domestic supply stays flat at current ~360mtpa
■
There's around 260mtpa of excess ROW seaborne supply by 2016, and
■
The 2016 cost curve support sits at around $77/t, for the highest cost non-China
supplier
Yes
No
Do you believe that China's
domestic supply is price elastic?
Exhibit 40: Where does iron ore cost curve support sit in 2016?
Do you believe we ought to net domestic freight off Chinese mine gate costs to
generate a China cost curve?
Yes
No
■ Cost curve support is at $101/t
■ Cost curve support is at $119/t
■ Chinese production falls to ~126mtpa ■ Chinese production falls to ~120mtpa
(62% equiv)
(62% equiv)
■ ROW excess supply of less than
■ ROW excess supply of less than
20mtpa
10mtpa
■ Chinese curve support remains at $119/t, as above
■ However if China is price inelastic ROW cost curve support is more relevant, and
this doesn't kick in until $77/t
■ Chinese production remains at 2013 levels of ~360mtpa (62% equiv)
■ ROW excess supply of roughly 260mtpa
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities Research
estimates.
Iron Ore Cost Curves
22
21 August 2013
The correct answer lies somewhere in between. Exhibit 40 might assist with framing these
questions and their commodity price implications.
Although there is no end to the desk top analysis we can do on this subject and the range
of scenarions we can create, there is really only one conclusion we can have absolute
conviction on:
The supply side will not behave rationally
■
Although our excel model might forecast the 'perfect world', game theory suggests that
many sub-economic producers will continue to use shareholder capital to oversupply
the market.
■
This will depress pricing for the entire market, and we would not be shocked to see
short term price fluctuations down to as low as $50/t at some point in the next 2-3
years.
■
Unprofitable supply will continue to operate for much longer than it should. Labor
commitments, infrastructure commitments, and supply contracts all complicate the
game theory decision making process.
th
th
All we know for certain is
that the supply response will
not be rational
th
Exhibit 41: 2016 cost curve, highlighting the 75 / 90 / 100 percentiles as discussed above
Blue = CS price fcst, Red = consensus price, Black = demand, Grey = cost curve without China domestic freight adjustment
160
100th
US$ per dry metric tonne
140
90th
120
75th
100
80
60
excess
supply
40
20
0
0
100
200
BHP.AX
300
CLF
400
500
FMG.AX
600
700
800
900 1000 1100 1200 1300 1400 1500 1600
Million tonnes per annum
KIOJ.J RIO.AX VALE.N China
Other
Reported Cash Cost (FOB)
All-In Cash Cost (FOB)
All-In 62% IODEX equiv (CFR)
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities Research estimates.
Refer Appendix for further discussion on methodology
As a reminder, we feel our approach to building these cost curves is somewhat
differentiated due to the pricing premium/penalty we use as an offset to the cost base. For
further details on the methodology and our underlying assumptions please see the
Appendix to this report.
Iron Ore Cost Curves
23
Exhibit 43: 2013 Cost Curve (with China domestic freight)
Blue = CS price fcst, Red = consensus price, Black = demand
Blue = CS price fcst, Red = consensus price, Black = demand
160
160
140
140
120
120
US$ per dry metric tonne
US$ per dry metric tonne
Iron Ore Cost Curves
Exhibit 42: 2013 Cost Curve (ignoring China domestic freight)
100
80
60
40
20
100
80
60
40
20
0
0
0
100
200
BHP.AX
300
CLF
400
500
FMG.AX
600
700
800
900 1000 1100 1200 1300
Million tonnes per annum
KIOJ.J RIO.AX VALE.N China
Other
0
100
200
BHP.AX
Reported Cash Cost (FOB)
300
CLF
400
500
FMG.AX
600
700
800
900 1000 1100 1200 1300
Million tonnes per annum
KIOJ.J RIO.AX VALE.N China
Other
Reported Cash Cost (FOB)
All-In Cash Cost (FOB)
All-In Cash Cost (FOB)
All-In 62% IODEX equiv (CFR)
All-In 62% IODEX equiv (CFR)
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities
Research estimates.
Exhibit 44: 2014 Cost Curve (ignoring China domestic freight)
Exhibit 45: 2014 Cost Curve (ignoring China domestic freight)
Blue = CS price fcst, Red = consensus price, Black = demand
Blue = CS price fcst, Red = consensus price, Black = demand
160
160
140
140
120
120
US$ per dry metric tonne
US$ per dry metric tonne
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities
Research estimates.
100
80
60
40
20
100
80
60
40
20
0
0
0
100
200
BHP.AX
300
CLF
400
500
FMG.AX
600
700
800
900 1000 1100 1200 1300 1400
Million tonnes per annum
KIOJ.J RIO.AX VALE.N China
Other
Reported Cash Cost (FOB)
0
100
200
BHP.AX
300
CLF
400
500
FMG.AX
600
700
800
900 1000 1100 1200 1300 1400
Million tonnes per annum
KIOJ.J RIO.AX VALE.N China
Other
Reported Cash Cost (FOB)
All-In Cash Cost (FOB)
All-In 62% IODEX equiv (CFR)
All-In 62% IODEX equiv (CFR)
24
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities
Research estimates.
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities
Research estimates.
21 August 2013
All-In Cash Cost (FOB)
Exhibit 47: 2015 Cost Curve (with China domestic freight)
Blue = CS price fcst, Red = consensus price, Black = demand
Blue = CS price fcst, Red = consensus price, Black = demand
160
160
140
140
120
120
US$ per dry metric tonne
US$ per dry metric tonne
Iron Ore Cost Curves
Exhibit 46: 2015 Cost Curve (ignoring China domestic freight)
100
80
60
40
20
100
80
60
40
20
0
0
0
100
200
BHP.AX
300
CLF
400
500
FMG.AX
600
700
800
900 1000 1100 1200 1300 1400 1500 1600
Million tonnes per annum
KIOJ.J RIO.AX VALE.N China
Other
0
100
200
BHP.AX
Reported Cash Cost (FOB)
300
CLF
400
500
FMG.AX
600
700
800
900 1000 1100 1200 1300 1400 1500 1600
Million tonnes per annum
KIOJ.J RIO.AX VALE.N China
Other
Reported Cash Cost (FOB)
All-In Cash Cost (FOB)
All-In Cash Cost (FOB)
All-In 62% IODEX equiv (CFR)
All-In 62% IODEX equiv (CFR)
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities
Research estimates.
Exhibit 48: 2016 Cost Curve (ignoring China domestic freight)
Exhibit 49: 2016 Cost Curve (ignoring China domestic freight)
Blue = CS price fcst, Red = consensus price, Black = demand
Blue = CS price fcst, Red = consensus price, Black = demand
160
160
140
140
120
120
US$ per dry metric tonne
US$ per dry metric tonne
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities
Research estimates.
100
80
60
40
20
100
80
60
40
20
0
0
0
100
200
BHP.AX
300
CLF
400
500
FMG.AX
600
700
800
900 1000 1100 1200 1300 1400 1500 1600
Million tonnes per annum
KIOJ.J RIO.AX VALE.N China
Other
Reported Cash Cost (FOB)
0
100
200
BHP.AX
300
CLF
400
500
FMG.AX
600
700
800
900 1000 1100 1200 1300 1400 1500 1600
Million tonnes per annum
KIOJ.J RIO.AX VALE.N China
Other
Reported Cash Cost (FOB)
All-In Cash Cost (FOB)
All-In Cash Cost (FOB)
All-In 62% IODEX equiv (CFR)
All-In 62% IODEX equiv (CFR)
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities
Research estimates.
25
21 August 2013
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities
Research estimates.
21 August 2013
Exhibit 50: Supply/Demand Model (Last Updated June 2013)
Mt
2011
2012
China Crude Steel Production
695
717
% Change
10.9%
3.2%
2013
755
5.3%
2014
779
3.2%
2015
806
3.5%
2016
833
3.3%
World ex-China Steel Production
% Change
796
4.0%
804
1.1%
820
2.0%
855
4.3%
877
2.6%
897
2.3%
World Steel Production
% Change
1,491
7.1%
1,521
2.0%
1,575
3.6%
1,634
3.7%
1,683
3.0%
1,730
2.8%
Chinese statistics
Total Chinese IO Demand
% Change
1,055
13.1%
1,088
3.2%
1,134
4.2%
1,163
2.6%
1,197
2.9%
1,230
2.8%
Domestic Production (62%)
% Change
418
16.8%
353
-15.6%
360
2.0%
320
-11.1%
300
-6.3%
250
-16.7%
98
34.4%
7.4488569
73
-25.7%
5.1014018
83
13.5%
95
13.9%
100
5.9%
102
2.0%
Seaborne demand (imports)
China
% change
687
11.0%
746
8.5%
783
5.1%
855
9.1%
902
5.6%
982
8.8%
World ex-China
% change
442
-0.3%
404
-8.7%
421
4.4%
440
4.5%
446
1.2%
454
1.8%
World
% change
1,129
6.3%
1,149
1.8%
1,205
4.8%
1,295
7.5%
1,348
4.1%
1,436
6.5%
Seaborne supply (exports)
Australia
% change
439
9.2%
494
12.5%
573
16.1%
674
17.6%
724
7.3%
791
9.4%
Brazil
% change
331
6.4%
327
-1.3%
321
-1.8%
361
12.4%
415
15.0%
438
5.7%
India
% change
81
-24.3%
35
-56.8%
5
-85.8%
17
240.0%
25
47.1%
25
0.0%
Other LatAm
% change
26
7.1%
28
5.3%
29
3.3%
32
12.3%
32
0.0%
32
0.0%
South Africa
% change
53
11.2%
54
1.3%
59
8.2%
59
1.0%
59
0.0%
59
0.0%
Other Africa
% change
12
16.1%
20
65.8%
34
69.3%
42
23.8%
53
27.7%
63
18.8%
North America
% change
34
13.0%
36
4.9%
40
11.2%
44
11.0%
39
-10.5%
40
1.2%
EU27
% change
9
1.1%
9
2.9%
10
5.1%
10
10.4%
10
0.0%
11
3.0%
RUK
% change
73
9.0%
73
0.3%
74
0.4%
74
1.1%
74
-0.7%
74
0.7%
Other
% change
71
31.5%
74
5.1%
69
-7.1%
68
-2.1%
69
1.9%
70
0.9%
World
% change
1,129
6.3%
1,149
1.8%
1,211
5.4%
1,381
14.0%
1,500
8.6%
1,603
6.9%
---
---
7
86
152
167
Iron Ore Inventories at Port
% Change
Required Market Adjustment
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities Research estimates.
Iron Ore Cost Curves
26
21 August 2013
Appendices
Definitions
To the extent possible, we have included three different ‘cost’ categories for our global iron
ore cost curve. It is the second, and particularly third of these categories which we believe
makes our iron ore cost curve unique.
■
Reported Cash Cost (FOB) represent cash costs as reported by the company (where
available) or as derived by our regional analysts from site visits or company
presentations. Iron Ore miners are often inconsistent with the items they chose to
include in their ‘reported’ cash cost number. Unlike some other metals industries, iron
ore miners have not adopted Brook Hunt/Wood Mac conventions. Most industry
consultants will typically only use costs to this level.
■
All-In Cash Cost (FOB): Our all in cash cost assessment is the same as above
except that we also include indirect operating items such as royalties, corporate costs
and sustaining capital. This is essentially the “all-in” cost of doing business. It does not
however include interest/financing costs or corporate taxes.
■
All-In 62% IODEX Equivalent (CFR): The final cost element we show includes two
further adjustments; being freight and pricing premium/penalty. The freight adjustment
changes our units from FOB to CFR China. For every individual product and project
we have also made an assessment of its pricing premium/penalty relative to the 62%
IODEX fines price. Realized pricing premiums/penalties are subtracted/added to the
CFR costs base—therefore we effectively normalize everything into 62% IODEX
terms. This is akin to adjusting a gold cost curve for a copper by-product. We have not
seen any other cost curves that do this, but we feel it is an essential step in order to
accurately compare mine profitability. We are in effect constructing a “margin” curve
rather than a “raw cost” curve, and it means that unlike others, we are able to draw a
horizontal pricing line straight across our chart.
Iron Ore Cost Curves
27
21 August 2013
Standardization of Key Assumptions
■
The “Reported Cash Cost” and “All-In Cash Cost” (both FOB) have been provided
from our respective analysts, and are in nominal terms. Although quoted in US$, these
assumptions use the house view on exchange rates, as summarized below.
■
Key assumptions are standardized across all products and regions. We are very
aware that the topic of iron ore pricing / VIU is a complicated one and depends on
significantly more variables than grade alone. For the purposes of this exercise
however, we have had to simplify it somewhat.
Exhibit 51: Key Macro Assumptions (Base Case)
2012
2013
2014
2015
2016
Currencies
US $1 =
US $1 =
US $1 =
US $1 =
US $1 =
US $1 =
AUD
BRL
CAD
CNY
EUR
ZAR
0.97
1.96
1.00
6.31
0.78
8.17
0.98
2.20
0.99
6.30
0.76
9.63
1.09
2.26
1.00
6.37
0.79
10.00
1.15
2.31
1.01
6.47
0.83
9.50
1.17
2.37
1.02
6.55
0.83
9.00
Pricing
Pellet Premium
Grade premium (concs)
Grade premium (fines)
62% IODEX
58% IODEX
$/t
US$ per 1% Fe
US$ per 1% Fe
US$/t
US$/t
20
2.93
2.93
125
114
30
2.5
2.5
119
109
30
2.6
2.7
96
86
30
2.7
2.9
97
86
30
2.8
3.1
97
85
Freight
Australia
Brazil
South Africa
West Africa
North America
Norway
China
China
China
China
China
China
7.7
19.4
11.5
19.4
21.5
26.9
8.0
17.6
12.0
17.6
22.4
28.0
9.5
20.9
14.3
20.9
26.6
33.3
10.8
23.7
16.1
23.7
30.1
37.6
11.5
25.3
17.3
25.3
32.2
40.3
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities Research
estimates.
■
The third of the three costs that we show (All-In CFR) has been calculated by a
standardized set of assumptions for freight and realized pricing across the entire
group. Although our model allows us to “flex” these assumptions, our base case
scenario which has been used for the charts in this report is summarized in Exhibit 51.
■
A discussion of pellet/grade premiums is beyond the scope of this report, but our
assumptions are consistent with the house view on the steel and iron ore industries
and we are happy to discuss this topic with interested investors.
Iron Ore Cost Curves
28
21 August 2013
China Iron Ore and Steel Production by Province
Exhibit 52: Chinese Domestic Iron Ore and Steel Production, by Province
100
Iron Ore production, by province
Steel production, by province
90
80
70
60
Short iron ore
50
40
30
Long iron ore
20
10
0
0
10
20
30
40
50
60
70
80
90
100
Source: Bloomberg, Credit Suisse estimates
Iron Ore Cost Curves
29
21 August 2013
Authors & Contributors
Exhibit 53: Contributors & Contributors
Equity Research - North America
Nathan Littlewood
Hubert Dagbo
Phone
+1 416 352 4585
+1 212 325 4739
Email
[email protected]
[email protected]
Equity Research - Australia
Paul McTaggart
Matthew Hope
James Redfern
Martin Kronborg
Michael Slifirski
Sam Webb
Phone
+61 2 8205 4698
+61 2 8205 4669
+61 2 8205 4779
+61 2 8205 4369
+61 3 9280 1845
+61 3 9280 1716
Email
[email protected]
[email protected]
[email protected]
[email protected]
[email protected]
[email protected]
Equity Research - Brazil
Ivano Westin
Marina Melemendjian
Phone
Email
+55 11 3701 6318 [email protected]
+55 11 3701 6341 [email protected]
Equity Research - India
Neelkanth Mishra
Ishan Mahajan
Phone
Email
+91 22 6777 3716 [email protected]
+91 22 6777 3894 [email protected]
Equity Research - London
Liam Fitzpatrick
James Gurry
Michael Shillaker
James Hanford
Phone
+44 20 7883 8350
+44 20 7888 7083
+44 20 7888 1344
+44 20 7888 1551
Email
[email protected]
[email protected]
[email protected]
[email protected]
Equity Research - Moscow
Semyon Mironov
Phone
+7 495 662 8510
Email
[email protected]
Fixed Income Commodities Research
Andrew Shaw
Marcus Garvey
Phone
Email
+65 6212 4244
[email protected]
+44 20 7883 4787 [email protected]
Other
Scott Chui
Wenzhe Zhao
Phone
+852 2101 7152
+1 212 325 1798
Email
[email protected]
[email protected]
Source: Credit Suisse
Iron Ore Cost Curves
30
21 August 2013
Macro Research Disclosure Appendix
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Iron Ore Cost Curves
31
21 August 2013
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Iron Ore Cost Curves
Iron Ore cost curve report
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