Falling iron ore prices will only increase the already heavy pressure on Fortescue Metals Group’s pricing and returns, even after it yesterday confirmed what everyone in the industry has surmised – that its lower grade ore was being priced at a smaller percentage of the benchmark 62% iron ore price in northern China.
On a day when the wider market rebounded from Monday’s five month lows, Fortescue shares (not unexpectedly) underperformed and dipped 0.6% to $4.58. That was after the shares hit $4.47, the lowest they have been since mid July 2016.
That Chinese iron ore price is now just over $US65 a tonne and has fallen 20% from its peaks in January and earlier this month – its down 12% in the past 10 days alone.
It’s all due to the way Chinese steel mills are focusing on higher grade ore because it takes less energy (and therefore generates less pollution) to convert it into crude steel than lower grade ores, such as Fortescue’s typical ore with grades around 58%.
This saw Fortescue receive a bigger discount to the benchmark index price (Platts or Metal Bulletin price generally) in the six months to December 31, with the miner receiving 68% of the index price on average during the period. Fortescue insisted in February when releasing its half year results that this trend would reverse in the six months to June 30, 2018, and forecast the discount on its product would average between 70% and 75% over rest of 2017-18.
But there’s been no improvement and in fact the discount has widened as Fortescue said on Tuesday when it told the ASX that its full-year average discount was likely to around 65% than 70%.
The company blamed recent fears of a global trade war, and a slower than expected resolution of winter shutdowns in China for the worse-than-expected price realisations.
But the real story is that even before prices started sliding, it was clear steel mills would not be moving to cheaper ore because that cost advantage was not big enough to make up for the lower energy costs and lower pollution for the steel mills.
"The updated guidance reflects a slower than anticipated recovery in contractual realisations due to Chinese construction activity remaining subdued, the extension of temporary production restrictions in certain Provinces in China as well as speculation regarding the potential impact of global trade tensions,” Fortescue said yesterday.
But the company remains positive the discount will narrow, claiming that "As market conditions stabilise, price realisation as a percentage of the Platts 62 CFR index is expected to increase. This view is supported by an expectation of strengthened demand for lower iron content ores as steel mill margins moderate and end users look to lower their raw material input costs,” the company claimed yesterday.
Fortescue’s new CEO Elizabeth Gaines said in yesterday’s statement, “Fortescue’s position as the lowest cost supplier of iron ore into China supports continued delivery of strong underlying earnings and cashflows as evidenced by the US$1.8 billion of Underlying EBITDA and US$1.4 billion of Cash from Operations generated in the first half of FY18.”
That might have been the case, but analysts were busy reworking their estimates for this half and the year and the news won’t be good for Fortescue when clients get these updates overnight Tuesday.