Iron ore, the true king of commodities

16 Feb, 2011

Forget other commodities. Results for BHP Billiton and Rio Tinto – the world’s number one and number three miners by market capitalisation, respectively – show that iron ore is the real king.

The bulk commodity accounted for almost 40 per cent of BHP Billiton’s underlying earnings before interest and tax of $14.82bn in the six months to the end of December. The iron ore unit reaped ebit of $5.8bn, up a mouth-watering 177 per cent year-on-year. For Rio Tinto, iron ore was even more important: it accounted for more than 60 per cent of the company’s $26.6bn annual earnings before interest, tax and amortisation. The ore unit reported ebitda of $16.6bn, up 133 per cent year-on-year.

Vale of Brazil, the world’s largest iron ore producer and second-largest miner by market capitalisation, will confirm the trend when it reports results on February 24.

Iron ore will remain king for the miners this year as the market tightens and prices rise. Amid the rosy outlook, however, a big note of caution. Miners are starting to face significant cost inflation, both for current operations and new projects. So even if prices remain high – as executives tell me – profits could suffer somewhat.

Before looking at the prospects for 2011, it should be noted that the market for iron ore has changed so much over the past 12 months that it is easy to lose perspective. This time last year, BHP, Rio and Vale were selling to China at $61 a tonne under annual contracts. Currently, the spot price – excluding freight – used to set the new quarterly contracts is above $185 a tonne.

Traders and industry executives believe that prices could soon pass $200. Nonetheless, with Chinese domestic production returning after the seasonal winter drop, prices could fall from late April or early May. But most executives I have talked to expect average prices in 2011 to be higher than in 2010.

On the supply side, there are no big new projects coming on stream over the next two years. Indian states appear set to restrain their output through export bans and cost inflation is delaying projects by small players in Australia and Brazil. Chinese output is increasing but the country is hitting the limits of how much iron ore it can produce and, crucially, transport from distant mines to steelmakers in the southern coast.

Demand is strong, too. China imported a record amount of iron ore in January and consumption appears robust in Japan, South Korea and Taiwan. Even European steelmakers are sounding more optimistic, with furnaces returning to production.

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