The reverb from Shanghai rebar | FT Alphaville

The reverb from Shanghai rebar

Shanghai rebar, the most-traded steel futures contract, hit a 2012 low last week and is showing little sign of letting up. Are iron ore prices — already bumping around near the $120/tonne floor — about to follow rebar?

Nomura says, probably:

China rebar vs iron ore - Nomura

The last time rebar was at its current price, iron ore was a great deal lower than it is now. Chinese steel mills, among which are state-owned entities that don’t have the profit imperative, have been maintaining near record levels of production of late. But Nomura steel analyst Matthew Cross writes that this could be about to change:

Chinese rebar prices are now 8% lower than October 2011 lows, while iron ore prices remain 5% higher; we believe few steel mills (if any) in China can make money in the current market. With steel production remaining at a very high 714mt run rate (latest CISA number, 1-10 July) and Chinese steel mills continuing to suffer losses, we think we’ve reached the point where the cost curve will discourage steel production. We see high probability that Chinese steel production decreases quite sharply over the next 4-6 weeks, possibly leading to an October 2011 type de-stock that could be negative for iron ore prices in the near term

Bloomberg is reporting today that Chinese steel mills are starting to target export markets, posing a threat to the likes of ArcelorMittal. Cross however thinks the bigger issue is that a round of de-stocking is upon us, and it could be a bumpy ride ahead for iron ore:

We don’t know at this stage, but we’re concerned this de-stock could be worse for two reasons: 1) Chinese steel mills are under more financial distress as destocking is beginning from loss-making/breakeven positions (see Figure 2), previous destocks have occurred from much higher (but still low) levels of steel industry profitability; and 2) Iron ore prices have already reached US$120/t “floor prices” but the destock may have just begun. Iron ore prices fell roughly 35% during both previous destocks, from US$180/t to around US$120/t, a similar decline from 2012 iron ore price highs of US$150/t suggests potential downside to around US$100/t (note this is a scenario rather than a forecast). Chinese domestic iron ore production remains a key wild card with producers having cut production aggressively at US$120/t iron ore prices in the past. Our channel checks with domestic producers suggest producers haven’t made meaningful cut backs as yet.

The second chart does raise the question of just how bad another destock would be:

China steel destocing history - Nomura

But wait: what about that $120/tonne iron ore floor? Below this rate, some marginal Chinese producers tend to drop out of the market, meaning prices tend to move back up towards this level. Cross writes:

Chinese domestic iron ore production remains a key wild card with producers having cut production aggressively at US$120/t iron ore prices in the past. Our channel checks with domestic producers suggest producers haven’t made meaningful cut backs as yet.

Doesn’t mean they won’t, of course.

Related links:
How China can keep urbanising – with flat steel demand – FT Alphaville
China’s mini stimulus, explained – FT Alphaville