china & india: rising demand or falling interest?

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Iron Ore: the end of the golden age?

Paul Gray, Principal Analyst, Wood Mackenzie


www.woodmac.comIron Ore: the end of the golden age?

© Wood Mackenzie 2

Agenda

Assessing China’s future iron ore requirements:

• How much?

• Where from?

• At what cost?

3

1Setting the scene:

Lessons learnt from 2012 and what to expect from 2013.

2 The rise of China and India: comparative analysis.

3

Some longer term considerations:

• Capital intensity.

• Ore degradation.

• Chinese overseas investment.



© Wood Mackenzie 3© Wood Mackenzie 3

Setting the scene (1).Iron ore is the ultimate “China play”.

Key data on Iron Ore

million tonnes 2012 (F) 2020 (F)

Global Exports 1195 1833

Australia’s share (global) 40% 43%

Chinese Imports 730 1125

Australia’s share (of Chinese imp.) 46% 55%

% of Australian exports destined to China 70% 78%

China accounts for entire growth since 2000.

Source: Wood Mackenzie

0

200

400

600

800

1000

1200

1980 1985 1990 1995 2000 2005 2010

Seab

orn

e t

rad

e:

mil

lio

n t

on

nes

1980s: 1.6% pa

1990s: 1.9% pa

2000s: 7.8% pa

Red segment =

Chinese

imports.




Setting the scene (2).China’s raw material conundrum.

0

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120

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2000 2006 2008 2010

Valu

e o

f C

hin

ese I

mp

ort

s:

US

$ B

n

Crude Oil

Iron

Ore

Copper

Coal

The spiralling cost of Chinese imports…..


China’s iron ore import bill:

$100bn in 2011.

5x bigger than coal.

Beijing response:

“Go Out” policy - since 1999!

“Two-ways” strategy – limited success.

Is there a domestic alternative?




Lessons learnt from 2012 (1): Anatomy of a price correction.

Correction #1

� Global Financial Crisis!

Correction #2

� Eurozone sovereign debt crisis (part 1)

Correction #3

� Liquidity squeeze – especially in China.

Correction #4

� Chinese steel “crisis” – margin squeeze.

A rollercoaster ride for iron ore.


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Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

TS

I 62%

Fe U

S$/t

, C

FR

1 2 3

4

Annual Average Price ($/t CFR)'08: 145 | '09: 86 | '10: 147 | '11: 168 | '12: 127?



Lessons learnt from 2012 (2): Iron ore does have a mind of its own!

Iron ore and copper – strongly correlated:

� Similar dynamics. Proxies for Chinese growth.

BUT – correlation broke down in Aug/Sep:

� Cu too high or Fe too low?

Limitations of index pricing:

� Exposed during recent correction.

Iron ore’s demise is “China steel specific”.

� Malaise of steel is amplified in iron ore price.

The myth of marginal cost support?

� Lagged response. Need a functioning market!

Cu and Fe – the end of the affair?

© Wood Mackenzie 6


0

2,000

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12

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13

0

50

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copper, $/t,(LHS) iron ore, $/t (RHS)

Cu and Fe

diverge!



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-12

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EB

ITD

A M

arg

in f

or

Iro

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re (

%)

Vale Rio Tinto BHP Billiton

What to expect from 2013 (and beyond).A more cautious approach from investors and corporates.

Margin compression:

� Commodity price impact, currency impact.

Existing supply response:

� Withdrawal of marginal suppliers.

Future supply response:

� Project delays/deferrals/scale backs.

� Driven by reduced appetite for investment – and pressure from shareholders!

Opportunistic acquisitions:

� Chinese buyers of distressed assets?

Margin compression – albeit from a high level.

© Wood Mackenzie 7




-120

-100

-80

-60

-40

-20

0

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2009 2010 2011 2012 2013Fye

ar-

on

-ye

ar

ch

an

ge

ho

t m

eta

l p

rod

'n (

Mt)

China Rest of World

lowest growth since 2008!

What to expect from 2013 (and beyond).Brace yourself for slowest growth for five years!

Hot metal production growth only 15Mt?

� But we have become accustomed to 50Mtpy!

� Slower growth in crude steel production and the “scrap effect”.

For iron ore it’s not as bad as it sounds!

� Accelerated displacement effect.

� Repeat of 2009 – but on a smaller scale?

Rest of the world:

� Hot metal production unlikely to return to pre-GFC levels before 2014.

A sharp slowdown in Chinese hot metal production.

© Wood Mackenzie 8




© Wood Mackenzie 9

Agenda


• How much?

• Where from?

• At what cost?

3

1Setting the scene:



3







China: Population by Province (Millions)

> 10080 - 10060 - 8040 - 60

< 40

Scale

Key Facts

GDP: $4.16 trillion (2000 US$)

GDP per capita: $2,827 (2012)

Land area: 9.6 million square km

Population: 1,354 million (2012), 1,393 million (2030)

Number of employed: 773 million

Life expectancy: 73 years

Literacy rate: 96%

Access to electricity: 99% Source: Wood Mackenzie, China Bureau of Statistics, World Bank

© Wood Mackenzie 10



Maharashtra

Madhya Pradesh

Andhra�Pradesh

Chhatt-Isgarh Orissa

Gujarat

Rajasthan Uttar�Pradesh

DelhiHaryana

Punjab

Jammu &�Kashmir

Himachal Pradesh

Uttarakhand

Bihar

SikkimAssam

Meghalaya

Arunachal�Pradesh

Nagaland

Manipur

Tripura

West�Bengal

Jharkhand

Karnataka

PuducherryTamil�Nadu

Goa

Kerala

Mizoram

70

62

115

63

87

74

7

10

1

2643

74

34

1

94

205

34

106

1

2

3

4

1

3

32

1

17

26

28

13

Andaman & Nicobar Islands

0

> 10080 - 10060 - 8040 - 60

< 40

Scale

India: Population by State (Millions)

Key Facts

GDP: $1.1 trillion (2000 US$)

GDP per capita: $875 (2012)

Land area: 3.3 million square km

Population: 1,258 million (2012), 1,524 million (2030)

Number of employed: 446 million

Life expectancy: 65 years

Literacy Rate: 63%

Access to electricity: 68%Source: Wood Mackenzie, India Census 2011, World Bank




When will China and India catch up with the developed world?

Source: IMF (WEO, Sept 2006), World Bank, Hausmann et al (2005)

Growth takeoff years based on IMF (WEO, Sept 2006) and Hausmann et al (2005), Growth Accelerations. Dating was based on an assessment of significant and sustained increase in per-capita growth post-turning point. In addition, growth acceleration periods were found to be correlated with trade and investment positions as well as government policies.

GDP per capita was comparable between China and India during the 1970s but significant economic reform pushed China ahead in the 1980s and 1990s

• China’s GDP per capita increased ~ 13 fold between 1980 and 2010

• India’s GDP per capita increased ~3 fold, 1980 –2010

India’s lack of economic reform has left it approximately 20 years behind China on the development curve

Both countries still have a long way to go to reach the developed world. Per capita wealth in China would have to almost double to match that of Brazil today and increase 6 fold to catch South Korea today

2010 Real GDP per capita

Thailand

Taiwan

Brazil

Argentina

Israel

USA

Japan

Hong Kong

Singapore

Malaysia

IndonesiaIndia

China

Vietnam

South Korea

China (1979)India (1982)

Pakistan

PolandEgypt

Australia

New Zealand

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

0 10 20 30 40 50 60

Years since beginning of growth takeoff

Co

ns

tan

t U

S$

2000

pri

ces

x




Capital stock per person (2010)

The stock of capital in both China and India remains extremely low

20

40

60

80

100

120

140

160

India China Korea

1990

Korea Japan

1965

Japan USA

Th

ou

sa

nd

US

$ (

2000$

)

The ‘stock of capital’ measures the total amount of assets in an economy – both tangible e.g. machines and buildings; and intangible e.g. patents and software

China’s investment (and level of capital stock) has grown rapidly over the past decade. But that does not mean China has over-invested, and cannot sustain further investment growth.

China’s capital stock per person is still very low compared with Korea, Japan and the USA

• China’s current level of capital stock per worker is approx. 8.7% of the US’ level today

• This is less than Japan’s level in 1965 and Japan continued to invest rapidly up to the mid-1970s

India’s capital stock per person is even lower – just 40% of China’s level. Today, India is close to where China was in 2002

Source: Wood Mackenzie estimates

0




The World in 2030: How will China and India fare?

Source: IMF (WEO, Sept 2006), World Bank, Hausmann et al (2005), Wood Mackenzie forecast

Growth takeoff years based on IMF (WEO, Sept 2006) and Hausmann et al (2005), Growth Accelerations. Dating was based on an assessment of significant and sustained increase in per-capita growth post-turning point. In addition, growth acceleration periods were found to be correlated with trade and investment positions as well as government policies.

China’s GDP per capita is forecast to treble by 2030

• China will reach $US10,000 by 2030 (in real year 2000, US$ terms) – comparable to South Korea in 1995

• China’s GDP per capita is forecast to be higher than other emerging economies such as Brazil and Malaysia

India’s GDP per capita will increase 2.7 fold by 2030

• India will reach $US2,300 by 2030 – comparable to China in 2010

• This would leave India in 2030 at only 50% of the per capita wealth of Brazil today

Real GDP per capita in 2030 (constant US$)

Years since beginning of growth take-off

Thailand

Taiwan

Brazil

Argentina

Israel

Japan

Hong Kong

Singapore

Malaysia

Indonesia

India 2030

China 2030

Vietnam

South Korea

China 1979India 1982

Pakistan

Poland

Egypt

Australia

New Zealand

USA

0

10,000

20,000

30,000

40,000

50,000

60,000

0 10 20 30 40 50 60 70 80

China 2010India 2010





Agenda


• How much?

• Where from?

• At what cost?

3

1Setting the scene:



3







China’s future raw material requirements – how much?Challenging the base case view.

Base Case:

� Steel cons. peaks at 907Mt (650kg/capita) in 2028.

� Hot metal production peaks at 862Mt in 2025.

Low Case Scenario:

� Steel cons. peaks at 835Mt (600kg/capita) in 2027.

� Hot metal production peaks at 800Mt in 2022.

Impact on Iron Ore:

� Avg. “loss” (low case vs base case) = 30Mtpy 2015-2020; 100Mtpy post 2020.

A possible downside scenario for China.



1000 120




China’s future iron ore requirements – where from? Domestic production - running to stand still!

Raw ore production running at 1.3Bn tpy ….


…. but China’s import dependency is also rising!



China’s future iron ore requirements – where from? Domestic production ...... limited potential.The map shows the major provinces producing iron ore: 2011 total raw ore production = 1.33 Bn tonnes.

Limited reserves:

� “Basic” reserves = 22Bn tonnes. 15yrs of prod’n at current rate.

� Hebei, Liaoning, Sichuan a/c for 65% of reserves.

� Key prospective zones for iron ore are in central and far west provinces, far away from the high consuming coastal belt.






China’s future iron ore requirements – where from?The changing composition of Chinese imports.

47%

21%

21%

0%

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100%2000

2002

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Co

mp

osit

ion

of

Ch

inese I

ron

Ore

Im

po

rts Other

S.Africa

India

Brazil

Australia

Jan-Sep '12

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India's share of Chinese imports.

Australia's share of Chinese imports.

“Non-core” suppliers gaining share in China …. …. while India is squeezed out.




China’s future iron ore requirements – where from?Australia should be the big long term winner.

The Australia/China bond – China to account for almost 80% of Australian exports by 2020!

India squeezed out.

Brazil & Africa – small gain in share.

Risk – cost pressures in Australia prohibit development on the scale required by Chinese importers!

Australian exports to China – could double by 2020!






China’s future iron ore requirements – at what cost? 2012 Global Cost Curve: 154 mines across 14 countries..


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US

$ /

we

t to

nn

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Australia Brazil China RoW

90th percentile: US$89/tonne



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$ /

w

et

ton

ne

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Royalties and Levies Direct Cash Cost (C1)


Chinese Cost Curve58 operations and projects across 21 provinces..




Base case valuation assumptions 20% of mines have negative operating margins in 2012…


2012 Chinese mines operating margin (base case)

-50.0

0.0

50.0

100.0

US

$ /

we

to

nn

e

Million tonnes

20% Chinese mines with negative margin




..and the number of negative operating margin mines rises to 40% in 2017.


2017 Chinese mines operating margin (base case)

-100

-50

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100

US

$ /

we

t to

nn

e

Million tonnes

~40% Chinese mines with negative margin





Agenda


• How much?

• Where from?

• At what cost?

3

1Setting the scene:



3








Capital intensity (U$/tonne) by ore type.

Some longer term perspectives – spiralling capital intensity.



Some longer term perspectives - ore degradation.

It’s not just a China issue!

High prices have induced new sources of low quality product into the seaborne market:

Vietnam, Indonesia, Philippines, Honduras!

Traditional suppliers are not immune.

Implications for consumers – reduced blending options (eg with low quality Chinese ore).

Implications for producers – need to supplement existing production with new higher quality sources.

Implications for trade – a 1% decline in Fe between now and 2020 could imply additional 200Mt of seaborne trade!

Ore grade and quality decline.



0 20 40 60 80

Newman Fines

Yandi Fines

Vale: South

Vale: Carajas

Newman Fines

Yandi Fines

Vale: South

Vale: Carajas

% Fe; % combined silica/alumina

1999 2011

Fe Grade is FallingImpurities are Rising

% F

e

% a

lum

ina

& s

ilica




Longer term considerations: China extends its global reach


The rising share of “captive” foreign ore.

5yr plan – to raise China’s iron ore self sufficiency to 40% (was 50%).

An ambitious target and highly improbable!

“Captive imports” currently ~5% of consumption.

By 2020 could account for ~14%.

Not a “game-changer” for iron ore.

5%14%

35%

64%

72%

51%

31%

14% 14%

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2012 2020 (base) 2020 (high)

Co

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s.

Imports (captive) Imports (non-captive) Domestic




Summary …….. the end of the “golden age”?

Demand drivers:

� Hot metal production (slower not lower).

� Displacement of Chinese domestic ore.

Supply side issues:

� Existing expansions remain on track, but appetite for risk is waning.

� Potential for a supply squeeze 5 years forward?

Cost support:

� High cost Chinese mines.

� Ever increasing capital intensity.

Keep an eye on:

Chinese politics/policy.

Steel makers’ profitability (lack of it)!

Chinese overseas investment.

2013 price outlook: down, but not out!

Source: TSI, Wood Mackenzie

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TS

I 6

2%

Fe

US

$/t

, C

FR

Annual Average Price ($/t CFR)'08: 145 | '09: 86 | '10: 147 | '11: 168 | '12: 127?

2013:

$125/t ?



Wood Mackenzie Disclaimer

This presentation has been prepared by Wood Mackenzie Limited for delivery at the InformaAmericas Iron ore Conference in Belo Horizonte on 6-8 November 2012. It has not been prepared for the benefit of any particular attendee and may not be relied upon by any attendee or other third party. If, notwithstanding the foregoing, this presentation is relied upon by any person, Wood Mackenzie Limited does not accept, and disclaims, all liability for loss and damage suffered as a result.

The information contained in these slides may be retained by attendees. However, these slides and the contents of this presentation may not be disclosed to any other person or published by any means without Wood Mackenzie Limited's prior written permission.





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