Looming Iron Ore Market ‘Bubble’ Will Force Down Prices, Baosteel Says

The iron ore market has risen to “bubble” levels that will burst as new mines create oversupply of the steelmaking raw material, according to Baosteel Group Corp., China’s second-biggest mill.

“There is a bubble in this market, many are gambling,” making acquisitions and investment expensive, Chairman Xu Lejiang said in an interview in Shanghai, without saying when prices would drop. “Everyone who has money is rushing in to invest in iron ore.”

Vale SA (VALE3), Rio Tinto Group and BHP Billiton Ltd. (BHP), the three biggest suppliers, plan to spend $45 billion on mines. Global exports of iron ore may gain 28 percent to 1.4 billion metric tons by 2016, the Australian Bureau of Agricultural and Resource Economics and Sciences has forecast.

“The reason the big three keep spending is that they probably think growth in India, Brazil, Russia and South Africa will be sustained, and also because they believe the return on their input would beat those blind investments” by smaller rivals, Xu said.

The biggest losers from the new mines may be the speculative companies that haven’t yet started production and their investors, Xu said.

“Some investors are simply making money by trading the iron ore projects before seeing actual output,” he said. “Iron ore prices will definitely fall at some point because the supply-demand situation will have a turnaround.”

Photographer: Qilai Shen/Bloomberg

Xu Lejiang, chairman of Baosteel Group Corp., speaks during an interview in Shanghai. Close

Xu Lejiang, chairman of Baosteel Group Corp., speaks during an interview in Shanghai.

Photographer: Qilai Shen/Bloomberg

Xu Lejiang, chairman of Baosteel Group Corp., speaks during an interview in Shanghai.

Prices Surge

Demand from steelmakers in China spurred an almost threefold jump in iron ore prices since 2008, driving a surge in producers’ valuations. The Bloomberg Global Iron Ore Mining Index of 30 iron ore companies have surged four-fold since 2008.

“In Australia, South Africa and America, I’ve seen a lot of investors whom only ‘dig’ iron ore on the stock market, they will never see physical output” from their mines, said Xu.

The average profit margin of Chinese steelmakers was 3.5 percent in the 2010, the lowest of any industry, because of overcapacity and rising raw material costs, according to the government. That’s about a tenth of the margins the largest iron ore miners make, Xu said.

China’s economy may grow at a slower pace in the next five years, curbing steel demand, the China Iron and Steel Association estimated on April 29.

The cash price of 62 percent-iron ore shipped to China’s Tianjin port has almost tripled from Nov. 21, 2008 when data became available, according to the Steel Index. It was $175.30 a ton on May 19.

Price Decline

Iron ore may trade between $150 and $190 a ton for the next three years, and may decline to a long-term average of $80 a ton after 2017, according to Graeme Train, a Shanghai-based analyst with Macquarie Group Ltd.

“The structural drivers behind Chinese demand growth remain firmly in place and while we acknowledge new seaborne supply is coming to market, it will not come on fast enough to offset the high cost material at the top of the cost curve,” Train said in an e-mail today.

BHP will spend $6.6 billion expanding output in Western Australia to more than 220 million metric tons a year, the Melbourne-based company said on March 24. Rio is spending $14.8 billion to boost output by 50 percent to 333 million metric tons and Vale plans to invest $24 billion this year alone on expansions.

Iron ore supply may outstrip demand “sooner than expected,” as production increases after record prices spurred investment in mines, Baosteel’s Xu said on April 26. He had previously forecast the market to move into surplus in 2014.

China has been encouraging state-owned steelmakers to invest in overseas resources to cut their dependence on the three miners. Baosteel is “very interested” in participating in Rio and Aluminum Corp. of China Ltd.’s Simandou iron ore project in Guinea, Xu said. Wuhan Iron & Steel Group has invested in eight projects in Canada, Brazil, Australia, Liberia and Madagascar.

The cost of the acquisitions has instead forced steelmakers Magang (Group) Holding Co., which imports 75 percent of its iron ore needs, to abandon acquisition plans. Angang New Steel Co. General Manager Zhang Xiaogang said March 5 that asset prices were “too high” for investment.

--Helen Yuan. Editors: Rebecca Keenan, Indranil Ghosh

To contact the Bloomberg News staff on this story Helen Yuan in Shanghai at hyuan@bloomberg.net

To contact the editor responsible for this story: Andrew Hobbs at ahobbs4@bloomberg.net.

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