Iron Investing News

By Melissa Pistilli-Exclusive to Iron Investing News

Customers of the world’s three largest iron ore producers have asked for shipment deferrals leading the big miners to consider production cutbacks.

Vale [NYSE: RIO], the world leader, has cut output by 10 per cent and maintains it will cooperate with customers needs. Rio Tinto [RTP] has also committed to cutting 10 per cent of its production output by the end of 2008.

BHP Billiton [NYSE: BHP] customers have also made deferral requests of about 5 per cent of 2008 production; however, the world’s third largest iron ore miner said it does not plan on cutting output and is instead exploring alternatives to minimizing the deferrals over the remainder of the business year to June 30.

“We have received some requests for deferrals of shipments from some customers,” said BHP spokesman Peter Ogden. “The important point is that we are not cutting production.” BHP insists production cuts are not necessary because it is a low-cost supplier.

Ogden said BHP is “actively working” with customers to reduce the deferral request-about 6 million tonnes of ore. “It’s about working your way through what is currently obviously a challenging period.” Although the current global economic crisis has placed massive downward pressure on the iron ore and steel industries, BHP remains positive. “The long-term story remains intact,” added Ogden.

Instead of cutting production like Vale, Rio Tinto and even Fortescue Metals [ASX: FMG] has done, BHP intends to sell into the spot market where iron ore prices are currently 40 percent below the contract benchmark price set in April of this year. Its competitors, Vale and Rio, view this strategy as one which will only serve to extend the downturn.

Reduced BHP earnings forecast

Despite BHP’s determination to maintain its iron ore production in the face of shrinking demand from its steel manufacturing clients, the company’s earnings forecast has been reduced by Macquarie Equities, which serves as an advisor to BHP’s takeover target Rio Tinto.

Macquarie has reduced its estimates of BHP’s iron ore production by 17 per cent to 111 million tonnes and its coking coal shipments by 15 per cent for 2009, resulting in cuts to the previous earnings forecast for the miner by 31 per cent this year and 50 per cent for next year. However, Macquarie is still anticipating overall increases in BHP’s 2009 profit to $16.51 billion from $15.3 billion this year.

The brokerage expects iron prices to decline by 20 per cent in 2009. Goldman Sachs anticipates a decline of 30 per cent.

Given all this, it seems ridiculous for BHP to believe it can preserve its production rates during one of the worst commodity downturns in years. The Financial Times believes “a formal cut in [BHP's] forecast output may not be far away, and if that is the case, a central tenet of BHP’s rationale for the bid disappears.”

Chinese optimism

Cutbacks in production from the world’s largest iron ore producers and bleak forecasts from top financial institutions may give many investors serious cause to believe the future of the iron and steel industries is quite bleak. However, moves by Chinese investment groups, mining companies, and steel manufactures to acquire iron ore properties around the world is a clear indication that confidence in recovery exists.

At the moment, China Investment Corp (CIC) is in talks once again to purchase a minority stake in Fortescue Metals Group, Austrailia’s third-largest iron ore producer. Its possible CIC could involve, China’s largest iron and steel maker, and, the nation’s largest coal miner. “They’ve looked at this before, and now the price is in a zone that suits them,” said a source for the South China Morning Post.

Fortescue shares have plunged nearly 75 per cent this year, hitting a 52-week low last Thursday. The Australian miner has said demand for its products is still strong and it maintains healthy relationships with its customers despite the economic slowdowns. Fortescue Founder Andrew Forrest said the company’s financial position remains solid.

As the current crisis continues it is quite likely more large investment firms and mining companies will be seeking to acquire stakes in mining firms whose drastic declines in share price make them viable targets at bargain prices; Especially, investors from resource hungry China.

Asia Pacific Citigroup Metals and Mining department Manager Alexander Molyneux believes spot iron ore prices will begin to recover in the second half of 2009. Molyneux said the 2009 contract benchmark price will drop 20 percent. This drop along with falling supply levels should lift Chinese demand. Ministry of Land and Resources analyst Zhang Mu believes China’s economic growth will continue to rapidly develop in the future renewing base metals demand.