China’s stricter environmental regulations and structural changes in its steelmaking industry is boosting ongoing demand for high-quality iron ore and coking coal and widening premiums and discounts for the products’ various grades relative to benchmarks, but the effect on individual miners’ cash flow depends on the prevailing product grade in each company’s portfolio, Fitch Ratings and CRU said.
“We expect the wider premium and discount relationships to persist in the short term, but for the gap to tighten over time. This mutes the effect on miners’ ratings, as we rate on our mid-cycle long-term pricing assumptions and the ratings already capture the miners’ product quality,” Fitch said in a statement.
China’s steel sector has undergone significant reform since March 2016, eliminating 260 million tonnes of capacity and increasing capacity utilisation to above 85%, from 70%-75%.
Enhanced efficiency and maximisation of blast furnace output has seen record premiums for high-grade iron ore and coking coal, as premium input materials improve steelmaking productivity. Discounts for lower-grade products have widened due to lower demand.
However, there is an upper threshold for the price of high-grade iron ore that steelmakers are willing to pay, as blast furnace productivity is a function of numerous variables, including injection rates, oxygen and pellet usage as well as coke strength after reaction.
“These variables are more likely to be employed if the premium on higher-grade iron ore remains high, resulting in a narrowing price differential between various iron ore grades in the long term. Similarly, we expect the price difference between premium coking coal and standard coking coal to come closer to the historical 25%-30%, down from the recent 40%-65% range,” Fitch said.
According to Fitch, Brazil-based Vale’s cash flow benefits the most from the prevailing pricing conditions due to its high-grade iron ore content of over 64% across the portfolio, with a number of assets producing 65% ore.
The cash flow of Australia-based Fortescue will suffer due to wider discounts on its 56%-59% ore, while that of BHP and Rio Tinto will remain largely unaffected due to an average iron content of 61%-62% produced in their mines. However, BHP is set to benefit from the record premium coking-coal price difference due to its large portfolio of premium coking-coal assets, Fitch said.