Under a fixed GDP growth plan, China is slated to produce over 600 million tons of steel this year. If China hits or nears that mark, demand for iron ore could reach record levels and spot prices could rise 40% over 2009 levels. Add the likelihood of higher export tariffs on iron ore from producing nations and the upward pressure on iron ore prices has momentum — enough to carry it through the first half of 2010 at least.

The single moderating factor is economic inflation. Such a rise in raw material costs (iron ore prices are increasing at their fastest rate since July 2008) would bring substantial inflationary pressure to bear on the world’s economies, particularly in developing nations. Widespread adoption of anti-inflationary measures by industrial and developing nations would tamp down demand for steel and iron ore as higher interest rates impede the capitalization of large construction and public infrastructure projects.

So far, the People’s Bank of China has kept its benchmark interest rate at 5.31% (since December 2008), but PGR’s network consistently points to growing pressure on the bank to adjust its rates upward. Exacerbating the raw material situation, China will be a major player in the spot market for ore if, like last year, major exporters (BHP, RIO, VALE) are unable to come to agreement on long- term contracts. Last year after negotiations with producers failed, China ended up buying over 60% of its iron ore on the spot market where prices are typically far higher than contract prices.

Rising ore prices are also a result of government tariffs where certain producing nations are levying export taxes in support of indigenous steel production.

India is a recent example having imposed a new export tax and raised its export duty to add approximately $5/metric ton to the cost of iron ore out of that country.  PGR has several experts who believe this tax could go as high as $20/ton in 12 months time.  Others think $8/ton or somewhere in between would be more likely as such cost increases would render India’s iron ore less competitive on the world market. A moderating factor is also in the fact that India produces low quality ore (sub-60 iron quality), which is used primarily in China.

Reports indicate that Brazil, the second largest exporter of iron ore, will tax iron-ore exports this year. Support for this outlook is in the Brazilian government’s effort to persuade VALE to create internal jobs and domestic spending by constructing its own steel plants.

Of course, steel makers who obtain ore without added tax penalties i.e., material out of the U.S. and Australia, will have better margins.

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