Iron ore prices pretty much collapsed over the past few years, done in by oversupply and declining demand. But in 2018-19, prices have seemed to stabilize.

Prices were above $125 per metric ton in 2013, just as they began a slow decline to about $45 in late 2015. As of mid-September 2019, they were hovering near $95.

The decline in iron ore prices in recent times raised questions about the sustainability of iron ore mining projects around the world. For several years, expanded production by the big three mining companies created stiff competition in a market that was experiencing a slowdown in demand. Some iron ore mines, including some in Canada, China and Africa, buckled under the pressure.

Nevertheless, producers with operating costs that are far below current iron ore prices are well-positioned to take market share. (To see how demand, prices and supply interact to shape market conditions see video: Law Of Supply And Demand.)

Key Takeaways

  • Iron ore is a mined commodity and is the key input into refined iron and steel and related products.
  • The price of iron ore has fluctuated over the past ten years greatly as its global demand has waxed and waned with economic recession and expansion.
  • Investors can gain access to iron ore price fluctuations by investing in public companies that involved in the extraction of iron ore or that use it as a key input in their businesses.

What Is Iron Ore?

Iron ore is a mineral that is rich in iron and oxide. It is found in rocks and minerals in any of several forms, including magnetite, hematite, geothite, limonite and siderite.

Metallic iron is used mainly in the production of steel. And steel is essential for many industries. It’s used in engineering applications, repair and construction of maritime equipment and vessels, automobile manufacture, construction and general industrial activities. 

Mining iron ore entails excavating sedimentary rocks, extracting the metallic iron and then dumping waste materials, including rocks that aren’t ore. The extracted ore is then transported by rail and ship to markets around the world. 

Price Plunge

The price of iron ore showed great volatility the ten years beginning in 2009.(See the Figure below). Data from the International Monetary Fund (IMF) show that iron ore prices fluctuated between a low of US$45 per metric ton and a high of US$187 per metric ton during that period. In the two years previous to that period the price of iron ore fell by about 55%.

This collapse in iron ore prices can be attributed to an increase in iron ore supply by the big three iron ore companies (BHP Billiton (NYSE:BHP), Rio Tinto (NYSE:RIO), and Vale (NYSE:VALE)) and a slowdown in the growth of Chinese demand. It resulted in the shut-down of some high-cost iron ore mines in China, Canada and Africa.

Iron ore prices 2009-2019
Iron ore prices 2009-2019.

Cost is Key

The operating costs of the top four iron ore producers are among the lowest in the world, and the barriers to entry for suppliers to the market are high. A fully commercial iron ore mine requires heavy capital investment in infrastructure like rail lines and heavy machinery. Upfront capital cost for mines can run anywhere from US$160 per metric ton to US$240 per metric ton, depending on the type of metallic iron that is economically retrievable at the mining site.

Operating costs also vary, depending primarily on the scale of operations, the distance to market, government regulations and the cost of fuel.

Data from company reports suggest that the cash operating costs of the big four mining companies are US$23.6 per ton for Vale (NYSE:VALE), US$20.8 per metric ton for Rio Tinto (NYSE:RIO), US$25.89 per metric ton for BHP Billiton (NYSE: BHP) and US$51 per metric ton for Fortescue Mining Group (OTCBB:FSUMF).

There are, however, many other iron ore mining companies with cash costs that far exceed US$60 per metric ton, and some companies have costs as high as US$120 per metric ton.

Large Players Dominate

A few key players, both on the demand side and the supply side, control the iron ore market. According to data from the US Geological Survey, the top five iron ore producing countries control about 85% of production and 73% of reserves (FIGURE 2).

The largest iron ore reserves are in Australia, followed by Brazil, Russia, China and India. Nevertheless, the largest producer of iron ore in the world is China, followed by Australia, Brazil, India and Russia.

Four companies dominate global iron ore production: BHP Billiton (NYSE: BHP), Vale (NYSE:VALE), Rio Tinto (NYSE:RIO) and Fortescue Metals Group (OTCBB:FSUMF). Together these companies control more than 70% of the iron ore export market.

https://i.investopedia.com/u53697/iron_ore_producers.jpg

The Strategy Unfolding

Despite the decline in iron ore prices in recent times, the large players in the industry plan to increase supply to take market share from smaller players. Demand for iron ore is expected to remain high for many years to come, given its many uses in infrastructure, transportation and manufacturing. Iron ore is necessary for an economy to function and to remain productive.

The long-term investment plans of the top three iron ore producers show that they intend to reduce costs further and increase production aggressively. Over the long term, the low-cost iron mines could potentially fill the gap that appears as smaller companies go under. The gain in market share will likely increase margins, operating cash flow and profits.

(To understand why the large-scale operations of certain companies enable them to lower their prices and to get an edge over competitors, see article: What Are Economies Of Scale.)

The Bottom Line

The iron ore market has been very weak in recent years. On the other hand, large mining companies, with massive economies of scale and low costs, were increasing production aggressively and moving in to claim a bigger market share. In the long run, iron ore companies with the lowest costs should be stronger, especially given the fact that the barriers to entry are high. The threat of a new entrant changing the dynamics in the iron ore market, as it is today, is low.