Trade Review: China's import losses to temper iron ore price uptick in Q2 amid thin seaborne liquidity

This report is part of the S&P Global Commodity Insights' Metals Trade Review series, where we dig through datasets and digest some of the key trends in iron ore, metallurgical coal, copper, alumina, and steel and scrap. We also explore what the next few months could bring, from supply and demand shifts, to new arbitrages, and to quality spread fluctuations.

China's iron ore import losses will continue to act as a counterweight to global price strength in the second quarter, after steepening in Q1 as seaborne prices were stoked by expansionary Chinese fiscal and monetary policies while portside prices in the country lagged due to lackluster physical steel demand.

The 62% Fe iron ore index, or IODEX, rose 32% in Q1 to reach $158.30/dmt March 31 as positive policy signals in China buoyed expectations of strong demand recovery for steel and iron ore. Meanwhile, iron ore supply in Q1 turned weaker seasonally, particularly in Brazil due to a wetter-than-usual monsoon season and after Russia's invasion of Ukraine further tightened supply.

However, demand concerns in China interrupted the price rally in February and March due to heightened market supervision and COVID-19 lockdowns -- concerns that could resurface in Q2.

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Spot liquidity dries up

Widening import losses between the seaborne and China portside markets suppressed seaborne buying interest in Q1 as Chinese buyers searched instead for cheaper alternatives at the ports.

S&P Global Commodity Insights observed that Rio Tinto and Vale dialed back spot supply in Q1, while BHP's spot availability remained stable. Market sources said that instead of selling spot Pilbara Blend Fines or PBF, Rio Tinto sold between one to three strip PBF contracts in the second half of March at premiums of 20-45 cents/dmt to the monthly average of the IODEX for the respective shipment months.

The secondary market, which sees deals not involving mining companies, also saw subdued liquidity in January and February. However, in March, seaborne demand for PBF, the most liquidly traded iron ore brand, showed signs of recovery, firstly in the secondary market and later in the primary market as well, as steel production in China restarted as winter production curbs eased and low inventories at Chinese mills ignited restocking hopes.

While the wide import losses could be the main driver of reduced spot sales by some miners, S&P Global Commodity Insights' cFlow trade-flow analytics software showed that Vale and Rio Tinto shipped noticeably lower volumes in Q1 than in the previous quarter and in Q1 2021. Market sources said this could be due to the wetter Brazilian monsoon season, which impeded Vale, and possible delays in the commissioning and ramp-up of new mines in Australia by Rio Tinto.

Preference for floating price cargoes

Heightened seaborne price uncertainty due to the divergence between seaborne and portside prices in Q1 saw buyers and sellers increasingly preferring cargoes to be priced on a floating basis to avoid taking outright positions due to the potential price downside.

For iron ore brands equally commonly priced on a fixed and floating basis in the spot market, BHP and Vale sold more on a floating basis in Q1, while Rio Tinto sold spot PBF 100% on a fixed-price basis. However, most of Rio Tinto's spot PBF cargoes were sold in January, before the import losses widened.

U-turn in direct feed premiums

Winter environmental controls in China and expectations of European demand due to supply disruptions caused by the Russia-Ukraine war lifted direct feed premiums in Q1. Hopes of higher Chinese steel margins on the back of expansionary fiscal and monetary policies also provided support to direct feed premiums in the first half of Q1.

However, as Chinese steel margins were subsequently weighed down by the muted steel demand recovery and European demand also underwhelmed, direct feed premiums came under pressure in March.

S&P Global Commodity Insights observed more spot lump supply from the miners collectively in Q1, mainly due to BHP supplying 0.41 million mt, or 128%, more Newman Blend Lump and 0.25 million mt, or 13%, more Newman Blend Lump Unscreened in Q1 than in Q4 2021, while spot supply of Pilbara Blend Lump from Rio Tinto shrank by a further 0.14 million mt or 67% quarter on quarter.

Producers and traders transacted more pellet cargoes on an FOB basis in Q1, with the intention of selling into Europe following Russia's invasion of Ukraine. However, the preference for lower-alumina pellets by European mills made a large portion of Indian pellets undesirable for consumption. Hence, the rise in pellet cargoes sold on an FOB India basis was relatively muted. S&P Global Commodity Insights also observed a dwindling number of Indian pellet cargoes sold on a CFR China basis, as Chinese end-users shied away from direct feeds, including pellets, once sintering restrictions were relaxed after the winter heating season.

Pressure on direct feed premiums is expected to continue to mount in Q2. In addition to seasonally lower demand, lump supply from BHP may continue to increase due to the ongoing ramp-up of the South Flank mine -- which the company describes as Australia's largest new iron ore mine in more than 50 years -- that is expected to raise BHP's overall lump ratio in supply from 25% to 30%-33%.