Iron ore feels effect of Thai flood

The eurozone may be on the brink of collapse, but the price of iron ore has been on a tear.

The bulk commodity, the raw material for steel and one of the most important global natural resources markets, has leapt 27 per cent in three weeks, on Friday trading at $148 a tonne in the physical market for benchmark 62 per cent ore.

But don’t break out the champagne just yet. While buying by Chinese steel mills – the main driver of demand in the iron ore market – has caused the rally, the country may not have succeeded in saving the global economy just yet.

The main cloud on the horizon for the iron ore market is Thailand. The worst flooding in half a century – and not the stocking cycle of Chinese traders or the latest headline for the eurozone – is the hot topic on the lips of iron ore and steel industry executives at the moment.

The floods are being felt by the iron ore industry, not because Thailand is a large consumer or producer of the commodity, but because of its importance to the supply chains of global manufacturers. With much of the country under water, crucial components for the auto industry are not being made, forcing manufacturers in the whole region to idle production lines.

The impact is beginning to be felt in demand for steel, and hence for iron ore. Car manufacturers have been asking mills for delays in their deliveries, executives say, which is likely to feed into steel shutdowns.

Japanese steelmakers in particular have started shutting down some production. For example, Nippon Steel, Japan’s largest steelmaker, last week reduced its guidance for steel production to 15.25m tonnes for the October-March period, down 6 per cent from last year, citing flooding in Thailand as well as uncertainty over the global economic outlook.

While Japan’s steel production was down just 0.3 per cent from a year earlier in October, industry executives expect further closures in the coming weeks.

The steel industry weakness in Japan is unlikely to cause a collapse in iron ore prices: unlike their counterparts in China, Japanese steelmakers do not tend to cut production drastically, instead trimming at the edges. And they are less active in the spot market than the Chinese so less likely to drive volatility in spot prices.

But it could take the edge off the iron ore rally.

What’s more, the collapse and subsequent rebound in prices have been driven in part by supply rather than demand. Miners flooded the spot market with cargoes last month, only to withdraw them in recent weeks. As supply returns to normal, prices may ease.

Already on Friday, the nascent iron ore derivatives market took a tumble, with swaps linked to the average price in January falling almost $5 a tonne. The iron ore market is not yet out of the woods.