Iron Ore Miners, OPEC on Same Path

One of the themes from the recent weakness in crude oil and iron ore is that major producers are deliberately oversupplying as they are willing to tolerate falling prices in order to drive market share.

This sounds logical and provides a convenient explanation as to why output of these two major commodities has continued to rise even as prices fall to multi-year lows.

But there are problems with suggesting that the big three iron ore miners, Brazil's Vale and the Anglo-Australian pair of Rio Tinto (RTNTF) and BHP Billiton (BHPLF) , are on a parallel track with Saudi Arabia and others in the Organization of the Petroleum Exporting Countries (OPEC).

The main issue assumes that the iron ore miners and OPEC are in effective control of the markets in which they operate, or at least exercise a large degree of influence over them.

However, it's worth looking at the market dynamics for iron ore and crude oil to work out how the producers got themselves into the situation they are in, and how they may manage to improve conditions for themselves.

There are probably members of OPEC that wish their market was more like iron ore, and vice versa.

Unlike OPEC, the iron ore miners don't have a producers' group and would struggle against legal considerations if they actually tried to put one together, whether overtly or covertly.

The mere suggestion by the chief executive of fourth-ranked miner Fortescue Metals Group (FMG.AX) that the producers should think of limiting output in order to boost prices attracted an immediate "please explain" from the Australian competition authority, not to mention a derisive dismissal from Rio Tinto.

What happened in iron ore is that the miners are most likely guilty of a certain level of "group think," where they accepted as fact bullish forecasts for the growth of Chinese steel demand and took comfort in each other's similar views.

In 2011, when the major miners embarked on expansion plans that will add more than 400 million tonnes to global seaborne supply, the spot Asian iron ore price <.IO62-CNI=SI> reached a record above $190 a tonne.

As that new supply has come to market and it became more apparent that Chinese steel demand was likely to peak well short of the 1 billion tonnes touted by the miners, iron ore prices collapsed to a low of $46.70 a tonne on April 2.

They have since recovered to $57 a tonne on April 24, partly on hopes of stimulus spending in China, which buys two-thirds of seaborne iron ore, and on BHP Billiton's announcement that it was slowing its expansion plans slightly.

Whether a rally built on shifts in sentiment rather than actual demand and supply changes can be sustained remains uncertain, but what is certain is that iron ore is still vastly oversupplied and the situation will worsen in the next few years as more mines are commissioned.

This is where the narratives of iron ore and crude oil start to diverge.

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Similarly to iron ore, crude prices fell sharply with global benchmark Brent tumbling almost 60 percent between June last year and January, before a recovery to $65.28 a barrel on April 24.

Last year's plunge came after top OPEC producer Saudi Arabia confirmed it would not cut supply in order to boost prices, as it didn't want to surrender market share to rivals.

Much has been written about how this was effectively a tactic to drive U.S. shale oil from the market, given the role of rising U.S. production in creating the global surplus in the first place.

Like the iron ore miners, the argument goes that Saudi Arabia, and to a lesser extent its fellow OPEC members, are prepared to wear lower prices for now in the hope that when prices rise the idled production will be slow to re-enter the market.

However, the arguments that the major iron ore miners and oil producers like Saudi Arabia are deliberately continuing to raise output in a bid to drive higher-cost competitors from the market seems a case of the horse before the cart.

Rather, it's more likely that their decisions to continue to drive output and keep, or increase, market share is a response to a situation that they didn't anticipate or welcome.

There's little doubt that the iron ore miners are the architects of the price collapse, having increased production to levels beyond even their heroic forecasts for demand.

They are now seeking to make a virtue of necessity, claiming that their low-cost models makes a survival of the fittest strategy a good idea.

Again, the high price of oil in the lead-up to the 2008 global recession sowed the seeds of today's higher production.

It's debateable as to whether OPEC was to blame for the surge in prices to close to $150 a barrel in 2008.

But there seems to have been little that they could have done to arrest the recent slide, other than shoot themselves in the foot by cutting their own output and giving market share to rivals who were continuing to produce all they could.

Both the iron ore miners and Saudi Arabia have concluded that it's better to have market share than higher prices that benefit your competitors.

Both are responding logically to a set of circumstances.

In the longer term, it will more likely turn out better for the oil producers as the oversupply in their market isn't as severe as for iron ore, and the prospect of future demand growth is far better.

The iron ore miners may have to live with the consequences of their actions for longer, given the oversupply is now structural and unlikely to be eaten away by demand growth for many years.

By Clyde Russell