Iron ore enjoyed an amazing head start in the New Year, as the CIF 62% Fe spot price traded over US$90/t most of last week. That followed an outstanding year of recovery, almost 100% over 2016, from a monthly average price of about US$40/t in December 2015 to US$80/t in December 2016. Granted that short-term factors like Australian tropical cyclones and the disastrous accident at Vale/BHP's Samarco mine did cause some noticeable supply disruptions, the strength of the iron ore market's performance to date has analysts surprised by the margins and they are revising their forecasts, if not yet for the long term, certainly for 2017. As a bulk commodity, iron ore seems to have behaved quite differently from other commodities (even within the bulk class like coal). Its most distinguishing characteristic is the oligopolistic nature of its market structure: the highly concentrated upstream mining supply sector was consolidated towards the end of the last and the beginning of the current century, yet the downstream steel industry is very fragmented and thus commands little bargaining power. Because of the long development cycle and the high capital intensity of the iron ore mining sector, the emergence of any significant player is simply not easy. The geological and geographic concentration of resources further raises the barrier to entry. The downstream steel industry is also highly capital intensive, but spread all over the world. The world's largest steel maker, ArcelorMittal, for example, has operations in some 60 countries and a capacity of roughly 100 million tonnes of steel per annum. At the beginning of the century, there were only three big players (Rio Tinto, BHP and CVRD, now Vale). In 2006, they enjoyed a market share of approximately 60%, with total production of close to half a billion tonnes a year. Supply discipline was managed well among the Big Three. The industry was stable for a long time, until demand from China took off at breakneck speed on the strength of the country's fixed asset / infrastructure investment strategy. Unable to produce enough iron ore to meet its insatiable appetite for the raw material, China had to import huge quantities. The country's reliance on imported iron ore grew from 48% in 2006 to its current level of ~86%, on track to exceed 90% in 2018.

In this environment, this oligopolistic structure of the sector gave the Big Three tremendous pricing power and the price of iron ore soared many times, peaking at $187.18/t in Feb 2011. The lucrative margin attracted many players to the sector. FMG, the most successful one, took its project to production in about 2008 and reaching 170Mtpa capacity a couple of years ago. Roy Hill, with a nameplate design capacity of 55Mtpa, join the race and is now ramping up toward that target. The existing Big Three then commissioned multi-billion-dollar expansions that almost doubled their production within a few years. The Big Five now dominate the market with 75% market share of the seaborne trade.

The net effect of all this is that these new entrants and new expansions disrupted the effectiveness of the oligopolistic structure. New and fierce competition has set in. At the same, China is transitioning from a fixed asset-led economy to a consumer-driven one. Demand is not growing as quickly as before. All players had no choice but to cut coss and deleverage in order to survive, including the major players. The iron ore price dropped continuously over 2014 and 2015, month to month, thus breaking up the oligopoly. However, as the expansions and new mining developments are drawing to an end (anticipated to be next year when Vale’s S11D and Roy Hill reach their designed capacity), low-cost solid capacities will be well established soon. Supply discipline will reign. We are now beginning to see the re-emergence of the oligopoly with the return of the cycle. Though the next cycle is not expected to be as spectacular as the last Super Cycle, with a new readiness and a much flatter cost curve, the structure will have more tools to maximize pricing power again, thus sustaining prices that can be higher and more sustainable than the normal balance of supply and demand might suggest.