Cold Snap Cuts China Iron Ore Output, May Extend Price Rally

Iron Ore mining China
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China's harshest winter in nearly three decades has hit iron ore output and driven up prices just as demand from steel mills revives in a resurgent economy. Imports are at record levels.

Tighter domestic supply in the world's top steel producer could mean global iron ore prices will continue to rise - they are already up more than 80 percent since September - a boon to mining giants such as Rio Tinto and BHP Billiton after a slump in prices last year forced them to re-think their expansion plans.

Temperatures in China have plunged to their lowest in 28 years, with frozen coastal waters, cancelled flights and closed highways. Once a thaw arrives, however, prices will likely come under pressure as Chinese miners return to full production.

Up to 15 percent of China's iron ore mines, especially those located in the northern region where it has been coldest, remain shut, said Henry Liu, head of commodity research at Mirae Asset Securities in Hong Kong. Many small mines and processing plants closed last year after iron ore prices slid to 3-year lows and made China's more costly producers unprofitable.

When prices rallied last month, it was already too cold for them to resume production.

"They would want to return to production, but they can't because of the weather," Liu said. "We estimate 10-15 percent of these local mines are still closed because of the cold weather."

(Read More: Australia's Port Hedland Ships 25% More Iron Ore to China in December)

The harsh weather conditions have halved utilisation rates at private mines and processing plants in some areas, according to a survey by consultancy Mysteel published on Dec. 28.

China, the world's biggest iron ore producer, imported a record 70.94 million tonnes in December, nearly 2 million tonnes above the previous record. Imports will again be high this month if the weather remains cold, analysts said.

"If the domestic supply of iron ore in China remains constrained, iron ore import prices will stay at high levels," said Zhang Yong, an analyst with Mysteel.

The price rally could be further fuelled as a cyclone threatens Australia's Pilbara producing region and its export facility at Port Hedland. Australia is China's main iron ore supplier. On top of that, shipments from Brazil have been hit by rain.

China typically produced 120-130 million tonnes of low-grade iron ore each month last year, and imported around 60 million tonnes of high-grade material. Output traditionally falls in December-February. In January last year, it tumbled to around 72 million tonnes.

Utilization rates of all surveyed mines in northeast China were at just 61 percent at end-December, according to Mysteel, lower than the national average of 68 percent.

Seeking Cheaper Ore

The benchmark price for iron ore delivered to China has climbed 37 percent from early last month to $158.50 a tonne this week, and is up 83 percent since September.

The rise in iron ore prices from suppliers Australia and Brazil has prompted some Chinese steelmakers to buy cargoes from smaller exporters such as Malaysia and Indonesia to trim their costs, said one physical ore trader in Shanghai.

(Read More: Bear Case — Iron Ore to Hit $50 in 2013)

"For the same grade, cargoes from Malaysia and Indonesia are probably $10-$15 cheaper than those from Australia and Brazil, although the quality is not always reliable," he said.

Iran is another source of cheaper iron ore for China, although prices there have also surged given the brisk demand, said a Chinese trader who sells Iranian iron ore.

"Steel mills are always looking for cheaper non-mainstream iron ore sources, but the problem is there are no large quantities available and they're high on impurities, so may not really help mills lower their production costs," said an official who buys iron ore for a small steelmaker in eastern China.

"The only way out is for steel prices to rise, to transfer the soaring costs, but this isn't happening due to the weak winter consumption season."

China's steel prices, based on Shanghai rebar futures , have risen by around a quarter from September's lows - a much smaller increase than in the price of iron ore.