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Downward-sloping iron ore forward curve suggests higher dry bulk shipments ahead

Commodity prices and demand

As we discussed in another series, Must-know: Commodity prices and dry bulk shipping stocks, commodity prices can have a significant impact on iron ore demand and China’s import volume. So it helps if investors can get a sense of where commodity prices will move in the future—the forward curve. If the forward curve for iron ore is upward-sloping, when future prices are higher than near-term prices, investors can expect future prices of iron ore to rise, and vice versa. Although lower future prices may be negative, they will be positive for shipping companies that haul iron ore across the ocean if the catalyst behind the lower expected iron ore prices isn’t lower demand, but an increase in supply.

Iron Ore Forward Contracts Curve 2013-07-25Enlarge Graph

Downward-sloping forward curve

Based on SGX Asia Clear’s data on July 25, the iron ore forward curve is downward-sloping. While one- or two-month forward contracts priced at $127 per metric tonne, 12-month forward contracts priced below $113 and 24-month forward contracts priced at $106. Although this could be because of China’s lower expected growth, the likely reason is the anticipation of increased capacity at large mining companies in Australia and Brazil that are trying to increase their market shares (see Rio Tinto to increase iron ore capacity, positive impact to dry bulk shippers).

JP Morgan EstimateEnlarge Graph

Negative for Chinese iron ore producers

Lower iron ore prices, on the other hand, will hurt Chinese iron ore producers, which are some of the more expensive producers in the world. If the government doesn’t want to see further declines in profits among its domestic mining firms, it will have to step up demand for steel. Given the importance of China’s industrial sector in supporting stable economic growth and in continuous reform to grow the middle class in China, industrial output growth is unlikely to fall much further.

Implication for dry bulk shippers

This should support demand for iron ore shipments over the long term, which is positive for dry bulk shipping companies that haul iron ore from countries such as Australia and Brazil to China. Some examples of companies that will benefit are Diana Shipping Inc. (DSX), DryShips Inc. (DRYS), Knightsbridge Tankers Ltd. (VLCCF), Safe Bulkers Inc. (SB), and Navios Maritime Partners LP (NMM).