BHP: Iron ore is heading under $40 a tonne

Image: Port Hedland Port Authority.

Alan Chirgwin is BHP’s president of marketing for iron ore based out of Singapore. So he is a man acutely tuned to the ebb and flow of supply and demand in the iron ore market as he steers BHP sales through the stormy seas of slowing growing demand and rapidly growing supply.

Understandably, against that backdrop, his outlook on where the long term price of ore will settle is driven by expectations of further price pressure from as Gina Rinehart’s Roy Hill and Vale’s SIID project come on line and release new product into the market.

“In medium term, the next few years, it’s going to be much of same, we will continue to see very modest demand growth, and strong supply growth outpacing demand. That pressure will continue to gradually push it (the price) down – because the rate of displacement will get slower,” Chirgwin said.

Chirgwin told the AFR that the price will be driven down to settle at a level that is the highest break-even production cost “of a major producer in Australia or Brazil”.

Classical economics would agree that it’s rational for a producer to continue producing until marginal revenue equals marginal cost. The question is which of the major producers’ costs curves?

The Australian majors, BHP and Rio, have the lowest cost curve so it’s likely that Chirgwin is expecting the price to settle somewhere in the high $30 a tonne region to low $40 region where Fortescue and Vale sit.

indexmundi.com – iron ore monthly 15 years

Once prices settle towards this level then further price falls shouldn’t necessarily hurt companies, Chirgwin said, because it is productivity and production efficiencies that will drive lower prices.

Chirgwin told the AFR:

What that means is that price will very much depend on the cost structures of the miners and their ability to preserve them and bring them down.

Ultimately the price in the longer term is going to be set by the marginal cost producer either in Australia or Brazil and it is going to be one (the miner) that inherently lacks scale, quality and infrastructure simplicity.

Indeed, it’s almost always the marginal player who sets the price.

But like everything in mining and iron ore, it’s the “big” marginal player not the small ones who will be driving prices. Chirgwin said about 60 million tonnes of high cost production, and by extension the companies that produce that ore, would exit the market in 2016 following the current run rate of 125 million tonnes dropping out in 2015.

You can read more here.

NOW WATCH: Money & Markets videos

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.