Here's another reason why you shouldn't bank on higher iron ore prices

The spot price for benchmark iron ore continued to fall overnight, dropping to a fresh four month low of $47.74 a tonne according to Metal Bulletin. The benchmark price has now fallen by a third this year as slumping demand and oversupply continue to pressure prices.

One factor many analysts point to to explain the continued price slide is the reluctance of high cost Chinese iron ore miners to exit the marketplace. Their output, although largely uneconomic from a profitability perspective, is preventing the market from reaching equilibrium, adding to pressure on seaborne prices.

However, perhaps that view is not entirely accurate. According to U-Metal, an information provider and consultancy firm for steels and raw materials producers in China, Chinese iron ore supply is dropping at a far greater pace than what other industry bodies currently suggest.

In discussions with Morgan Stanley’s Asia research team, comprising of Rachel Zhang, Ada Gao, Sara Chan, Frankie Zhu and Han Fu, the group suggests that production in China has fallen by 30% over the past 12 months, and by a larger 40% from its all time peak.

This is a significantly larger figure than that offered by the China Iron and Steel Association (CISA) who suggest domestic production has fallen by just 9-10% this year, something they put down to China’s import dependency ratio rising to over 80% as Brazilian and Australian seaborne supply increased rapidly.

U-Metal suggests that as a result of cheaper seaborne supply, domestic production will drop to 250 million metric tonnes this year, before sliding by a further 20% in 2016.

However, despite this expected reduction, they suggest tepid domestic steel demand, expected to fall by 3% in 2016, along with a forecast 10 million tonne reduction in steel exports, could see the spot iron ore price to drop to as low as $40 a tonne (CFR China) by early February next year, coinciding with the Chinese Lunar New Year.

That’s a fairly pessimistic forecast, particularly given the group’s expectation that Chinese domestic supply will continue to abate – the very factor more bullish analysts, and miners, suggest will help to underpin prices in the years ahead.

If their $40 a tonne forecast comes to fruition it will not only pressure some high cost Australian iron ore miners but also the Australian government’s budget, something that was formulated on an average iron ore price of $48 a tonne (free on board) being achieved over the 2015/16 financial year.

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