COLUMN-Big iron ore miners supply strategy working partially: Russell

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--Clyde Russell is a Reuters columnist. The views expressed are his own.--

By Clyde Russell

LAUNCESTON, Australia, Jan 14 (Reuters) - China's record imports of iron ore in December capped a year of strong growth, while also proving that the strategy of the big miners is at least partially working.

China brought in 86.85 million tonnes of the steel-making ingredient in December, bringing the total for 2014 to 932.5 million tonnes, a gain of 13.8 percent over the previous year.

The jump in iron ore imports isn't because China is producing more steel, with output of crude steel rising a mere 1.9 percent in the first 11 months of 2014 over the same period in 2013, according to official figures.

It's also not because huge stocks of iron ore are being built up in warehouses, with inventories monitored by the Shanghai Futures Exchange (SH (Madrid: ABB.MC - news) -TOT-IRONINV) dropping to 99.85 million tonnes in the week to Jan. 9, the lowest in 11 months.

The most logical explanation is that the 47-percent decline in the Asian spot iron price in 2014 is displacing some high-cost Chinese domestic output.

This has been the strategy of the big three iron ore miners, Brazil's Vale and the Anglo-Australian pair of Rio Tinto and BHP Billiton (NYSE: BBL - news) .

Rio Tinto (Xetra: 855018 - news) and BHP Billiton have repeatedly argued that the ultimate impact of the massive expansions of their Western Australia mines would be to force high-cost producers to leave the market.

This has already been seen in producers outside China, with smaller miners in Australia and elsewhere struggling to compete with the big three.

It now appears to be working in China as well, with even the notoriously unreliable official iron ore output numbers showing production dropped 7.5 percent in November from the year-earlier month.

The issue for the big three miners is whether enough high-cost production is being displaced, and it's here that the doubts lie.

DISPLACED OUTPUT DWARFED BY NEW SUPPLY

The gap (NYSE: GPS - news) between the increase in China's iron ore imports and the gain in its steel output is about 11 percentage points.

A rough calculation implies that this means that just over 100 million tonnes of domestic iron ore output, on the basis of an iron content of 62 percent, has been displaced by imports.

This sounds significant, but pales when compared to the 400 million tonnes of additional supply the big three are bringing to the market within the next three years.

Some of this new supply hit the market last year, with severe consequences for the spot price, which dropped to a five-year low of $65.60 a tonne on Dec. 23, from which it has risen only marginally to $67.90 on Tuesday.

With more supply coming onstream in the next few years, the large miners must be hoping that more high-cost operations are forced to shut down.

While many smaller iron ore miners are undoubtedly doing it tough, the experience from the coal sector shows that output is slow to leave the market, even though it's loss-making.

More Chinese domestic production may be idled, but the bigger mines, which are largely owned by the state-controlled steel companies, are likely to keep going.

Production in other parts of the world may also drop, but it's unlikely this will be by enough to offset the increase in supply.

China's detailed import figures for iron ore show that shipments from Australia rose 30.7 percent in the first 11 months of 2014 from the same period in 2013, while those from Brazil gained 11 percent.

This does confirm that the low-cost output of Rio Tinto, BHP Billiton and Vale, and to a lesser extent of fourth-ranked miner Fortescue Metals Group is winning market share.

But they aren't the only winners, with Sierra Leone boosting exports to China by 52.4 percent and Ukraine by 11.4 percent.

While their total iron ore exports to China are tiny compared to those from Australia and Brazil, it does show that smaller producers still appear able to compete with the big three.

This means that iron ore prices may have further to fall if the big three really are determined to use their low-cost supply to drive competitors out of the market.

Of course, they could be rescued by a strong rise in steel demand, but this seems unlikely, even if China does accelerate some infrastructure projects in order to bolster economic growth.

The more likely scenario is that the oversupply of iron ore continues to grow, making a price recovery a distant prospect.

(Editing by Joseph Radford)