(Andy Home is a Reuters columnist. The opinions expressed are his own)
By Andy Home
LONDON, Aug 27 (Reuters) - The spot iron ore market is sinking under the weight of new supply.
The benchmark price for 62 percent iron ore as assessed by the Steel Index has just fallen below the $89 per tonne level for the first time since September 2012.
Gone is the golden age of super-charged prices, eye-watering profits for producers and boom times for iron-rich regions such as the Pilbara in Australia.
The new iron age will be characterised by a Darwinian struggle for survival, from which only the fittest will emerge.
Don't take my word for it. Take the word of Sam Walsh, chief executive of Rio Tinto (Xetra: 855018 - news) , one of the world's largest suppliers of seaborne ore and one of the companies contributing to the current supply surge.
Speaking to analysts after Rio's second-quarter results, Walsh dismissed any suggestion the company should hold back from increasing production at a time when demand from China is cooling.
"Now (NYSE: DNOW - news) is not a time for the best iron ore producer in the world to take a step back. Now is the time for others to really feel the consequences of the price against their operating costs and for them to make decisions."
By "consequences", he means that casualties will grow as higher-cost and fledgling producers feel the pricing pain.
At least they will see up close how the battle unfolds. The rest of us will see little. Only the price will tell how efficiently this market absorbs the wave of new supply.
Everyone knew that this battle was coming.
The price of iron ore surged over the 2009-2011 period, peaking at $191.90 in February 2011, as producers struggled to match China's rapacious appetite for steel to be used in its infrastructure and property boom.
Sown in that time were the seeds of current oversupply as established producers such as Rio embarked on major expansions and a host of juniors rushed to join the iron ore bonanza.
Now the market must correct itself. Higher-cost producers must "make decisions" and leave.
Rio won't be one of them. As Walsh explained in that Aug. 7 conference call: "We are producing at a cash cost of $20 a tonne with prices around $95 a tonne, so very, very attractive margins and a very attractive place for us to be."
Weaker players, however, are already falling by the wayside. Brazil's MMX said last week it was temporarily closing its last producing mine.
London Mining, a fledgling producer operating in Sierra Leone, is struggling with both shrinking operating margins and the regional impact of the Ebola virus.
It is, according to analysts at Investec (LSE: INVP.L - news) , "a binary investment". "Either it will succeed in finding a strategic partner and thereby realise its inherent value, or it will not and face bankruptcy."
In Iran, which entered the market at the height of the iron ore boom, stocks are piling up at ports, and small privately owned mines are closing en masse.
These global changes are being captured in the import figures from China, the world's largest buyer of seaborne iron ore. ************************************************************* Graphic on China's iron ore imports by origin country: http://link.reuters.com/teg72w *************************************************************
Australian exports have risen to account for more than 60 percent of China's total draw from the rest of the world in the past couple of months. Brazilian shipments are holding steady at just under 20 percent, but China's imports from everywhere else have been shrinking, from over 30 percent last year to 22 percent in June and July.
That's displacement of higher-cost supply with lower-cost supply in action.
The biggest displacement, based on where production sits on the global cost curve, should take place in China itself.
It too experienced a surge in iron ore investment thanks to those turbo-charged prices a couple of years ago.
China, however, is where things may get a bit messy.
Firstly, there is little transparency as to what is going on in its huge but hugely-fractured iron ore production sector.
Rio's Walsh talked on that conference call of 125 million tonnes of high-cost Chinese capacity being closed.
Yet the official figures from the National Bureau of Statistics (NBS) suggest the opposite. Those for July showed iron ore production up 11 percent year-on-year with cumulative year-to-date growth running at 9 percent.
This may in part be down to the fact that the NBS releases only crude production numbers. Missing, critically, is any information on grade.
But in part it may just be down to the fact the figures are wrong and have been for a long time. Analysts at Macquarie Bank, for example, are explicit that when it comes to calculating Chinese iron ore output, "one thing we do not use at all is the crude ore number produced by the NBS." ("Commodities Comment," July 22, 2014).
Macquarie back-calculates Chinese supply from the country's production of pig iron, adjusted to reflect imports and cross-checked against regular surveys by local information providers such as Mysteel.
Its conclusion, by the way, is that Chinese domestic ore production fell by 6 percent in the first half of this year, with the trend accelerating in the most recent months. Production in the second-quarter, for example, is estimated to have fallen by 18 percent year-on-year.
Macquarie's verdict: "so far, so efficient for iron ore in 2014, with the cost curve proving itself once more".
Lacking any independent evidence from China's statistics office, though, you're going to have to take them, and all the other analysts running the same numbers game, at their word.
THEORY AND PRACTICE
The second problem facing the iron ore market is that China is all too often where market theory breaks up on the rocks of market reality.
Aluminium is a case in point. Everyone knows that parts of the country's smelting sector are the highest-cost and most inefficient anywhere in the world. Such plants, in theory, should long ago have drawn down the shutters, but in many cases they haven't thanks to discreet and not-so-discreet help from local authorities, unwilling to stomach the consequences on employment and tax receipts.
Analysts such as those at Macquarie argue that iron ore is different, given the large number of privately owned operations, which have shown themselves to be highly response to price in the past.
But that's only half the problem. The other part is where all that iron ore is going.
China's leviathan steel sector is, like its aluminium sector, plagued by structural overcapacity and a tendency to produce more than even China can absorb.
Right now, for example, Chinese steel production is still growing, up 2.7 percent in the first seven months of this year, according to the official figures.
Which would be just fine were it not for the small fact that the China Iron and Steel Association estimates that demand growth in the first half of this year was just 0.4 percent.
Accelerating steel product exports, up 37 percent in the first seven months of 2014, have acted as a pressure valve, but there's no guarantee they can continue doing so, given the ominous creaking from China's commercial property sector, one of the pillars of its steel consumption.
This adds an extra level of uncertainty to the current iron ore narrative of efficient displacement of higher-cost with lower-cost supply.
In theory, the iron ore market is already reacting efficiently to the current surge in supply.
In practice, until the past few months most observers weren't expecting the iron ore price to languish so long below $100 per tonne.
The most recent drop in price suggests that the battle for survival in a lower price environment may be more protracted and less clear-cut than theory would suggest. (editing by Jane Baird)