Iron ore prices have fallen 20% since the start of the month, dragging shares in producers such as Rio Tinto plc  (RIO) and BHP Billiton plc (BHP) sharply lower, and there may be worse to come.

Environmental initiatives in China, which will limit the operating hours of steel smelters in a bid to ease smog in major cities, will hurt Chinese demand for iron ore in the fourth quarter and if strictly adhered to could lead to backlogs at ports and further price falls.

"We think that local governments are likely to carry out the environmental cuts forcefully," Goldman Sachs analysts noted in a report this week. "The market has not fully priced the negative environmental restrictions on iron ore demand. Therefore, we expect iron ore prices to fall further going into Q4."

Spot ore with 62% iron content traded this week at just under $65 a ton. That was up from recent lows of close to $64 but still well down on iron ore's August high of $80 and still-further south of its year-to-date peak of $95 in February.

The fall has dragged shares in Rio Tinto down 5% over the past month, though the stock ticked up 1.7% on Friday to 3,474.41 pence ($46.51). BHP Billiton's London-listed shares have fared worse still, down 8.9% over the month to 1,322.5 pence.

Yet the news out of China is not all bad for the world's two biggest suppliers to the seaborne iron ore market. Beijing this week announced it would revoke about a third of its national iron ore mining licenses in a crackdown expected to focus on smaller mine operators that produce the lowest quality ore.

The move could close as many as 1,000 Chinese mines unless they can show that they can upgrade their ore content so their product can avoid the highly polluting sintering process - whereby fines are mixed with coking coal and partially-smelted before being used in blast furnaces.

Mine closures on that scale would weigh on the supply of Chinese ore, and offer support for imports.

At the same time, if smelters' operating hours are crimped and steel production falls due to Chinese government policy, then steel prices could climb, providing producers with greater incentive to use higher-grade iron ore to maximize their output.

High grade 62% iron ore is already trading at an all-time-high premium to its lower grade 58% substitute, with each 1% increase in iron attracting a 1.8 times price multiple, according to Goldman Sachs figures.

That premium may cushion the blow for higher grade producers such as BHP and Rio Tinto but it is unlikely to save them all together. Goldman Sachs is predicting year-end iron ore prices of $60 a ton, suggesting further falls of about 7% before the year is out.

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