Cliffs Natural Resources
will face stiff competition from Australian miner – Roy Hill. The U.S.
Export-Import bank, signed off on a loan deal worth $694 million with Roy Hill.
Roy Hill will use the funds to buy bulldozers and trucks from Caterpillar
(CAT), locomotives from General Electric (GE), and drilling rigs from Atlas Copco
(ATLCF). This equipment will be used for Roy Hill’s Western Australia project,
which will produce 55 million metric tons of iron ore annually. It expects to
start shipment by 2015.
This project will create the
following risks for the U.S. iron-ore miners:
• With the increase in
global supply, iron-ore prices are expected to fall. Analysts expect that due
to the additional supply, the price may fall to $120 per metric ton this year
and $110 in 2015 from the current price of around $131.
• With this project, Roy
Hill can displace potential North America iron-ore sales to Asia because of the
mine’s proximity to Asian markets and thus lower shipping costs. Also, cheaper
iron ore means steel from Asian mills will also become cheap, and additional
steel from Asia can displace U.S. made steel, cutting domestic demand of
iron-ore pellets.
Cliffs accounts for 45% of
the supply of iron pellets in the U.S., while the rest of the supply is owned
by steel mills. Hence, weak U.S. steel demand will directly affect the
company’s revenue.
How this additional supply
may affect the company’s North American iron-ore segments?
U.S. Iron-Ore Segemnt:
Cliffs’ advantage is that most of its domestic volume is contracted long-term.
Under these contracts, the minimum volume of iron-ore purchase for buyers is
fixed, with an option to purchase additional supply.
The company’s long-term
contracts are as follows:
1. Essar Steel Algoma
(Contract validity till 2024)
2. A K Steel (AKS) (Contract
validity till 2023)
3. Severstal (SVJTL)
(Contract validity till 2022)
Cliffs also has a joint
venture with Arcelor Mittal (MT) at different facilities (mentioned below). It
is expected that this venture will continue for years to come.
1. Cleveland Works and
Indiana Harbor West facilities (Agreement Expiration in 2016)
2. Indiana Harbor East
facility (Agreement Expiration in 2015)
All of these companies
account for more than 60% of Cliffs’ total U.S. iron-ore product revenue.
Although most of these contracts are linked to international prices, the
volatility on the company’s revenue is lower, because it structures the
contracts on a 12-month average price. Therefore, these contracts allow the
company’s U.S. iron-ore segment to maintain its sales volume despite the
increase in global supply.
Eastern Canadian iron-ore
segment:
Cliffs’ Eastern Canadian
iron-ore cash cost, which denotes cost of goods sold and operating expenses
less non-cash expenses such as depreciation, depletion, and amortization per
metric ton, is higher than its other two segments. The cash cost per metric ton
(mt) in 2013 for the U.S. and Asia Pacific iron-ore stood at $65-$70, whereas
the cash cost per mt for Eastern Canada was in the range $90-$95.
In addition, the company
sells the iron-ore volume from this region on a spot-price basis. Therefore,
high cash cost and a lower price will significantly affect its profit. To cut
the cost, the company may increase production, but this is possible only if the
price stays above $120 per metric ton. In case the price falls below $100, it
plans to shut down the mine. Analysts expect the company to reveal the decision
before the end of February. As the iron-ore price is expected to stay above
$120 per metric ton, the company will likely increase production from this
mine.
Overall impact on the
company
Additional iron-ore supply
from Roy Hill’s Australian mine will affect Cliffs. The company’s Eastern
Canada segment’s revenue will be affected due to higher cash cost and lower
iron-ore prices. On the other hand, most of its U.S. iron-ore volume is
committed under a long-term contract, which will help it to maintain the volume.
However, due to additional low cost Asian steel supply in the future, the
company will face challenges from lower iron-ore prices, as its customers who
are not in a long-term contract can look for supplies from the competing Asian
markets.
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