The Rising Influence of Rising Affluence

[DewDiligence]

Re: CLF’s production costs/price outlook for iron ore

You asked about iron-ore costs in general; however, since you own CLF and CLF gives the most detail on production costs of any iron-ore company, let’s look at CLF’s costs in some detail.

CLF’s 4Q12 PR (http://finance.yahoo.com/news/cliffs-natural-resources-inc-reports-210100775.html ) gives the cash cost and DD&A (non-cash depreciation, depletion, and amortization) per tonne for each of its three iron-ore business segments: US, Canada, and Australia:

 
            Cash cost     DD&A 
            per tonne*  per tonne* 
 US          $65-70       $ 6 
 Canada      $85-90       $20 
 Australia   $70-75       $15 

* ‘Long tons’ for US segment and metric tonnes for Canada/Australia; the
distinction is too small to be of concern in the kind of analysis we’re doing.


Discussion of costs by segment

CLF’s US segment sells a specialized product to captive buyers—iron-ore pellets for US steelmakers—and hence it is almost guaranteed to earn a profit regardless of the worldwide spot price of iron ore. The selling price for this segment is based on negotiated benchmark prices, most of which are adjusted yearly.

The Canada segment sells to the seaborne market, mostly destined for Asia. The costs in this segment are currently unduly high due to the delayed scale-up of the Bloom Lake mine (which is now the only operating mine in the segment since the recent idling of the obsolete Wabush mine); however, CLF’s has stated that, when Bloom Lake is fully operational (probably in 2015), the cash cost will be about $60/tonne, which is close to the lowest cost of any mine in the world. Moreover, Bloom Lake has very high-quality ore, which garners a premium relative to the spot price of benchmark 62% Fe ore (see #msg-85543486 for further discussion). The one drawback of CLF’s Canada segment is that the freight cost to Asia is about $40/tonne, which is about equal to the freight for VALE’s ore shipped from Brazil.

CLF’s Australia segment has somewhat higher costs than what Bloom Lake will eventually be able to attain because the Australian mines are smaller and the ore quality is not as good; however, what the Australian mines lose on cash production costs are offset by the low freight cost to Asia.

Merging the segment-specific information above, the bottom line is that CLF’s can be cash-flow positive when the spot price of iron ore is about $100 or higher, which it will be for the next several years, IMO. Goldman Sachs’ forecast of $80 ore in 2015 (#msg-85861630) is in direct conflict with the projections of most industry analysts and with the projections of BHP, the world’s largest mining company.


Outlook for iron-ore prices

I commented on BHP’s outlook for iron ore in #msg-84866945; however, a visual depiction makes BHP’s projection easier to comprehend, so I’ve reproduced one of slides from BHP’s 4Q12 webcast:



The bottom chart shows the effect of the 3Q12 inventory adjustment (which caused iron-ore prices to plummet), and the top chart show the expected effect of the additional 60Mt/year supply coming online in 2H13. The salient point is that BHP sees steadily rising prices from a lower base in 2014 and beyond, not steadily falling prices as predicted by GS.