The Rising Influence of Rising Affluence

[jbog]

CS suggested the Essar deal this morning.


Investors and Great Lakes iron ore producers alike have queried some of the targets published by new entrants like Essar in the context of our thesis on the Great Lakes iron ore market.

¦ We are not naïve enough to think that all of the targets will be met, but frankly we don’t think it really matters if Essar’s costs are $20/t, $40/t or even $80/t. Once the capital has been deployed however, and Essar has its own iron ore mine, the ‘ship will have sailed’ for CLF. At this point, it wont matter whether Essar’s costs are $20/t or $80/t, it will still make more sense for Essar to use their own ore than to buy it from a third
party (i.e. CLF).

¦ What this all boils down to is that CLF is the only iron ore producer on the Great Lakes that is not vertically integrated into steelmaking. CLF therefore does not have an inhouse customer for its product. Everyone else does.

Essar’s Phase 1 project costing ~ $1.1bn and delivering 4.1mtpa appears relatively low risk, but it is our understanding that the company is still working on the $600mn required for Phase 2 which would take total production to 7.0mtpa (incremental 2.9mtpa). We
believe that it would be in CLF’s best interests to prevent this Phase 2 (2.9mtpa) from being funded and built.


We wonder whether CLF might be able to block new entrants out of the market by:

¦ Providing Essar with a lower cost, long term off take alternative to compete with building their own supply. In other words, provide Essar with the security of low cost, long term iron ore supply that is more attractive to Essar than finishing construction and financing of its own project.

¦ Alternatively, if Essar is intent on owning 7mtpa of iron ore capacity, then perhaps CLF could sell / JV the incremental ~2.9mtpa at less than what Essar will otherwise spend building it.