The Rising Influence of Rising Affluence

[Democritus_of_Abdera]

CLF x Essar - March 26 CS Stance (for the record)...

In the Credit Suisee Equity Research report of March 26, 2013 which downgraded CLF to a target of $10/share, the argument was made that Essar Algoma and Arcelor Mittal will soon become self sufficient in iron ore implying that CLF would lose these important customers.

This was an important thesis, and, as jbog post suggests (#msg-88995838) the new agreement between CLF and Essar might represent an effort by CLF to provide Essar an alternative to expansion of their iron ore mining initiatives. If so, I suspect that Essar was in the strongest position when negotiating this contract.

For the record, the key points regarding Essar's relationship to CLF in the March 26 Credit Suisee Equity Research report are reproduced here:

Essar Steel - Mesabi Range. Essar is currently building a 4.1 mtpa Phase 1 project which it expects to be commissioning in DecQ13. Starting around the same time, Essar has a 3.5 mtpa/10 year offtake contract with ArcelorMittal. The company is currently trying to raise $600 mn in order to finish Phase 2 of the project which would take capacity to 7 mtpa.At a total cost of around $1.7bn, the capex intensity is $227/t. Further expansion to 14 mtpa is currently being permitted, but remains unfunded.

... For the past several years, CLF has been Essar Algoma's primary iron ore supplier, providing around 3.2-3.7 mtpa of iron ore. Not only is the Essar group aiming for self-sufficiency, but Essar will in fact be long iron ore and recently announced a 3.5 mtpa/10 year offtake deal with ArcelorMittal. Arcelor Mittal is currently CLF's largest customer.

CLF is Essar/Algoma's only iron ore supplier until end 2015, and Essar/Aloma appears to be paying the highest price by far of CLF's big 3 customers. Perhaps this explains why a) Essar is so eager to build their own iron ore mine, and b) Essar is looking forward to the 2014 price reopener on this contract. Essar recently suggested that it would save $50/t on iron ore purchases from CLF as a result of the 2014 price reopener, an estimate that appears to have been based on the 2012 spread. If Essar is saving $50/t on iron ore, then CLF is losing the same, and for a customer that buys approximately 3.5 mtpa (17% USIO total volume) this would represent an immediate impact to USIO's avg realized price of 17% x 50 = $9/t. However, if the CS price deck (CY14 = $100/t) for iron ore turns out to be correct, then the price reopener may be a non-event.

Essar has been guiding investors toward US$40/t mine gate cash costs plus $10/t in infrastructure costs for a FOB Great Lakes' cost of US$50/t... On the assumption that the Essar/US Steel guidance is accurate, an incentive pricing model might suggest that an ROI of say 10-15% on capital intensity of $230/t implies that these projects need a $23-35/t margin. At $50/t cash costs plus a margin of $25-35/t implies an incentive price for US Steel and Essar of $73-85/t.