Major Iron Ore Projects Likely Delayed, 2 Producers Who Benefit Greatly
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It appears increasingly likely that BHP (NYSE: BHP) will push back a major iron ore project in Australia. Here's a quote from an Australian newspaper on August 15th:
"INVESTORS appear to have given up hope that BHP Billiton will approve its $20 billion outer-harbour project at Port Hedland. Suspicions have been building for months that the iron ore expansion project may not be approved, and in the past 24 hours JPMorgan and Deutsche Bank have declared they expect the project to be axed.
Both suggested that BHP's new iron ore boss, Jimmy Wilson, would seek more modest capacity increases through refurbishments to Port Hedland's inner harbour, or possibly through building a much smaller version of the outer harbour."
"The Serra Sul Project has turned into a regulatory nightmare for the company because of very strict environmental requirements imposed on the project by both the Brazilian national government and that of Carajas State." The article goes on to say:
"VALE had to agree to remove all waste material from the project to areas outside the Amazon rainforest region."
"VALE's planning director Stephen Potter stated last week that while the company still must obtain almost 175 permits for the Serra Sul and Brucutu Mine projects to progress..."
I've discussed in recent articles, such as this one, that the global marginal cost of iron ore is between $110 - $130 per metric tonne. I opined that the majors were not overly concerned with the level of global marginal costs because their cash costs were in the $40's to $50's per tonne.
The above quotes regarding two mega-iron ore projects by BHP and Vale are prime examples of the headwinds facing mining companies of all stripes. Here's a quote from another TMF piece I authored:
"BHP and Vale have a number of mid-sized, large and massive iron ore projects, both, "brown field" expansions and new, "green field" efforts. Some of these projects will be put on the back burner. Not due to currently lower iron ore prices but for cost, labor, equipment, permitting, regulatory, legal, tax & royalty regime uncertainty and environmental reasons."
Rounding out the BIG 3 iron ore producers, Rio Tinto, (NYSE: RIO) derives about 80% of its operating earnings from iron ore. That number will come down considerably when the company's massive Tavan Tolgoi copper/gold project goes into production next year. Rio has significant coal and aluminum growth plans in the pipeline as well.
Even without company sponsors of mega-iron ore projects delaying start-ups, first production of ore and the pace of ramping up to name plate capacity is already highly uncertain and subject to significant cost over-runs. To the extent that a company puts a mega-project on hold, it can be set for years. More likely, the biggest projects will be divided into smaller projects, which will slow industry supply growth markedly.
Therefore, even though the majors can justify aggressive expansions purely on economic grounds, uncertainty on multiple fronts will cause investment capital to be allocated elsewhere. I'm on record as saying that the majors should acquire rather than build. Two mid-sized iron ore producers that stand to gain from mega-project delays are Fortesque Metals and Cliffs Natural Resources (NYSE: CLF).
Each has robust growth underway through projects that are comparatively easy to get over the finish line. Fortesque is increasing production from about 65 million metric tonnes to 155 million tonnes within two years. That will rank FMG as the 4th largest producer in the world. With mega-project delays, there's a better chance that iron ore prices will remain comfortably above $100 per tonne in 2014-15 when Fortescue desperately needs a strong price to repay billions in debt taken on to grow.
Cliffs has a mature and highly profitable U.S. iron ore business and is growing in Canada's Labrador Trough where it made a meaningful acquisition last year. For Cliffs, a delay in mega-projects not only signals price support down the road, but it allows the company to grow as rapidly as it likes, because its added supply is not large enough to weigh on global iron ore prices. Both FMG and Cliffs look attractive once there's evidence of a sustainable bottom in iron ore prices. Of the two, I'm a buyer of CLF stock if it dips back below $40 per share.
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