Cliffs Natural Resources (NYSE:CLF) is the largest producer of iron ore pellets in North America and a major supplier of direct-shipping lump and fines iron ore out of Australia. It is also a significant producer of metallurgical coal. It operates iron ore and coal mines in North America and two iron ore mining complexes in Western Australia. In addition, Cliffs has a major chromite project in the feasibility stage of development located in Ontario, Canada.
In this article, we take a look at Cliffs’ North American iron ore business which contributes a majority of its revenues. This division comprises of the company’s U.S. and Eastern Canadian iron ore business segments. We take a look at the company’s major mines in these regions, the upcoming projects and the likely impact of iron ore prices on the division’s performance.
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What Does The North American Iron Ore Division Do?
Cliffs sells iron ore produced from its U.S. iron ore operations to integrated steel companies in the U.S. and Canada. It manages and operates five iron ore mines located in Michigan and Minnesota. According to the company’s latest annual report, the U.S.-based mines currently have an annual rated capacity of 32.9 million gross tons of iron ore pellet production, which represents 57% of total U.S. pellet production capacity. Based on the company’s equity ownership in these mines, its share of the annual rated production capacity is currently 25.5 million gross tons, which constitutes 44.2% of total U.S. annual pellet production capacity. In 2012, Cliffs produced a total of 29.5 million tons of iron ore pellets. Of this, Cliffs’ share was 22 million tons while 7.5 million tons belonged to the steel company partners of the mines.
Cliffs’ operations in Canada involve production from two iron ore mines that is sold primarily into the seaborne market to Asian steel producers. The Canadian mines currently have an annual rated production capacity of 12.8 million tons, comprising 7.2 million tons of iron ore concentrate and 5.6 million tons of iron ore pellets. In 2012, it produced a total of 8.5 million tons of iron ore pellets and concentrate. 
Who Are The Customers?
For Cliffs’ U.S. iron ore business, the three largest customers are ArcelorMittal, Algoma and Severstal. These three together accounted for 62% of Cliffs’ U.S. iron ore revenues in 2012. Last year, Cliffs sold 8.6 million tons of iron ore pellets to ArcelorMittal, 3.2 million tons to Algoma and 3.1 million tons to Severstal. These are all steel companies and have long-term agreements with Cliffs for the supply of iron ore pellets to serve as raw material at their plants.
The Canadian iron ore business revenues are derived from sales of iron ore pellets and concentrate to customers in Asia, Europe and North America. Cliffs has one major customer for iron ore concentrate and various customers, none of which are considered individually significant, for the iron ore pellets business. The prices for this division consist of a mix of short-term pricing arrangements that are linked to the spot market.
For mining companies, it is extremely important to look at their proven and probable reserves to gauge future growth potential. According to last year’s annual report, Cliffs had 823.3 million tons of “Saleable Product” available at its U.S. iron ore operations. Saleable Product is the term for a standard pellet containing 60-66% iron and its quantity is calculated using both proven and probable mineral reserves. The process recovery rates for converting crude ore tonnage to Standard Product are different for every category of crude ore.
Saleable Product at the company’s Canadian iron ore operations stood at 421.9 million tons at the end of 2012. In light of the production numbers mentioned earlier in this article, we think that Cliffs has sufficient reserves to ensure robust growth if other factors such as prices and demand remain favorable.
Cliffs has been facing challenging times for the last one year now. Iron ore and coal prices have tumbled steeply over the last one year and the company has suffered as it is heavily involved in both these businesses. As a result, it had to take heavy non-cash impairments on its balance sheet at the end of 2012 and slash dividends to shareholders.
In 2013, Cliffs expects to sell 21 million tons of iron ore pellets from its U.S. iron ore operations and 9-10 million tons from the Canadian operations. This would be almost similar to the combined sales tonnage last year from these two regions which stood at 30.5 million tons. The revenue per ton at the U.S. iron ore operations is expected to be between $115-$120, and that at the Canadian operations is estimated at $120-$125. However, the cash cost per ton in the Canadian business is expected to be $100-105 while that at the U.S. mines is estimated to be much lower at $65-70. 
Cliffs Naturals’ high cash cost per ton of iron ore produced puts it at a disadvantage when compared to mining majors like Rio Tinto, Vale and BHP Billiton. These firms leverage their economies of scale and high-quality, low-cost reserves to capture two-thirds of the global seaborne iron ore market.
At the currently prevailing iron ore price levels, Cliffs has an uphill battle on its hands. Much will depend on how the Chinese economy pans out over the next couple of years. China is the world’s biggest consumer of iron ore, and its economic growth largely determines iron ore prices in world markets. The data for the first five months this year has not been particularly encouraging. The country may be undergoing a structural transformation of its economy to move to consumption-led growth as opposed to exports-led growth experienced thus far. If this is true, the next few years will see iron ore prices tumbling because oversupply is also looming large on the horizon. ((Australia predicts fall in iron ore price, Financial Times))Notes: