An Overview of Cliffs’ North American Iron Ore Business

Cliffs Natural Resources (NYSE:CLF) is an international mining and natural resources company. It is a major international producer of iron ore as well as an important producer of metallurgical coal. Cliffs’ operations can be broadly segmented into three major divisions: North American Iron ore, Asia Pacific Iron ore and North American Coal. Out of these three divisions, the North American Iron ore division accounts for over 60% of the company’s revenue and is an extremely important component of its business. In this article we will take a closer look at it.

North American Iron ore

The North American Iron ore operations can be further geographically divided into US and Eastern Canadian operations.  We will look at these two segments one by one.

US Iron ore

The US Iron ore division is primarily involved in the sale of iron ore pellets which are used in blast furnaces as part of the steel making process. Various grades of iron ore pellets are delivered to customers based on their preferences, which in turn depends on the characteristics of their blast furnaces. The division primarily sells to the North American integrated steel industry. The sales are characterised by concentration of buyers with the division’s five largest customers combined accounting for over 80% of revenues. The US iron ore sales are characterised by long-term supply agreements with various price adjustment provisions.

The company operates five iron ore mines located in Michigan and Minnesota. These mines currently have an annual rated iron ore pellet production capacity of 32.9 million tons which accounts for 59 % of total U.S. pellet production capacity. Taking into consideration Cliffs’ equity ownership in these mines, the company’s share of annual rated production capacity is currently 25.5 million tons which accounts for 46 % of total U.S. annual pellet production capacity. During 2013 the company sold 21.3 million tons of iron ore pellets from its share of production of its U.S. Iron Ore mines. The US Iron ore operations are more profitable than the Eastern Canadian operations. The revenue and cash cost per ton for US Iron ore operations in 2013 were $113.08 and $65.08 respectively. ^[1]

The mineral reserves of a mining company are an important indicator of sustainability of current rates of extraction as well as potential for future growth. This may be measured in terms of saleable product, which is a standard pellet containing 60 to 66 % iron calculated from both proven and probable mineral reserves. The mineral reserves as of December 31 2013 for US Iron Ore operations stood at 836.9 million tons which is sufficient for current rates of production as well as supporting growth if costs and demand are favourable.

In 2014, the company expects to sell 22 – 23 million tons from the U.S. Iron Ore business at a cash cost per ton of about $65-$70. This increased sales forecast is primarily attributable to increased demand from North American steelmakers. Accelerated economic growth in the US in 2014 is expected to provide the support for this increase in demand. ^[1]

Eastern Canadian Iron ore

Cliffs’ Eastern Canadian Iron Ore revenues are primarily derived from sales to Asian steel producers through the sea-borne route. The Eastern Canadian iron ore produce is sold through a mix of short-term pricing arrangements that are linked to the spot market. These sales used to consist of a mix of iron ore concentrate and pellets. Due to the idled production of the Pointe Noire pellet plant in June 2013, sales will be derived from iron ore concentrate once all stockpiles of remaining pellets are sold.

Cliffs operated two iron ore mines located in Eastern Canada as of the end of 2013-Wabush and Bloom Lake. These mines combined had an annual iron ore concentrate production capacity of 12.8 million tons, which accounted for 21.8 % of total East Canadian iron ore concentrate capacity. However, in February 2014, the company announced plans to idle its Wabush mine in Labrador and Newfoundland in the first quarter of 2014 due to unsustainably high costs which would have rendered operations economically unviable. This step will lower its estimated capacity to 7.2 million tons or 13.5 % of East Canadian capacity. During 2013, the company sold 8.6 million metric tons of iron ore pellets and concentrate from the Eastern Canadian Iron Ore mines, with the segment’s five largest customers together accounting for a total of 70 % of Eastern Canadian Iron Ore product revenues. The Eastern Canada Iron ore operations are characterised by relatively high cash costs as compared to US Iron ore operations. The revenue and cash costs per ton in 2013 were $ 114.45 and $ 105.66 respectively and inclusive of non cash costs, the Eastern Canada Operations were loss making. ^[2]

The mineral reserves for East Canadian Iron Ore operations as of December 31, 2013 stood at 350.1 million tons of saleable product after excluding reserves at Wabush Mine, production from which is to be idled in 2014.These reserves are sufficient for current rates of production as well as supporting growth if costs and demand are favourable.

The company expects 2014 Eastern Canadian Iron Ore sales and production volumes of 6 – 7 million tons, mostly comprised of iron ore concentrate at a cash cost per ton of about $85-$90. This includes 500,000 tons from Wabush Mine and the remainder from Bloom Lake Mine.

You can check out our shipment volume forecasts for the North American division using the interactive graph below:

Outlook

In 2014, accelerating economic growth in the United States will provide some support to domestic steel production and demand for steel-making raw materials such as iron ore and metallurgical coal.  However, a major point of concern for Cliffs would be the growth of the Chinese economy. Being the largest consumer of iron ore in the world, China’s iron ore consumption, which is strongly correlated with economic growth, largely determines iron ore prices. Cliffs’ cash cost per ton of iron ore produced is much higher than that of mining majors such as Rio Tinto, BHP Billiton and Vale which leverage their economies of scale and high quality, low cost reserves. Thus a sluggish Chinese economy, which would translate into lower iron ore prices, could hurt Cliffs much more than its larger competitors. Fears over Chinese growth led to iron ore prices registering their 18-month low at $104.70 per ton last month. ^[3] Though prices have since recovered, much will depend upon the pace of growth of the Chinese economy.

Two factors may keep prices from recovering much further in the near term. Firstly, the tightening of credit by the Chinese government to steel mills which are not performing well has limited their capacity to buy iron ore. As a result, rising iron ore inventories at ports may limit scope for growth in iron ore imports, consequently limiting rise in prices. Secondly, some steel mills are adopting the practice of using iron ore inventories as collateral in order to get letters of credit which are used as short term loans to ensure solvency. This again suggests an excess inventory build-up which will limit growth in Chinese iron ore imports and would thus limit the scope for recovery in iron ore prices in the near term. Thus, at least in the near term, the outlook is bleak for Cliffs Natural Resources.

1. Cliffs Natural Resources 2013 10-K, SEC [↩] [↩]
2. Cliffs Natural Resources 2013 10-K, SEC [↩]
3. The Latest Iron Ore Price Slump: Causes and Effects, Forbes [↩]