Cliffs Sells Northern Ontario Exploration Camp, Maintains Commitment To Disciplined Capital Allocation

Cliffs Natural Resources (NYSE:CLF) is selling off its exploration camp at McFaulds Lake in Northern Ontario’s Ring of Fire mineral belt to Noront Resources for an undisclosed amount. The transaction is expected to close in the third quarter of 2014. ^[1]

The exploration camp is a part of Cliffs’ Chromite project in Northern Ontario’s Ring of Fire mineral belt. The company had indefinitely suspended its Chromite project in Q4 2013, citing uncertain timelines and risks associated with developing necessary infrastructure to bring the project online. The sale of the exploration camp at McFaulds Lake indicates that Cliffs is unlikely to revive its Chromite project anytime soon. However, the suspension of the Chromite project has already been factored into Cliffs’ stock price and the sale of the exploration camp is unlikely to significantly affect it. ^[2]

The sale of the exploration camp at McFaulds Lake is a part of Cliffs’ enhanced focus on discipline in capital allocation. In an environment of falling iron ore prices, Cliffs’ management has reaffirmed its commitment to disciplined capital allocation and reduced future capital expenditure plans. ^[3]

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The Chromite Project

Cliffs holds a controlling position in three chromite properties – a 100% interest in each of the Black Label and Black Thor deposits, and a 70% interest in the Big Daddy deposit. These deposits are situated in the Ring of Fire area, James Bay Lowlands, of Northern Ontario. The project suffered delays in its environment assessment process due to a judicial challenge by impacted First Nation communities. Additionally, in order to exploit these deposits economically, Cliffs had proposed building a 340 km all-weather road.

In September 2013, Ontario’s land and mining commissioner had dismissed Cliffs’ application for permission to build a road to its deposits at Black Thor. This proposed road was to pass through a region claimed by rival miner KWG, which wants to build a railroad instead. The region is too fragile to support two heavy ore transportation systems. While Cliffs proposed a $600 million road, KWG proposed a $1.6 billion railroad. However, the province of Ontario was expected to share half the cost of building Cliffs’ proposed road. The tribunal objected to the province paying for a private road that would bring no benefits to the general public.

In view of the uncertainties surrounding the Chromite project, Cliffs had indefinitely suspended it in November 2013. The recent sale of an exploration camp associated with it indicates that a revival of the project is unlikely in the near future. It is also consistent with Cliffs’ strategy of allocating capital to projects that deliver the maximum return and value to shareholders in a subdued iron ore pricing environment. ^[4]

Iron Ore Prices

Iron ore is the chief raw material for the steel industry. Thus, demand for iron ore by the steel industry plays a major role in determining iron ore prices. Though a majority of Cliffs’ iron ore sales are to the North American steel industry, sales agreements are benchmarked to international iron ore prices. International iron ore prices are largely determined by Chinese demand as China is the largest consumer of iron ore in the world. It accounts for more than 60% of the seaborne iron ore trade. Flagging demand for iron ore from China in the wake of an economic slowdown has put downward pressure on iron ore prices. According to data from China’s National Bureau of Statistics, growth in investment, factory output and retail sales has slowed to multi-year lows in the first two months of the year. A Chinese government crackdown on polluting steel plants has forced many of them to shut down. In addition, tightening of credit by Chinese banks to steel plants that are not performing well will affect their ability to purchase iron ore and thus the overall demand for it. This has resulted in an inventory build-up at Chinese ports which will further curtail imports. Further, the Chinese leadership has proposed structural reforms of the economy, shifting the emphasis from investment and export driven growth to services and consumption led growth. Such a transformation of the Chinese economy may negatively impact Chinese demand for iron ore in the long run. ^[5]

On the supply side, expansion in production by majors such as Rio Tinto and BHP Billiton has created an oversupply situation. A combination of these factors is likely to result in lower iron ore prices in the near term. Lower iron ore prices will impact Cliffs much more than the major mining companies due to the company’s higher cost of production of around $70 per tonne, as compared to less than $50 per tonne for Rio Tinto and BHP. ^[6]

Iron ore spot prices stood at $114.58 per dry metric tonne (dmt) at the end of April 2014, about 16.6% lower than a year ago. The outlook on iron ore prices remains bleak in the near term, in view of the oversupply situation. ^[7]

Disciplined Capital Allocation

In order to remain competitive in a subdued iron ore pricing environment, Cliffs has cut costs as well as adopted a strategy of disciplined capital allocation. The company has idled some of its higher cost assets in view of low iron ore prices. The Point Noire pellet plant was idled in 2013 and the Wabush mine was idled at the end of Q1 2014. Further, the company suspended Phase 2 expansion at its Bloom Lake operations. The sale of its exploration camp at McFaulds Lake is the latest in its series of attempts to free up capital and deploy it into projects that generate greater value for the company. ^[8]

Cliffs has lowered its capital expenditure target to $375-475 million for 2014. This is greater than a 50 % reduction from the $862 million in capital expenditure that the company incurred in 2013. There may be more reductions in capital expenditure if the iron ore pricing environment deteriorates further. The company has stated that it may idle Phase 1 operations at its Bloom Lake mine if prices fall further. Thus, Cliffs is sticking to its strategy of focusing on its lower cost assets that generate greater value for the company and its shareholders. ^[9]

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1. Noront Acquires Cliffs’ Chromite Ontario Exploration Camp And Receives Mining Lease Approval, Noront Resources Press Release [↩]
2. Cliffs Natural Resources Inc. Announce Plans to Halt Development of its Chromite Project Indefinitely, Cliffs Natural News Release [↩]
3. Cliffs’ Q1 2014 Earnings Conference Call Transcript, Seeking Alpha [↩]
4. Cliffs Natural Suspends Chromite Project Indefinitely, Trefis [↩]
5. The Latest Iron Ore Price Slump: Causes and Effects, Forbes [↩]
6. BHP, Rio Gamble with Stacked Iron ore Deck, Mineweb [↩]
7. Iron Ore Spot Price Chart, YCharts [↩]
8. Cliffs Natural Resources 2013 10-K, SEC [↩]
9. Cliffs Natural Resources Inc. Announces Significant Reduction in 2014 Capital Expenditures, Cliffs Natural News Release [↩]