Cliffs to Idle Pinnacle Coal Mine as Part of Response to Low Commodity Prices

Cliffs Natural Resources (NYSE:CLF) has announced its intention to idle its Pinnacle coal mine. In a recent SEC filing, the company disclosed that  it has issued notices to all the employees of the Pinnacle Mining Company, a wholly owned subsidiary of Cliffs, in advance of idling the mine, as required by union contracts and state law. Cliffs cited poor market conditions for metallurgical coal as the reason for its decision to idle the Pinnacle mine. ^[1] It is provisional; the temporary idling will occur only if conditions do not improve

This move is the latest step in Cliffs’ efforts to operate effectively in an environment of weak iron ore and coal prices.

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The Pinnacle Mining Complex

The Pinnacle Mining Complex consists of the Pinnacle and Green Ridge mines, located about 30 miles southwest of Beckley, West Virginia. It produced 2.8 million tons of metallurgical coal, or approximately 39% of Cliffs’ total coal production of 7.2 million tons in 2013. The Pinnacle mine contributes the bulk of the coal produced from the Pinnacle Mining Complex, with Green Ridge producing around 0.2 million tons annually. ((Cliffs Natural Resources 2013 10-K, SEC))

Falling coal prices have made Cliffs’ North American Coal segment unprofitable. Operating losses for the North American Coal segment rose to $1.99 per ton in 2013 from $o.28 per ton in 2012. ((Cliffs Natural Resources 2013 10-K, SEC))

Metallurgical Coal and Iron Ore Prices

Metallurgical coal is a major input in steelmaking. Thus, demand for metallurgical coal is indirectly influenced by the demand for steel. China is the largest consumer of metallurgical coal in the world. There has been falling demand for the commodity by the Chinese steelmaking industry, along with lower demand from other major consumers such as Japan and the EU. Flagging demand for metallurgical coal from China in the wake of an economic slowdown has put downward pressure on coal 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. ^[2] 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 mills that are not performing well, will negatively impact these mills’ prospects. ^[3] Furthermore, 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 steel in the long term. A slowdown in demand for steel has resulted in falling demand for metallurgical coal. Chinese steel demand growth is expected to slow to 3% and 2.7% in 2014 and 2015, from 6.1% in 2013. ^[4] Weak demand for steel has indirectly resulted in weak demand for metallurgical coal as well as iron ore.

Weak demand coupled with an oversupply situation due to expansion in production by major mining companies, has resulted in plummeting coal prices. ^[5] This will have a negative impact on Cliffs’ North American coal business, which primarily sells metallurgical coal, whose prices are linked to prices of Australian metallurgical coal. Prevailing coal prices are around a third of their 2011 peak levels of $330 per ton. ^[6]

On the supply side for iron ore, expansion in production by majors such as Rio Tinto and BHP Billiton has created an oversupply situation. Combined with weak demand for iron ore, prices of the commodity have tumbled.  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 ton, as compared to less than $50 per ton for Rio Tinto and BHP. ^[7]

Iron ore spot prices stood at $100.56 per dry metric ton (dmt) at the end of May 2014, about 18.9% lower than a year ago. The outlook on iron ore prices remains bleak in the near term, in view of the oversupply situation. ^[8]

Cliffs’ Response

In order to remain competitive in a subdued iron ore and coal 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 the planned Phase 2 expansion at its Bloom Lake operations. The company also recently announced the sale of an exploration camp which is a part of its suspended Chromite project in Ontario. These are attempts to free up capital and deploy it into projects that generate greater value for the company. ^[9]

The company has reduced its planned capital expenditure for 2014. The full-year capital expenditure range for 2014 is now expected to be $275-$325 million, around $100 million lower than its original guidance of $375-425 million, and approximately 65% lower than capital expenditure in 2013. Around 75% of the planned reductions in capital expenditure will impact the company’s high-cost Eastern Canadian Iron Ore operations and North American Coal operations. ((Cliffs Natural Resources Inc. Reduces Full-Year 2014 Capital Expenditures by an Additional $100 Million, Cliffs Natural News Release))

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. ^[10]

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1. Cliffs Natural Resources 8-K, SEC [↩]
2. China Premier Warns On Economic Slowdown As Data Fans Stimulus Talk, Reuters [↩]
3. The Latest Iron Ore Price Slump: Causes and Effects, Forbes [↩]
4. Short Range Outlook for Apparent Steel Use 2013-2015, World Steel Association [↩]
5. Australian coal industry caught in ‘perfect storm’, Financial Times [↩]
6. Pain of low coal prices finally too much for Australian miners, Reuters [↩]
7. BHP, Rio Gamble with Stacked Iron ore Deck, Mineweb [↩]
8. Iron Ore Spot Price Chart, YCharts [↩]
9. Cliffs Natural Resources 2013 10-K, SEC [↩]
10. Cliffs Natural Resources Inc. Announces Significant Reduction in 2014 Capital Expenditures, Cliffs Natural News Release [↩]