Cliffs To Sell Logan County Coal As Part Of Ongoing Response To Poor Market Conditions

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Cliffs Natural Resources (NYSE:CLF) has announced the signing of an agreement to sell Logan County Coal,  a fully-owned Cliffs subsidiary which represents the company’s coal assets in southern West Virginia. Logan County Coal will be  sold to Coronado Coal II LLC for $175 million in cash. [1] The transaction is expected to close by year-end. As a result of this transaction, the company expects to record a pre-tax loss of  $375-425 million in Q4 on the sale of these assets. [1] The company intends to utilize the proceeds of the transaction to pay off some of its debt.

The sale of Logan County Coal is consistent with Cliffs’ stated strategy of focusing on its U.S. Iron Ore operations. [1] U.S. Iron Ore is the most profitable business segment for Cliffs. In response to the prevailing environment of low iron ore and coal prices, the company intends to sell off most of its higher-cost iron ore and coal assets, provided it can find buyers for the same. [2]

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Logan County Coal

The Logan County Coal assets are located in the Boone, Logan, and Wyoming counties of southern West Virginia. These coal assets produce both thermal and metallurgical coal. Logan County Coal accounted for around 57% of the company’s proven and probable coal reserves, which stood at 187.7 million tons at the end of 2013. [3] Logan County Coal produced 1.5 million tons of metallurgical coal, out of Cliffs’ overall metallurgical coal production of 6.6 million tons in 2013. [3] In addition, these mines also accounted for all of Cliffs’ thermal coal production of 0.6 million tons in 2013. [3]

The sale of the Logan County Coal assets will reduce Cliffs’ exposure to coal. This is a part of the company’s response to the adverse market conditions for both iron ore and coal.

Iron Ore and Coal Prices

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Iron ore and metallurgical coal are important raw materials for the steel industry. Thus, demand for these raw materials by the steel industry plays a major role in determining their 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, since China is the largest consumer of iron ore in the world. It accounts for more than 60% of the seaborne iron ore trade. [4] However, weak demand for steel in China has translated into weak demand for iron ore. Chinese steel demand growth is expected to slow to 3% and 2.7% in 2014 and 2015 respectively, from 6.1% in 2013. [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 weak demand and oversupply is likely to result in lower iron ore prices in the near term. [6] As per Goldman Sachs, the worldwide surplus of seaborne iron ore supply will rise to 175 million tons in 2015, from an expected 72 million tons for 2014 and 14 million tons for 2013. [7] In view of the persisting oversupply situation, iron ore prices will remain subdued in the near term. Iron ore prices stood at $74 per dry metric ton (dmt) at the end of November, around 46% lower than at the same corresponding point of time last year. [8]

China is also the largest consumer of metallurgical coal in the world. Demand for the commodity by the Chinese steel making industry has been weak, adding to subdued demand from other major consumers such as Japan and the EU. Weak demand coupled with an oversupply situation due to expansion in production by major mining companies, has resulted in plummeting coal prices. [9] 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. The benchmark Australian metallurgical coal price stands at around $119 per ton, around a third of its 2011 peak level of $330 per ton. [10]

Thermal coal prices have also weakened due to an oversupply situation. This is primarily due to the ramping up of coal supply by major mining companies, in the face of weak demand. Demand for the commodity has weakened as a result of weakening demand from China, the world’s largest consumer of thermal coal. As a result of the country’s anti-pollution drive, coal’s share of new generation capacity has dropped to 40% over the past 12 months, from 75% between 2010 and 2012. [11]

Cliffs’ Response

Cliffs’ decision to sell its Logan County Coal assets follows its earlier announcement to exit its high-cost Bloom Lake iron ore mine in Canada. [12] Bloom Lake is a loss-making operation for the company. We feel that these are good moves by the company, given the weak commodity pricing environment. Getting rid of high-cost and loss-making assets will shore up the company’s cash flows, giving Cliffs greater flexibility to operate in the prevailing low commodity pricing environment.

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Notes:
  1. Cliffs Natural Resources Inc. Enters into a Definitive Agreement to Sell its Logan County Coal to Coronado Coal II LLC, Cliffs News Release [] [] []
  2. Cliffs Natural Resources Q3 2014 Earnings Call Transcript, Seeking Alpha []
  3. Cliffs Natural Resources 2013 10-K, SEC [] [] []
  4. China Ore Stockpiles Rise to Record on Financing Deals, Bloomberg []
  5. Short Range Outlook for Apparent Steel Use 2013-2015, World Steel Association []
  6. BHP, Rio Gamble with Stacked Iron ore Deck, Mineweb []
  7. Iron Ore Price Forecast Cut by Morgan Stanley on Supply, Bloomberg []
  8. Iron Ore Spot Prices, Y Charts []
  9. Coking coal price crashes through $100, Mining.com []
  10. Metallurgical Coal at 6-Year Low as Chinese Demand Slows, Bloomberg []
  11. Thermal coal falls victim to China’s energy policy, Financial Times []
  12. Cliffs Natural Resources Inc. To Pursue Exit Options For Its Eastern Canadian Operations, Cliffs Natural Resources News Release []