02/04/2015 - 14:08

Nightmare scenario as iron ore passes $50/t on the way down

02/04/2015 - 14:08

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Andrew Forrest’s worst nightmare is that he will one day relive his painful experience with pioneering low-grade nickel ore processor Anaconda Nickel; so surely he must have suffered an ‘Anaconda moment’ when the iron ore price fell below $US50 a tonne overnight.

Nightmare scenario as iron ore passes $50/t on the way down
Fortescue Metals Group chairman Andrew Forrest.

Andrew Forrest’s worst nightmare is that he will one day relive his painful experience with pioneering low-grade nickel ore processor Anaconda Nickel; so surely he must have suffered an ‘Anaconda moment’ when the iron ore price fell below $US50 a tonne overnight.

What happened 15 years ago with the collapse of Anaconda is somewhat different to the problems Mr Forrest is experiencing at the iron ore miner Fortescue Metals Group, but the end game is starting to look alarmingly familiar.

With Anaconda, the problem was a processing facility, which never quite performed as promised; this resulted in heavy financial losses and Mr Forrest’s acrimonious exit from the company, which became an asset of the commodities trader Glencore.

Fortescue’s problems are more directly linked to the price of iron ore, which is being crushed by a combination of declining demand and excess supply.

But there is a touch of Anaconda to the Fortescue story – the quality of assets.

In the case of Anaconda, the quality problem was largely linked to a complex acid processing system, but with some of the problems related to ore quality.

In Fortescue’s case, the problem is a combination of ore quality and high debt levels, which are producing an Anaconda-like squeeze on the company’s finances and on the personal fortune of Mr Forrest, who was once a $6 billion man but today is a $1.8 billion man.

In a way, what’s happening at Fortescue, and at other iron ore mining companies except Rio Tinto and BHP Billiton, is bleak demonstration of several indisputable facts about iron ore.

• There is only one use for the material – steel – and if steel demand falls in countries that consume a lot, which it is in China, then iron ore demand falls just as night follows day.

• Western Australia’s iron ore boom, which kicked off in 2004, was based entirely on an assumption that Chinese demand would grow strongly for decades. The boom actually lasted 10 years (which isn’t bad in the highly cyclical mining industry), but it has ended.

• Entrenched iron ore miners such as BHP Billiton and Rio Tinto always had an advantage over newcomers because they owned the best ore bodies, best railway systems and best ports.

• Iron ore quality varies from ore body to ore body, and that means discounts are applied by customers on ore lower than the widely quoted 62 per cent purity price, and heavier discounts are applied for material high in phosphorus, alumina and silica.

• Because iron ore is a bulk commodity, the price is only one element in success. Transport economics and efficient overall infrastructure can be more important than ore quality.

• Small players in the iron ore business, which relied on road haulage, were always going to be in trouble when the price dropped below $US100/t.

• Medium-sized players, even those with rail and port access, but with high debt levels and inferior ore quality, were always going to be in trouble when the price dropped below $US70/t.

• Everyone other than the biggest and lowest-cost producers (BHP Billiton and Rio Tinto) was always going to be in trouble if the price fell below $US50/t – which it just has.

The squeeze that started with last year’s price fall will now become life threatening to everyone producing iron ore in WA – bar the big two.

Atlas Iron, BC Iron and Mt Gibson (the three small survivors) will be desperately looking around for a way to ride out the latest price fall; though their problem is that no-one can see a time in the next year, or longer, when the price might lift them back to a profit-making level.

Gina Rinehart, the newest kid on the block, will be looking very closely at the break-even point of her Roy Hill mine, which is believed to have $US45/t pencilled in as the critical price.

Fortescue, however, is the miner everyone will be watching because it is the business showing the most obvious signs of financial and operational stress, including:

• two failed attempts over the past two months to restructure its debts;

• a bizarre speech by Mr Forrest in which he suggested that everyone in the iron ore industry made production cuts to try and force the price up; and

• it is an operation with relatively high cost compared with BHP Billiton and Rio Tinto because its ore grades are not as high; and that means accepting a quality discount on what it sells.

Given time, Fortescue could ride out the current problems – in most commodities that can be done because commodity prices are cyclical.

The problem with iron ore is that cycles can last for several years, and perhaps as long as a decade.

WA has enjoyed the 10-year up-leg of the price cycle. Now we ride out what could be a 10-year down-leg, and that’s going to be a time when only the most efficient and lowest-cost iron ore producers will survive.

An Anaconda-like squeeze is being felt across the iron ore industry, and for Mr Forrest that is likely to be a particularly distressing experience.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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