Pellet prices put Sino, Karara in play

Before the unexpected (and perhaps unsustainable) rise in the price of iron ore, a more interesting trend was developing in the mineral that could put a spring under one of Western Australia’s most heavily criticised projects, and an equally criticised businessman and (one-time) populist political novice.

Sino Iron, a $10 billion development that converts low-grade magnetite ore into a high-quality concentrate, has been hemorrhaging cash since it suffered a massive capital cost blowout and completion delay, which meant it missed the super-cycle commodities boom.

As if that wasn’t enough the test the patience of Sino’s owner, the China-based CITIC Pacific Mining, there has been an ongoing, and sometimes vitriolic, dispute with the

man who sold the magnetite-rich tenements near Karratha to Citic and who claims he is owed royalty payments – Clive Palmer.

A refresher in the depths to which Citic’s relationship with Mr Palmer has sunk came last week at a mining conference in Melbourne, when the Chinese company’s chairman, Zhang Jijing, said of Mr Palmer that: “The approach of our counterparty is a clear and present danger to Sino Iron reaching its full potential”.

While Citic and Mr Palmer seem unlikely to kiss and make up any time soon, they do both have an interest in what’s happening in the iron ore market and, somewhat curiously, the market for coking coal, the other material (along with iron ore) essential in making steel.

Chinese coal production cutbacks and a slow response from Australian and Canadian miners of coking coal has helped lift its price from less than $US100 a tonne earlier this year to more than $US300/t today.

While not seemingly a factor that might affect iron ore, the high price of coking coal is changing the way Asian steel mills operate – with demand for high-quality ore adding substantially to a premium steel mills pay for the best ore and for material low in impurities, such as phosphorous, silica and alumina.

Iron ore pellets, a material similar to the concentrate produced by Sino and another WA magnetite processor,

the Karara plant near Geraldton, are reported to have enjoyed a significant price boost since January, with the premium paid for pellets up from $US26/t to around $US35/t.

Because Sino and the owners of the Karara project (locally based Gindalbie and its Chinese partner Ansteel) do not publish the prices they receive for their magnetite concentrate, it is not certain that they are getting the pellet premium.

But because their concentrate has similar properties to pellets (high grade and low impurities), it seems likely that a premium boost is being received as steel mills seek to lift the efficiency of their blast furnaces by melting the least ‘non-iron’ material as possible with expensive coking coal.

Another factor potentially boosting the financial performance of Sino Iron and Karara is the removal of about 30 million tonnes a year of iron ore pellets once produced at the Samarco project in Brazil, which has been closed since a tailings dam burst and killed 19 people.

If the pellet premium is flowing to Sino and Karara the price those projects might currently be receiving could be exceeding $US100/t – the $US79/t for ore assaying 62 per cent iron and a premium of up to $US35/t thanks to the high grade of the concentrate (up to 69 per cent iron) and

the low level of impurities removed in the processing of the magnetite.

On the flipside, even with a price of more than $US100/t the magnetite plants are expensive to operate, leaving open the question as to whether they have been lifted from the ranks of loss makers into profit.

Two financial tests indicate that conditions are improving for Sino Iron and Karara, with Mr Palmer a very keen observer as he continues to fight for the payment of royalties he claims are owned, while also battling problems associated with the closure of the Yabulu nickel refinery in Queensland.

The first test is the historic reaction of the pellet premium to a sharp increase in the price of coking coal.

According to investment bank Macquarie, the pellet premium tends to react quickly to moves in the price of coking coal. In 2005, when coking coal rose by 116 per cent the pellet premium went up by 111 per cent. In 2008 (the height of the super-cycle), coking coal rose by 206 per cent and the pellet premium by 126 per cent.

So far this year, coking coal is up by close to 150 per cent but the pellet premium is only up by around 50 per cent – with previous moves indicating there’s more to come for producers of pellets and concentrate.

The other financial test is the stock market, where the rising iron ore price is driving all miners of the material

higher, including the once deeply unloved Gindalbie Metals, which is up 50 per cent to 2.6 cents in little more than a month, and the equally disliked Atlas Iron, which has doubled to since early October.

Whether the higher iron ore price can be maintained, and whether the pellet premium is flowing to WA’s magnetite miners, are two of the unknowns in a complex equation that could change the outlook for several companies, and relieve some of the pressure on Mr Palmer.