Editorial: Iron ore prices – Where’s the bottom?

As the daylight hours shorten and winter chill takes hold of the iron ore mines and surrounding communities in the Labrador Trough, it’s as good a symbol as any of the deep freeze that is engulfing the global iron ore market, as spot prices continue to head south.

Back in October, Cliffs Natural Resources said it would permanently close its Wabush iron ore mine on the Labrador side of the Trough, after having laid off some 500 workers in February when it first idled the mine.

And now Cliffs says it has failed in its attempts to find investment partners for the US$1.2-billion expansion of its Bloom Lake iron ore mine on the Quebec side of the Trough — an expansion that the struggling major said was needed to make the Bloom Lake mine financially viable.

While Cliffs had been optimistic about finding such financial partners as recently as a month ago, layoff notices have been sent to some 400 workers at Bloom Lake ahead of the closure of the entire Bloom Lake complex, which will take affect in mid-December. Around 80 workers will be kept for care and maintenance.

Cliffs now states bluntly that it is pursuing its “exit options” for all its Eastern Canadian iron ore assets. Perhaps the biggest surprise in the announcement is the high price tag that Cliffs has put on closing shop and leaving Eastern Canada: up to US$700 million in the next five years.

Cliffs already prepared some of the financial groundwork for its exit in its third-quarter results, having written off US$4.5 billion related to Bloom Lake mine’s long-lived assets, US$28 million related to Wabush’s long-lived assets and US$254 million on the Chromite Ring of Fire assets in Ontario.

One of the realities of living in a remote mining town is the community’s vulnerability to macroeconomic events on the other side of the world, with little to no access to the real decision makers.

In the case of iron ore, the market is oversupplied courtesy of massive production increases by some of the biggest players, including BHP Billiton, Rio Tinto, Vale and Fortescue Metals. BHP and Rio Tinto in particular have lowered their iron ore mining costs in Australia to such a degree that they have no immediate incentive to cut back production. Adding to the imbalance is a dramatic softening in China’s residential housing market, with prices declining 2.5% in October, and the bankruptcy of the Chinese steelmaker Haixin Iron & Steel Group. (Remarkably, China’s property market accounts for almost half of all steel demand.)

Iron spot prices have now ducked below US$70 per tonne for the first time in five years, and some analysts are positing that the price will fall further, and US$100 per tonne will never be seen again. Iron ore prices are off 12% just in the past month and down 47% from a year ago. There’s also little short-term price optimism, as the Nymex forward curve slumped to US$65 per tonne going out until August of next year.

Tom Albanese, former head of Rio Tinto and current CEO of India’s Vedanta, told India’s Fairfax Media that weak iron ore prices are here to stay for at least a couple of years, depending on how quickly high-cost Chinese production exits the market.

“The new normal is volatility,” Albanese told Fairfax. “For the past five years we’ve had to accept a high level of it and post the collapse of the benchmark pricing system. While it was fun on the way up, it’s painful on the way down.”

The fall in iron ore prices is even affecting currencies, with the Australian dollar sinking to just US85.14¢ in late November — its lowest level since June 2010. That only helps lower salary costs at BHP, Rio Tinto and Fortescue’s Australian iron ore mines, further removing incentive for the three to throttle back their Aussie output.

Despite the iron ore price fall, BHP and Rio Tinto’s margins are still incredibly robust with BHP planning to cut production costs to less than US$20 a tonne from US$27.50 for the 2014 financial year, and Rio Tinto already boasting costs of only US$20.40 a tonne in the first half of 2014.

It all sends a strong message to any competitor operating a high-cost iron ore mine or contemplating building a new one: batten down the hatches for lean times ahead in iron ore, as BHP and Rio run the table.