Industry Trend Analysis - Iron Ore Miners: Struggles Ahead, Especially Juniors - JUNE 2014

BMI View: The downtrend in the Bloomberg Iron Ore Mining Index will persist over the coming quarters as mining equities remain under pressure from lower iron ore prices compared to the boom years in 2010 and 2011 . Junior miners will struggle to survive due to funding constraints . Meanwhile, many Chinese projects will become economically unviable at prices below USD120/tonne. India n miners will also grapple with problems surrounding mining restrictions and the temporary mining ban in Odisha.

We expect the downtrend in the Bloomberg Iron Ore Mining Index since 2011 to persist over the coming quarters. Iron ore prices will come under sustained pressure from a growing supply glut as a result of the economic slowdown in China. We forecast iron ore prices to average USD115/tonne in 2014 and USD105/tonne in 2015, significantly below the average price of USD135/tonne in 2013. This implies further pain ahead for mid-sized and small iron ore miners, many of which are already beset by a string of challenges.

Stuck In Downtrend
Bloomberg Iron Ore Mining Index (Weekly Chart)

We believe the growing dominance of the big three miners - BHP Billiton, Rio Tinto and Vale - will push smaller players to the sidelines over the coming quarters. These majors derive significant economies of scale from their operations in Australia and Brazil, both of which are home to high-grade hematite ore that substantially lowers the cost of production. As illustrated by the chart below, the majors sit comfortably at the lowest end of the global iron ore cost curve.

Majors Sitting Comfortably
Global - Iron Ore Cash Costs By Company/Group of Companies (USD/tonne & Production As % Global Capacity)

Junior Miners Most Vulnerable

Junior miners will be most exposed to the downturn in iron ore prices. Australian miners such as Atlas Iron and BC Iron will not only be hit by falling prices, but also investors' growing pessimism regarding junior mining stocks. The share prices of Atlas Iron and BC Iron have taken a battering in recent weeks, plunging by more than 23% and 25% since April 2014, respectively. We maintain a sceptical outlook on the sustainability of many junior miner operations, particularly those with no assets in production, as they will struggle to survive on the back of a funding crunch that is likely to persist over the course 2014-15 ( see 'Funding Crunch Not Going Away', March 17).

Struggles Ahead For Juniors
Share Price (USD) - Atlas Iron (LHS) & BC Iron (RHS)

A bright spot, however, is the continued push for overseas mining assets by Chinese investors ( see 'Baosteel Eyes Aquila, Chinese Overseas Mining To Continue', May 07). This should cast a much needed lifeline for some junior miners, as Chinese investors look to develop foreign mining assets through strategic alliances with the juniors.

Chinese Miners To Consolidate

Our downbeat view on iron ore prices suggests that consolidation activity in China's mining space will continue to pick up over the coming quarters. The slump in iron ore prices will threaten the economic viability of many mining projects in China. The country's iron ore industry is dominated by small-scale players, which account for 60-70% of domestic output with cash costs around USD120/tonne. This contrasts with cash costs of USD30-50/tonne in Australia and Brazil, and approximately USD40-50/tonne in West Africa.

Apart from Beijing's push to eliminate excess capacity in heavy industry, the sharp decline in domestic ore grades and increasingly depleted ore bodies in China will put mounting pressure on mining operations. According to China Customs General Administration, the average grade of marginal Chinese iron ore has fallen from 41% in 2004 to 13% in 2013. Subsequently, Chinese miners have to adopt more complex and expensive processing methods, with energy becoming a larger constituent of the overall cost structure.

Tough Digging
China - Iron Ore Grade (Fe %)

Persisting Challenges For Indian Miners

The recent resumption of iron ore mining in the Indian state of Goa will not significantly resuscitate earnings for Indian miners ( see 'Headwinds Remain, Despite Lifting Of Goa's Mining Ban', April 24). The green light to resume mining in Goa has come with several restrictions, including a limit on output at 20mn tonnes per annum (mntpa). Additionally, mining firms will have to contribute 10% of their proceeds from ore sales to a welfare fund set up for mine workers. These restrictions imply that domestic miners such as Sesa Sterlite, the largest private iron ore miner and exporter in India, will continue to grapple with a string of challenges in the coming months.

Bouncing, But Challenges Remain
Share Price - Sesa Sterlite (USD)

Additionally, 26 iron ore-producing mines in the state of Odisha were ordered to cease operations by India's Supreme Court on May 16, following the court's verdict that these mines were operating illegally. Odisha is the country's top iron ore producing state accounting for 45% of total output. The closure of the mines would slash iron ore output from Odisha by around 50% (or 40mntpa) and entails a halt in operations of six Tata Steel mines, two Steel Authority of India Limited (SAIL), two Orissa Mining Corporation and one Essel Mining.

Mining Struggles Not Over
India - Iron Ore Production by State (mnt)

That said, we will continue to keep an eye out for concrete signs that the recent victory of the pro-business Bharatiya Janata Party (BJP) in India's general election will improve the operating environment for Indian miners ( see 'BJP's Landmark Electoral Win: Our Initial Thoughts', May 19). The new government may speed up environmental clearances for mining projects and reduce bureaucratic red tape in order to revitalise the iron ore sector, where exports have slowed to a trickle in recent years. Indeed, the share prices of major Indian corporates such as Sesa Sterlite and Coal India Ltd have soared in recent days in a knee-jerk reaction to the positive reforms that BJP could bring about.