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The might of iron ore

It's time to revisit iron ore, already and still ranking as the resources investment of the decade.

Author: Barry Sergeant
Posted: Wednesday , 20 May 2009

JOHANNESBURG -

When Chip Goodyear, a past CEO of BHP Billiton, gave a presentation at a Rosebank, Johannesburg hotel in September 2005, it was Alcoa that showed up first on a slide of the top 20 global mining companies, ranked by market valuation. Alcoa, the US-based transnational aluminium name, involved in mining, smelting and fabrication, was worth around USD 30bn. Today, the same Alcoa ranks 27th, with a more modest value of USD 9.4bn, seemingly overcome by China's huge developments, specifically in aluminium, over the past decade.

The point in time used on the chart by Goodyear was March 2001, which pretty much marked the start of the so-called commodities supercycle, which peaked, for different commodities, across 2007 and 2008. Back in March 2001, a little known company called CVRD ranked as sixth most valuable miner on the global scene. Today that company is known as Vale; where Alcoa has fallen off a cliff, Vale today ranks as No 2 miner in the world, by value, behind BHP Billiton. What's more to the point, perhaps, is that Vale's market value over the period has increased by nearly ten times - 980% - from around USD 10bn to close on USD 100bn.

While Vale ranks as a diversified miner, especially after its frolic with nickel during the higher parts of the commodities supercycle, iron ore remains the backbone of the Brazilian supergroup. The Carajás name is synonymous with the world's biggest miner of seaborne iron ore, with Rio Tinto and BHP Billiton, both with production out of Australia, ranking No 2 and 3. These three dominant names mine huge, high grade deposits, and control, if not own, much of the logistics vital to the trade: rolling stock, railway lines, ports, handling facilities, and, in the case of Vale, an entire monster shipping fleet. Vale recently invested USD 1.6bn in 12 "large" iron ore carriers.

In terms of country production, China ranks as the biggest iron ore miner by far, with around 770m tonnes of the stuff dug out during 2008, followed by Brazil, mainly Vale, with 390mt, Australia with 330mt, India with 200mt, and Russia with about 100mt. Much of China's iron ore rates as low grade; recent estimates by a Rio Tinto executive put current Chinese production down by up to 50% from rates seen during 2008.

As seen across most sectors of the global mining scene, with the key exceptions of gold and silver, cutbacks have indeed been severe in iron ore mining, in adapting to new market conditions. During the first quarter of this year, Vale slashed its iron ore production by 37% to 46.9mt, compared to the first quarter of 2008; pellet production was slaughtered down 73% to 2.9mt. All else being equal, the seaborne iron ore trade should emerge with some kind of price preservation within the foreseeable future.

While seaborne iron ore has played a material part in the emergence of BHP Billiton as the world's biggest diversified resources stock, at Rio Tinto, the story was somewhat spoiled by the ill timed acquisition of Alcan during 2007, for USD 38bn in cash. Pipping an initial bid by Alcoa, Rio Tinto paid a massive premium for a company which, like Alcoa, has very little going for it on the commodity pricing front. Strategically, the key to playing to China's aluminium demand game is at the mining level, by supplying alumina rather than aluminium.

Iron ore ranks as a bulk commodity, much as do oil, coal, cement, potash, alumina, and so on. There is no shortage of iron ore. According to recent US Geological Survey numbers, the global reserves base for iron ore sits around 350bn tons, where some 150bn tons may be classified as usable reserves. Ukraine leads the pack, with 30bn tonnes, followed by Russia with 25bn, China with 21bn, Brazil and Australia with 16bn each, Kazakhstan with 8bn, and the US and India with 7bn each.

Vale's claimed iron ore reserves in the ground are at 14.3bn tons, at an excellent grade of 59%; Rio Tinto claims reserves of 2.7bn tonnes, while BHP Billiton claims 1.7bn tonnes in its latest annual report. These numbers are strictly defined economic reserves. Rio Tinto, for example, claimed no reserves figures for Brazil's Mineração Corumbaense Reunida (Corumbá), which produced 2mt of lump and fines during 2008, and where Rio Tinto has outlined a resource of 8 to 10bn tonnes of iron ore at 52 to 55% iron. Earlier this year, Rio Tinto sold Corumbá to Vale for USD 750m, highlighting the relative abundance of iron ore, and assisting Rio Tinto in meeting its financial challenges.

Rio Tinto has also not yet counted any tonnages from Simandou, in Guinea, where it has outlined a resource of 2.25bn tonnes of iron ore at 66% iron. Simandou, according to Rio Tinto "lies within one of the best undeveloped major iron ore provinces in the world". During 2008 Rio Tinto conducted advanced studies into establishing an iron ore mine of 70mt a year capacity, and potentially of up to 170mt a year of capacity, at Simandou.

Vale, by comparison, produced a total of 302mt of iron ore in 2008 (including a restricted fourth quarter). So far, Rio Tinto has looked at a number of options to establish "the most efficient and economic means of transporting the mined ore from" Simandou, where it has so far spent nearly USD 400m on "the work necessary to develop a long life iron ore mine". During 2008, Rio Tinto spent an average USD 20m a month at Simandou on drilling, engineering and support.

In common with mining of any kind, iron ore needs big capital. Australia's Fortescue, one of the newest names on the iron ore block, and also a recent producer, and which claims 4.5bn tonnes of iron ore resources, recently found itself with some interesting liquidity issues, and sold fresh shares to China's Hunan Valin, first 35m, and then 225m, to raise the equivalent of USD 67m and USD 432m, respectively.

Even so, there are investors once again hunting for possible transactions to match some of the legends of the previous supercycle, not least the sale of LionOre (nickel) for USD 5.5bn to Norilsk in May 2007, the sale of Uramin (uranium) to Areva for USD 1.9bn in June 2007, and the sale by London Mining for USD 810m of Brazilian iron ore assets to ArcelorMittal in August 2008; nearly USD 400m of that was returned to London Mining's shareholders.

On this score, there are any number of pretenders to the thrones held by the three dominant names in seaborne iron ore, but when a company's stock price has risen by 1,800% in six months, to a market value of USD 500m, it is more than enough reason to take notice. That's the short story applying to African Minerals which ranks itself as the largest holder of mineral rights in Sierra Leone, with a focus on iron ore, base metals, uranium, gold, and diamonds.

The focus for now is the Tonkolili iron ore project, where, as a veteran London-based analyst puts it, African Minerals "unabashedly claims" five to 10bn tonnes of iron ore at a grade of 30% iron. This needs little investigation across the trading desks in London: the rumour is that ENRC is going to swallow up African Minerals. Speculators need to ask about that grade at Tonkolili; it's simply not royalty class.

Norway listed London Mining today sits with USD 260m in cash and no debt, and three iron ore projects in Saudi Arabia, Greenland and Sierra Leone. London Mining also has some small Chinese iron ore production, and four minority coal interests in four projects globally, with an attributable resource of 121mt and near term production of coking coal from expanding Colombian coal mines and coke furnaces. In absolute terms, London Mining ranks as one of the world's best performing stocks of any kind.

Just as African Minerals is being chased in London, so also is Ferrexpo, distinguished, however, by already being in production, in Ukraine. Among the more hotly chased Australian iron ore names may be mentioned Atlas Iron, Murchison, Mount Gibson Iron; in Canada, Cons.Thompson and Baffinland continue to plot strong stock price recoveries; Australian juniors strongly back in the game include Iron Ore Holdings, BC Iron, and Talisman Mining.

The apparent rebirth of iron ore has stimulated all kinds of recovery projects and mining around the world; Magnetation, found on Minnesota's gigantic, but low grade, iron ore range, is just one example. Palladon Ventures has looked at reopening a Utah iron ore mine; other smaller miners have looked at opening or reopening iron ore mines in Alaska, Arizona, Missouri, Nevada, and New Mexico. This is a vast global sector, indeed, that includes major state owned players such as Luossavaara Kiirunavaara AB (LKAB, Sweden), and Société Nationale Industrielle et Minière (SNIM, Mauritania).

For the meantime, the three members of the seaborne iron ore royalty set look likely to prevail, with any number of opportunities available. Vale, Rio Tinto and BHP Billiton have also fashioned customer groups to enhance their iron ore customer relationships, mining and offering products required in the production of iron and steel, not least coking coal, nickel, manganese and molybdenum. The entry costs to this club are very high, as Anglo American is finding with its USD 5.5bn cash purchase in 2008 of control of the Minas-Rio iron ore project and the Amapá iron ore system in Brazil.