Iron ore is the second most traded commodity in the world after crude oil. However, despite an extensive seaborne iron ore trade totaling around 1.5 billion metric tons annually, it is dominated by a small number of large mining companies. As a result of high supplier concentration, large iron ore producers such as Brazil’s Vale and Australia’s Rio Tinto, BHP Billiton, and Fortescue Metals Group play a pivotal role in determining the scale of the global supply of iron ore and, consequently, can significantly influence pricing. In contrast, smaller producers such as Cliffs Natural Resources do not have much of a say in influencing global iron ore supply, and therefore are “price takers” in the market. Thus, to a large extent, the fortunes of smaller iron ore miners such as Cliffs can be determined by production decisions made by the larger producers.
High Supplier Concentration
Brazilian and Australian iron ore producers taken together account for close to 80% of the iron ore traded in the seaborne market. As a result, changes in the output of these companies significantly impact the global balance of demand and supply and consequently, iron ore prices. Further, all of these companies have access to low-cost iron ore deposits in Brazil and Australia, which translates into profitable operations even at relatively low prices. The breakeven price for these producers ranges from $30-40 per metric ton.
China constitutes the largest market for iron ore, accounting for close to two-thirds of the imports of the world’s seaborne iron ore. China is also the major market for the big iron ore suppliers in the seaborne iron ore trade. Accordingly, production decisions at these companies are made keeping Chinese demand in mind, which results in a uniformity in terms of production decisions at the big iron ore miners. All of these producers bet big on growth in Chinese demand for iron ore in recent years, investing heavily to scale up production capacity. However, as illustrated by the chart shown below, these production increases translated into a sharp decline in prices in 2014 and 2015.
Iron Ore Spot Prices, Source: Y Charts
The big producers collectively overestimated the growth in Chinese demand, translating into an oversupply situation and an extended period of weak prices. The decline in prices adversely impacted the profitability of all iron ore miners, but more so that of smaller producers such as Cliffs.
Cliffs Natural Resources Stock Price, Source: Google Finance
As illustrated by the chart shown above, Cliffs’ stock is trading at less than half of its levels from the beginning of 2014. The downturn in the company’s fortunes was largely due to external factors, due to the production decisions made by the larger producers.
Decoupling From Seaborne Trade
In order to lessen its dependence on the seaborne trade, Cliffs’ management decided to focus on its U.S. iron ore operations following a management change in 2014. The pricing contracts for Cliffs’ Australian operations, which cater to clients in Asia, are closely linked to spot prices determined by the seaborne trade, thus exposing the company to the vagaries of seaborne iron ore prices. The company’s management has decided not to invest further in its Australian operations, and its Australian mines should cease production in the next three years. Though the pricing contracts for the U.S. iron ore operations do have adjustments linked to international iron ore prices, they are more closely linked to the demand-supply dynamics in the U.S. market. Thus, with its U.S.-centric strategy, Cliffs has partially decoupled itself from the seaborne iron ore trade. Cliffs’ fortunes will still be influenced by international iron ore prices, and therefore production decisions of the large producers, but the extent of the dependence will be much smaller.
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