BMI View: Blessed with an abundance of high grade reserves and well-developed infrastructure, Australia will remain the global cost leader in iron ore production. While miners operating in countries such as India and China will remain near the top of the iron ore cost curve, West Africa is poised to become the new iron ore frontier as considerable efforts are made to uncover some of the world-class deposits in the region.
The stellar run in iron ore prices of recent weeks has ignited much optimism among mega miners, with Fortescue Metals announcing its decision to restart the Kings project in December 2012. This contrasts to the trend we highlighted in H212, when a collapse in prices catalysed a wave of project cancellations across the iron ore industry. Nevertheless, we expect optimism to be shortlived and anticipate renewed weakness in the latter part of 2013. Our forecast for prices to average US$110/tonne in 2013 and US$105/tonne in 2014 will be a key challenge for mining firms with a heavy punt on the commodity. Taking into consideration a number of factors, we expect Australian miners to prove their mettle and retain dominance at the bottom end of the global iron ore cost curve. In contrast, China will remain one of the costliest places to produce iron ore and many miners will be prompted to cease operations once prices fall below the US$120/tonne level on a sustained basis.
|Iron Ore Miners To Enjoy Brief Respite|
|China Iron Ore Import Price, 62% CFR (US$/tonne)|
Australia: The Low Cost Leader
The cost of producing iron ore in Australia is substantially lower than the global average due to the abundance of high-grade hematite ores (iron content of 62.5% and above) and extensive infrastructure facilities. Hematite ores (also known as 'direct shipping ores') can be fed directly into iron-making blast furnaces and require relatively little beneficiation. As such, production from these deposits tends to place miners at the lower quartile of the cost curve. We believe mining giants such as Rio Tinto, BHP Billiton and Fortescue Metals will continue to enjoy the lowest cost of operations and remain the largest players in the global seaborne market. While the escalation in operating cost will be a major drag on miners' profits over the coming years, the high quality ores and geographical location of Australia will keep a lid on cash costs and places the country as one of the best places for iron ore investment.
|Australia To Remain Unrivalled|
|Global - Iron Ore Exports (2011)|
With more than 70% of its earnings derived from iron ore, Rio Tinto's profit is heavily tied to movements in both the prices of the key steel-producing mineral and its underlying cost of production. The company's costs of producing iron ore in the Pilbara region was US$24.50/tonne in the first half of 2012, while the all-in cost per tonne to deliver to China (including royalties, shipping and underlying capital costs) was US$47/tonne. The significant cost advantage that Rio Tinto enjoyed has prompted the company to boost its iron ore production target for 2013 by 15%. It is also spending more than US$12.5bn on the expansion of the Pilbara's iron ore operations, in conjunction with plans to reduce capital expenditure for other minerals by US$5bn over the next two years.
|Links To Riches In China|
|Map - Countries & Ports|
With approximately US$21bn dedicated to mine, port and railway expansion programmes to boost its Australian capacity, we expect Rio Tinto to stay at the bottom of the global cost curve due to its efficient and well-developed infrastructure. Iron ore is a bulk commodity and transportation costs are a much larger component of total costs than is the case for other metals. Aside from Rio Tinto, we expect BHP Billiton and Fortescue Metals to be the lowest-cost iron ore producers in the world. Apart from their high-grade mineral ores, these two companies are well-positioned with its extensive infrastructure support and close proximity to China, which accounts for 60% of global iron ore consumption. Given our forecast for iron ore prices to average US$110/tonne in 2013, the operations of Australian miners will remain solidly profitable at this level.
|China's Supersize Binge|
|Global - Iron Ore Imports (mnt)|
Brazil: Second To Australia
While Brazil is also home to an abu ndance of hematite deposits, we expect Australian producers to hold a cost advantage over their Brazilian counterparts du e to their geographic proximity to China. For instance, vessels from Australia take 11 days t o travel from Port Hedland to Qingdao ( 3,458 nautical miles) in China, as compared to 36 days from the Tubarao port ( 11,023 nautical miles) in Brazil. Moreover, Vale ' s recent attempt to dimi nish the cost advantage of Australian producers has been futile at best. The company spent more than US$8bn to construct the larg est bulk carriers in the world befo re they were banned from entering the Chinese ports in February 2012. Chinese s hip owners and steel makers w ere worried that Valemax class ships would depress freight rates and defer too much pricing power to the world's largest iron ore producer .
|Australia A Winner In The Distance Race|
|Vessel Roundtrip Days To Qingdao, China|
That said, we expect Australian and Brazilian producers to experience rising cost pressure over the coming years. Despite their geological advantages, the cost of producing iron ore in these countries remains susceptible to further tax hikes and labour costs increases. The former has seen the imposition of a 30% super-profit tax on iron ore miners in 2012, while the latter has continued to suffer from China's ongoing ban to Vale's mega vessels.
China: Declining Ore Grade The Biggest Threat
Although the growth in Chinese iron ore production has been impressive over the past few years, the sharp fall in implied grade has meant soaring production costs for domestic miners. According to China Customs General Administration, the average grade of marginal Chinese iron ore has fallen from approximately 43.1% in 2004, to 15% in 2012. As grade declines, many of the miners will have to adopt more complex and expensive processing methods, with energy becoming a larger overall constituent of the cost structure.
|Cost To Escalate With Falling Ore Grade|
|China - Iron Ore Grade|
India: Infrastructure Constraint s To Weigh On Costs
Similar to Australia and Brazil, the vast majority of India's iron ore production is produced from the higher grade hematite iron ore reserves. Although the country is home to an abundance of lower grade magnetite ores, exploration work on magnetite resources has been scant with only 0.2% of total resources considered as reserves. The country also lacks low-grade iron ore beneficiation capacity, which makes exploitation of low grade magnetite iron ore and lower grade hematite reserves not yet feasible. Nevertheless, Indian iron ore miners continue to sit near the top of the global cost curve owing to the incurrence of high rail freight charges. Due to infrastructure constraints, the freight tariff largely negates any of the cost advantages derived from higher-grade ores. Coupled with the 30% export duty on iron ore exports, we see little scope for Indian miners to challenge the dominance of its peers sitting at the bottom of the global cost curve.
|India - Breakdown Of Resources By Type (%)|
West Africa: The New Iron Ore Frontier
In a bid to secure more iron ore deposits, an increasing number of investors have ventured into West Africa for investment opportunities. Most importantly, China ' s heavy reliance on iron ore imports, diminishing grades in Austr alia and Brazil, as well as the gap left by receding Indian exports will support the case for the rapid expansion of Africa ' s iron ore industry. While many of the countries in West Africa do not boast the most stable political regimes, the rich reserves of high grade hematite and magnetite ores in the region have been a major draw for many international players including the likes of Rio Tinto , London Mining and Vale. W e expect Guinea to become one of the world ' s largest iron ore exporters and possibly Africa ' s biggest producer by 2017 as a stream of iron ore projects come online. The country has some of the world ' s largest high grade reserves of iron ore, with most deposits above 60% grade.
|Guinea Awaiting Iron Ore Boom|
|Guinea - Iron Ore Mines|
Furthermore , we expect Liberia and Sierra Leone to join Guinea as part of West Africa ' s iron ore boom. In total, with projects owned by BHP Billiton, Vedanta and Severstal & African Aura, Liberia has over 1.5bnt (billion tonnes) of iron ore reserves due to come online over the next few years, which will see output rapidly expand from negligible at present to approximately 50mntpa (million tonnes per annum) by 2014. In terms of Sierra Leone, we expect the country's iron ore output to reach 85mntpa in 2017, up from 23mntpa in 2011. The majority of this growth will be driven by African Minerals' Tonkolili mine, one of Africa's largest iron ore deposits. Indeed, the iron ore boom in West Africa, which has the potential to rival Australia's ore-rich Pilbara region, has encouraged African Minerals, Rio Tinto and ArcelorMittal to spend US$25bn on the construction of 3,170 miles of new and rebuilt railways and 11 new ports in the region.
|na = not available. Source: BMI, Company Announcements|
|Sierra Leone||African Minerals & Shandong Iron||Tonkolili||40mntpa||2014|
|Sierra Leone||London Mining||Marampa||16mntpa||2015|
|Sierra Leone||Argosy Minerals||Bembeye||2.2bnt reserves||na|
|Liberia||BHP Billiton||Goe & Fantro||28mnt||na|
|Liberia||China-Africa Development Fund||Bong||110mnt||na|