Record Iron Ore Prices Are Good for Cliffs Natural Resources

by Tony D'Altorio

Record Iron Ore Prices Are Good for Cliffs Natural Resources

by Tony D'Altorio, Investment U Research

Tuesday, January 25, 2011

Many commodity prices, like iron ore, continue trekking upwards.

The spot Australian benchmark iron ore price just hit $185 a ton - an all time high. That includes shipping costs from western Australia to the Chinese port of Qingdao.

Even without freight costs, however, the price only drops to $177.90. And that's still a record, topping April 2008's $175, which also doesn't factor in shipping.

That spike adds further inflationary pressure on the global economy. Since steel prices reflect iron ore prices, consumers should expect cars and appliances to cost more as well...

La Nina Disrupts India's Iron Ore Mine Output

Blame much of the mess on La Nina. The weather pattern caused a prolonged monsoon in India, the world's third-largest iron ore exporter, disrupting iron ore mine output.

Global iron ore supplies tightened after India's state of Karnataka decided to ban such exports. It accounts for about a quarter of India's annual exports of over 100 million tons of the commodity.

Yet it barred those sales due to the monsoon rains and a clampdown on illegal mining.

Another state, Orissa, accounts for about a fifth of India's iron ore exports and recently said it too was considering the ban. If so, supplies will tighten even further.

Meanwhile, some major iron ore projects in Australia and Brazil also face delays. So even if demand cools, limited supplies will likely keep prices high in the long term.

That works out very nicely for large miners such as Vale ADR (NYSE: VALE), Rio Tinto ADR (NYSE: RIO) and BHP Billiton ADR (NYSE: BHP).

Peter Richardson, chief metals economist at Morgan Stanley in Sydney, Australia, said the industry can expect a "very positive" 2011 and 2012. He also sees the iron ore market falling short of supplies until at least mid-2013.

Cliffs Natural Resources

More than just the three big miners win from the iron ore trend. It also benefits companies like U.S.-based Cliffs Natural Resources (NYSE: CLF), the largest iron ore producer in North America.

Cliffs recently made the news with an all-cash $5 billion bid for Canada's Consolidated Thompson Iron Mines (TSE: CLM). Consolidated just opened its first iron ore mine - Bloom Lake in Quebec - nine months ago.

That happens to be strategically located near Cliffs' Wabush mine in the prolific Labrador Trough iron-mining region. Their closeness means Cliffs should easily achieve the $75 million annual synergy target it expects from the deal.

And it should be even easier after spending $600 million to double the mine's annual capacity to 16 million tons by late 2012. That will also fund developing a second mine.

Cliffs used to take all its revenue in North America. But in 2004, it bought Australia's Portman Iron Ore and now makes about a quarter of its sales in the Asia-Pacific region.

As its CEO, Joseph Carrabba, said, "The North American economies are very stagnant... we needed more exposure to growth markets."

Sure enough, the U.S. steel industry is traveling opposite China's. Long-term contracts with U.S. steelmakers for iron ore range closer to $100 per ton, well below Asian prices.

Carrabba says: "The next level of the chess game is establishing a strategic partnership with a large Chinese [steel] producer. The Chinese mills are always looking at alternative suppliers outside the big three [Rio Tinto, BHP Billiton and Vale].

The man must be quite a chess player since the Consolidated deal does just that. The takeover target's largest shareholder, with 19% of the outstanding stock, is China's third-largest steelmaker, Wuhan Iron & Steel.

Wuhan Iron & Steel Gets First Dibs...

Wuhan has agreed to sell its Consolidated stake to Cliffs, while keeping 25% of the Bloom Lake iron ore mine. In order to gain its support, Cliffs promised it first dibs on a minimum of half the iron ore extracted annually from the site.

Once Consolidated ramps up its production, over half of the combined revenue base of the two companies should be generated outside North America, much of it in Asia.

Cliffs' stock climbed nicely after announcing the deal. And its shareholders have every right to celebrate.

While the North American steel market flounders, it flourishes in Asia and especially China. As mentioned before, seaborne prices for iron ore are hitting record highs.

Cliffs now has a locked-in Chinese buyer willing to pay more than domestic customers for its iron ore.

Mr. Carrabba must be saying "Checkmate" right now.

Good investing,

Tony D'Altorio

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