NEW YORK Iron ore miner Cliffs Natural Resources Inc. could become a marginal producer and be forced to consider a significant equity raise or even an asset sale if major structural changes take place in the companys key Great Lakes market, according to a report by Credit Suisse analysts.
Cleveland-based Cliffs generates 75 to 80 percent of its group earnings in the Great Lakes region, which is now a net importer of iron ore, Credit Suisse said. But with a number of new entrants scheduled to come online in coming yearsincluding Essar Steel Minnesota LLC, AK Steel Corp.s joint venture with Magnetation Inc., and U.S. Steel Corp.s planned Keetac expansionthat region could be facing a potential surplus, Credit Suisse said.
"A structural iron ore surplus appears likely on the Great Lakes in the future, and the fact that Cliffs may be positioned as the marginal supplier in this market has the potential to change the mechanics of pricing arrangements with customers," the bank wrote in a March 26 report.
Also concerning is the fact that many of those new competitors are historically some of the companys main customers, the bank said. "For the past several years, (Cliffs) has been Essar (Steel Algoma Inc.s) primary iron ore supplierproviding around 3.2 (million) to 3.7 million tonnes per year of iron ore. Not only is the Essar group aiming for self-sufficiency, but Essar will in fact be long iron ore and recently announced a 3.5-million-tonne-per-year (for) 10 years offtake deal with ArcelorMittal (USA Inc.)," Credit Suisse said.
Cliffs two active iron ore agreements with its largest customer, ArcelorMittal USA, will expire in 2015 and 2016, while its 15-year supply agreement with its second-largest customer, Essar Steel Algoma, will end in 2016, Credit Suisse said. Cliffs is also the sole supplier of Severstal North America Inc.s iron ore requirements for its Dearborn, Mich., facility until 2022. Once these agreements expire, however, Cliffs will be forced to find new markets.
These expected market changes could have the potential to "compromise" Cliffs pricing power and "erode the earnings potential for the U.S. iron ore business," Credit Suisse said, noting that it believes Cliffs "will need to consider more drastic solutions" ahead.
"We believe ... a multi-billion-dollar equity raise and/or core asset sales are required to comprehensively address the balance sheet," the bank added.
A spokeswoman for Cliffs has dismissed Credit Suisses forecast, calling the report sheer speculation.
"The analyst is speculating and creating a scenario that does not represent our current business plans," a Cliffs spokeswoman told AMM sister publication Steel First.
But the bank maintains its stance, calling the Asia-Pacific iron ore business the most marketable asset in Cliffs portfolio because of the potential interest from Asian-owned steel mills in Australia.
One wild card in the equation, however, is the development of direct-reduced iron (DRI) technologies in the United States. Credit Suisse believes that DRI potentially represents a demand growth opportunity for iron ore if it can displace ferrous scrap as a source of iron in the steelmaking industry. However, it cautioned that its still too early to tell how the new development will play out and on what scale.
"Although wed find it hard to argue that tangible opportunities do exist in DRI, the conceptual scale of this emerging industry appears relatively small in the context of the greater market," Credit Suisse said.