AXI still of the radar to most people, but once it does become noticed it should be of the ground and flying high.
Solving the Global Iron Ore Shortage
Source: Brian Sylvester of The Gold Report 12/03/2010
Ifthere is one thing UBS Securities' Dieter Hoeppli knows it's steel. Asglobal head of steel, as well as metals and mining in the Americas forUBS, he's spent the last 20 years analyzing the steel business andacting as an advisor on countless mergers and takeover deals. Heregularly travels the world and crunches numbers to determine what'sgoing to grow and what's not. In this Gold Report exclusive, wetake you inside the recent Forbes & Manhattan summit for some ofDieter's candid thoughts on the shortage of iron ore global steelmanufacturers are now facing.
"I am bullish about steel, I thinksteel has a great future," said Dieter Hoeppli, managing director of UBSSecurities' steel and metals group in New York City, during apresentation at the first annual Forbes & Manhattan Resource Summitin West Palm Beach, Florida.
"There is a lot of infrastructureto be built if you go to places, such as India and Brazil, which I camefrom this morning," he added. "You see a lot of activity taking place;that's going to run for the next 5 or 10 years and a lot of steel isgoing be consumed for that."
Annual global steel production wentfrom 770 million tons (Mt.) in 1990 to 847 tons in 2000 to roughly 1,367Mt. in 2010. Steel production is expected to have a compound annualgrowth rate of 5.6% in each of the next two years and total productionshould reach 1,524 Mt. in 2012.
Moving Away from the U.S.
Henoted, however, that biggest change from 1990–2010 is where steel ismanufactured. In 1990, Russia made about 20% of the world's steel; butby 2010, Russian production accounted for just 8%. European and NorthAmerican steel production witnessed similar or even more drasticdeclines. And most of that production has shifted to Asia, which nowproduces about two-thirds of the world's steel.
In 1994, onlyfour of the world's top-40 steel producers were Chinese companies,whereas six were American. Today, seven are based in China and just twoare left in America.
Dieter said that shift has brought with itthe disappearance of well-known steel companies like Bethlehem Steel andBritish Steel. Those names have been replaced by new ones like ArcelorMittal (NYSE:MT), Nucor Corporation (NYSE:NUE) and Nippon Steel Corporation (OTC:NISTF; OTC:NISTY).
"Theseare the new leaders in the industry," Dieter said. "They are morenimble, further diversified and many of them are backward integratedinto raw material."
Merger and acquisition (M&A) activity inthe steel sector peaked in 2006 with 27 deals valued at nearly $60billion. The number of deals picked up pace following that year, with 39deals worth roughly $37.3 billion in 2007 and about $20 billion over 32transactions in 2008. As of Nov. 1, 2010, M&A activity stood at 13pacts valued at $5.4 billion.
Dieter said the key development inconsolidation was the creation of large steel companies with numerousblast furnaces that give them greater production flexibility. In the1990s, many of the small steel companies had but a single furnace, whichmeant it had to be kept running, even at a loss.
India and Brazil Poised for Future Production Growth
Dieterexpects future steel production growth to come from India—a countrywith a population that rivals China but that only produces about 60 Mt.of steel annually, versus China's roughly 600 Mt. He cautioned, though,that steel production growth in India could take some time.
"Indiais a very difficult place to build new capacity," Dieter explained;"acquiring land in India and getting permits can take a very long time. Pohang Iron and Steel Company (POSCO) (NYSE:PKX) announced a $10 billion investment in a steel plant [in India] about seven years ago. It still hasn't broken ground."
He also sees steel production growth coming from Brazil.
"TheBRIC countries [Brazil, Russia, India and China] are going to be the[production] drivers while in more developed markets, we will still haveexcess capacity," Dieter said.
From July 2008 until mid-2009,North American steel production operated at just over 40% ofcapacity—even below the levels of the 1982 recession when steelproduction plummeted to about 70 Mt. from 110 Mt. in 1981. Dieter notedthat it took North American steel producers 15 years to return to the1981 production mark.
It may not take as long this time,however, given that higher steel prices have boosted North Americansteel production to 70% of capacity—an increase of about 30% since 2008.
Theprice of hot rolled coil is at roughly $550/ton, up from a low ofroughly $210/ton in the late 1990s but down from a peak of $1,100 in2007.
Dieter believes steel makers can make money selling steelat $550/ton but that the rising cost of raw materials has forced steelproducers to get directly involved in mining them to reduce costs.
"If they are not backward integrated, most steel companies are not making money today," he noted.
Dieter said there are three main sources of raw material—scrap, iron ore and metallurgical coal.
Scrapprices have skyrocketed from $80/ton in recent years to around $300/tonnow, while iron ore prices went from $35/ton in 2005 to between $150and $175 per ton today.
He said this has led to a change in ironore contracts. Deals used to be done annually but now prices areadjusted quarterly using a system similar to spot prices—an arrangementthat largely favors the iron ore producers.
"[The new system] isvery positive for the iron ore companies, but more challenging for thesteel companies," Dieter said. He noted that in the near term only twoof those raw materials would be in short supply—metallurgical coal andiron ore.
Metallurgical coal (met coal) is used as a fuel and asa reducing agent in smelting iron ore in a blast furnace. The supplydeficit in met coal, Dieter said, has led to prices reaching $210/ton,up sharply from $50 per ton in 2001. What's more, steel companies aremoving upstream into coal mining operations to reduce or stabilize theircosts.
Dieter said there is a similar shortage of iron ore butthat by 2015 the deficit would become a surplus after severalsignificant iron ore projects in Brazil and Australia reach production.
Iron Ore Leads Pack
Butwhen it comes to value creation in the steel sector, iron ore clearlyleads the pack. Over the previous five years, the prices of iron orecompanies have risen a collective 400% owing largely to the growingnumber of takeovers. Over the same timeframe, steel companies were up acombined 12.1%. Met coal and scrap iron companies were up 34% and 28.1%,respectively.
Although the value of steel companies increasedonly 12% over the last five years, the value of steel companies based inLatin America increased by a staggering 165%. The value of their Asiancounterparts, meanwhile, decreased 31.1% over the same period. Dietersaid Latin American steel companies often have the advantage of owningtheir iron mines, whereas most Asian steelmakers work with tight marginsbecause they have to buy iron ore at market prices.
In thequestion and answer session following Dieter's presentation, he wasasked about consolidation in Quebec's North Shore where a number of ironore players operate within spitting distance of each other.
The players include Iron Ore Company of Canada (IOC), the majority of which is owned by London-based Rio Tinto (NYSE:RIO; ASX:RIO); ArcelorMittal subsidiary, Quebec Cartier Mining; Cliffs Natural Resources Inc. (NYSE:CLF),which acquired Wabush Mines earlier this year, mostly to keep Wasbush'siron pellet plant out of the hands of its competitors; Consolidated Thompson Iron Mines Ltd. (TSX:CLM), an iron concentrate producer; and the only junior in the camp, Alderon Resource Corp. (TSX.V:ADV; OTCQX:ALDFF), which resides under the Forbes & Manhattan banner.
Quebec'sNorth Shore features a geological belt known as the Labrador Trough,which first witnessed iron production in 1954. Iron mining continuedunabated until steep drops in iron ore prices forced IOC to shutter itsoperations in 1982.
The camp underwent a renaissance when steelprices started to rebound in the early part of the previous decade. Theiron mines in Labrador are served by two rail lines that link to ayear-round ocean port at Sept-Îles, Quebec, an advantage not lost onDieter.
"The mine body is important but logistics are asimportant. And what's very attractive about the North Shore is that youhave two rail lines in place that have lots of capacity," he said."Consolidated Thompson has shown it can get ore concentrate down to theport at $30/ton. It's highly competitive to produce up at the NorthShore. . .Clearly, Consolidated Thompson could be one of the chips thatcould fall."
Dieter then discussed other targets. His thesis involved U.S.-based AK Steel Holding Corporation (NYSE:AKS),which posted a loss in the recent quarter due to a 100% increase in thecost of iron ore. He said companies like AK Steel, which has a marketcap of $1.4 billion, are forced to look at only the smallest fish tomeet their iron needs.
"I think there is going to be a renewedfocus on attractive companies with great ore bodies, Dieter said, "whichI think Alderon Resource has in areas with logistics already in place,where you can actually bring the product to the market in a reasonableperiod of time."
"Clearly, raw material is an absolutely criticalfactor in steel manufacturing and I'm sure Alderon is going to play amajor role in that," Dieter said.