Even as Fortescue Metals Group races to hammer down production costs, the leaner miner faces the prospect of becoming the marginal producer of the large iron ore players once Brazil's Vale brings its new mega expansion project online, analysts say.
Iron ore crashed spectacularly overnight Thursday - falling 6 per cent to $US55.63 a tonne - it's biggest one-day decline in a year. It snatched back much of the modest recovery made since hitting a record low of $US47 a tonne in early April.
UBS mining analyst Glyn Lawcock told The Australian Financial Review that "the concern the market has is that the all-in cash delivered price that FMG needs to be cash neutral is ultimately going to be the dictator of where the long-term price settles".
"As more low-cost supply comes on, and high-cost supply is pushed off, ultimately the risk is that Fortescue becomes the most signficant size marginal player.
"So even with their newly discovered cost base, they could still find themselves not making cash."
It could be the highest cost of the large producers - Vale, Rio Tinto and BHP Billiton, and newcomers Roy Hill and Anglo American, he said.
Vale sealed a major $US16.5 billion expansion last month with financial backing from China that will allow the Brazilian miner to produce 90 million tonnes of high-quality iron shipped to China at a cost nearly as low as that achieved by industry leader Rio Tinto. The project in the Amazon, called S11D, should be finished next year.
"We would expect S11D to drop Vale below FMG on an all-in cash breakeven basis, to China," Mr Lawcock said.
"At the moment Vale's costs are inflated by their hedged freight. When S11D comes in at an $US11 (a tonne) cost base, that will drop their weighted average cost."
Fortescue chief financial officer Stephen Pearce told the Financial Review last month that the miner has a cost structure superior to Vale's, and believes some investors have failed to recognise this.
"We believe we are well positioned in terms of the four global iron ore majors and we expect [on a break-even basis] to even come a little bit below where Vale sit," Mr Pearce said.
London-based Barclays analyst Amos Fletcher told the Financial Review that "whether the higher cost producer is FMG or Vale, the cost curve is going down; so investors should stick with the lowest cost producers - BHP and Rio".
"If FMG's financial 2016 cost targets are achieved – and I would question if not the achievability then certainly the sustainability - e.g. maintenance capex at $US2 a tonne is probably not sustainable for FMG – that would see them at a lower cash breakeven than Vale," Mr Fletcher siad. But the London-based mining analyst agreed that S11D could see Fortescue become the marginal producer.
Fortescue puts its current breakeven at about $US39 a tonne, while Mr Lawcock estimates it at about $US44 a tonne. Vale's breakeven is about $US43 a tonne, and the miner is aiming to pare it to about $US40 this year.
Over the next one to two years there are other producers that potentially fit that marginal cost producer profile, some Chinese domestic mines, and producers in non-traditional exporting countries like Iran, Iraq, Mexico, but they will be replaced by low-cost supply, Mr Lawcock said.
Record shipments were made from the Pilbara last month, up 14 per cent to 38.4 million tonnes on the year earlier period, while Brazilian exports also hit an all-time high in the month. The new figures could have contributed to the price woes overnight Thursday.
UBS is tipping that Gina Rinehart's Roy Hill project will come onto the market, later this year, with a lower breakeven than Fortescue.
"Fortescue has got cash today but the risks are that if they hold their cost base down here, the question ultimately is...will the price come down to meet them? Then they will be in just as much trouble as if they'd been running at a $US50 cost base."
Fortescue's has made huge progress on paring production costs, also known as cash or C1 costs, in the past six months, but the cuts could change the longer-term profile of the business, Mr Lawcock said.
The miner is targeting cash costs of about $US18 a tonne this year - down on $US26 last half.
Fortescue will do everything it can to sustain their new cost position, but its breakeven will start to creep up in one to two years, when sustaining capital will need to increase and its strip ratio will also rise, Mr Lawcock says.
The two key factors outside the industry's control that drive breakeven prices are freight rates and currency. The fall in the Australian dollar and oil prices have been much needed tailwinds for all Australian players, but both can change quickly.
Fortescue shares were trading at $1.83 on Friday morning, down 3.8 per cent, and less than half the price they were fetching a year ago.
The miner is thought to have held talks with China's biggest conglomerate, CITIC Ltd, and its biggest steelmaker, Baosteel, about a potential capital restructure.
Fortescue should consider selling equity in its assets, Mr Lawcock said.
"They are demonstrating a $US15 -$US20 cash margin at the moment.
They could look at selling down to a customer - who has to take a very long term view. Industry tends to take a longer-term view than equity markets."
He pointed to Posco buying into Ms Rinehart's Roy Hill project - saying the Korean giant likely took a 30-year view of the iron ore price. All of Fortescue's product is sent to China.
Source: Australian Financial Review
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