The celebrated 'new force in iron ore' is bleeding. Iron ore prices have fallen from peaks of US$180 a tonne to just over US$60 a tonne and savaged Fortescue Metal's share price, which has fallen from $6 just 12 months ago to about $2 today.
With net debt of over $9bn and a shrunken market capitalisation of just over $6bn, things appear grim for the one time market darling. It isn't just that iron ore prices have fallen or that Fortescue carries comparatively more debt than just about any other producer.
The real problem bleeding the business is the refusal of producers, especially Chinese domestic miners, to cut output in response to lower prices.
Fortescue might have expected that that BHP and Rio Tinto, the lowest cost producers in the world, would ramp up volume. Management at both companies have been telling everyone just that. BHP will raise output to 240m tonnes this year, up from 100m in 2005. Rio will produce about 300m tonnes.
They can afford to increase output because they boast low costs, less than $40 a tonne. Their actions have knocked about 120m tonnes of Chinese production out of the market. High cost imports from Iran, Malaysia and Indonesia have also disappeared but domestic Chinese miners still supply about 400m tonnes per annum to Chinese mills. This residual amount is proving hard to dislodge.
That's because iron ore for Chinese miners isn't just about economics; they must consider the social impact of closing miners and, because mines are often integrated with steel mills, the impact of production cuts on steel margins.
Fortescue has done all the right things as prices have fallen. It has prepaid debt, cut costs and looked at asset sales. But it can't control the actions of competitors. It could take a long time of very low iron ore prices to knock out residual supply. Eventually, it will be either Chinese local miners or Fortescue that will cut output. Someone will blink.