The iron ore ship sets sail

An exodus may sound harsh, but it is one way of describing what's happening at the small end of the Australian iron ore industry where a number of companies are diversifying out of their core commodity.

Companies which were once pure-play iron ore miners are rushing to invest in other commodities with no common theme, except a desire to be in anything but iron.

For investors who have followed small iron ore miners the trend represents a fresh challenge, because companies once dominated by iron ore might now also be exposed to copper, potash, lithium, coal, salt, or some other commodity.

Spreading risk away from iron ore, which appears to have entered a long-term period of flat-to-low pricing, is a sensible move for any business. But it also prompts a question about whether the new interests will perform any better.

The driving force behind this herd-like migration of small iron ore stocks is a combination of tough trading conditions as the iron ore price swings erratically, but trends down, and a greater appreciation of the history of the capital intensive nature of mining iron ore.

Traditionally, iron ore has been a business dominated by big miners able to fund major mine developments that generate the economies of scale essential in all bulk commodities mining where infrastructure costs (rail and port) are often higher than mining the ore.

That's why, after 15 years of unusually attractive market conditions created by China's demand for steel, the Australian iron ore sector is reverting to its roots as a business dominated by a handful of mega-miners. It is still led by long-term players in the game, Rio Tinto and BHP Billiton, and with room for a handful of big newcomers, such as Fortescue Metals and Hancock Prospecting.

Where the small miners are heading

Over the past six months small iron ore miners which have shifted their focus to include other commodities include:

• Gindalbie Metals, one of the early movers into small-scale iron ore mining and a leader in the troublesome business of processing low-grade ore into a higher-value product. It recently invested in the Mt Gunson copper exploration project in South Australia.
• BC Iron, another early but small-scale player in the iron ore industry, which recently invested in a potash exploration joint venture centred on Lake Carnegie in the north of WA, and is also investigating a salt-producing project.
• Atlas Iron, once the leader of the small iron ore pack, is looking for investment opportunities outside iron ore and has made an initial small move into lithium exploration through a joint venture with Pilbara Minerals which will see Pilbara, a lithium specialist, farm into Atlas' Cisco project in WA, and
• Mt Gibson Iron, perhaps the most successful of the small iron ore stocks which has started re-developing its flooded Koolan Island mine while reportedly considering other opportunities, including a potential offer to buy the Curragh coal mine of Wesfarmers.

Iron ore remains a key asset of the four companies mentioned, but it is no longer the sole interest of each business. That's thanks to a growing understanding of risk in an industry that no longer suits small producers, unless they can match (or beat) the big miners on costs or ore quality.

An anomaly in the pack

Mt Gibson is a potential winner on costs and quality at its Koolan Island mine where the ore assays an eye-catching 66 per cent iron, a premium grade compared with ore grades of between 55 per cent and 62 per cent iron exported by the big miners. It also has the added advantage of the mine being immediately adjacent to the ship loader.

It's the grade and a forecast of an attractive break-even cost of $US46 a tonne which encouraged Mt Gibson to announce last month that it would spend $97 million on dewatering the Koolan Island pit to mine an estimated 12.8 million tonnes of high-grade ore over an initial 3.5 years of mining.

In the weeks before the re-development decision was announced the price of 62 per cent iron ore had moved above $US90 a tonne. By the time of the decision to proceed on April 27 the price has retreated to around $US68/t and fell further yesterday to about $US62 – though Mt Gibson is covered because it is assuming a future iron ore price of $US55/t for 62 per cent material.

Because of its quality and transport advantage the small Koolan Island mine will be profitable even if the price falls closer to $US40/t – but it is an exception because a price that low is borderline for most small iron ore mines, but relatively comfortable for the bigger producers which operate at a cash cost of around $US13/t, and an all-in sustaining cost of around $28/t.

Steel demand weakens

What particularly concerns small iron ore mines is the outlook for the commodity which is inextricably linked to global demand for steel, especially in China, and that is for a long period of low growth which the World Steel Association estimates will be around 1.3 per cent a year.

That growth forecast for steel is one of the key factors in most investment banks tipping a continued slide in the iron ore price. The other important factor is that iron ore production is increasing faster than demand.

Morgan Stanley, an investment bank, in its latest price forecasts, is tipping an iron ore price of $US55/t by the end of next year. Macquarie Bank reckons the price will dip to $US47/t, recovering to $US50/t in 2019.

A significant problem for the small miners is that those price predictions are for high grade (62 per cent) iron ore ore, which few of the small companies produce, and it is also before discounts for impurities in the ore (such as phosphorous and alumina), which can make a deep cut into the price actually received.

What next for small iron ore is a tricky question but it is one that a former chief executive of Western Mining Corporation (WMC), Hugh Morgan, answered several years ago when he told me that the iron ore business, because of its capital intensity, moved in long cycles of 15-to-20 years.

Morgan's former company was an iron ore pioneer in WA, operating a series of small mines before quitting the business after BHP Billiton and Rio Tinto opened their giant projects in the Pilbara region of WA.

WMC's iron ore history is a sobering reminder that in a bulk commodity size really does matter, and it's a smart company which diversifies – before it is forced out.