While other commodities have taken a hit thanks to COVID-19, iron ore has been remarkably resilient thanks to several factors that led to declining supply prior to the pandemic.

And with demand again starting to ramp up and supply substantially diminished, those mines already on the road to production have a clear advantage.

Iron ore is now largely the domain of four of the world’s biggest miners — BHP (ASX:BHP), Rio Tinto(ASX:RIO), Vale and Fortescue Metals (ASX:FMG) — thanks to iron ore prices hitting rock bottom in late 2015 which resulted in a mass exodus of companies from the sector.

And while iron ore prices are now more than double what they were at the bottom, supply has continued to be cut from the market following events like the most recent tailings dam failure in Brazil, cyclones in Western Australia and mines reaching the end of their lives.

But that is just the icing on the cake for iron ore prices.

In actual fact, the majors have been seeing their production capacity decline for some time. Vale has even lost its spot as the world’s largest iron ore miner, being overtaken by Rio – which also isn’t even producing at full capacity.

“A lot of people have said the recent iron ore spike was to do with Vale’s tailings dam problems and the Brumadinho tailings dam collapse,” Mark Eames, director of Magnetite Mines (ASX:MGT), said.

“That’s certainly the trigger or the catalyst, but the underlying problem that I think a lot of observers have missed is fundamentally there’s very little additional capacity being built, and Chinese steel demand has grown dramatically.”


In-elasticity of available supply response

BHP, Rio, Vale and Fortescue sunk about $65bn between them into projects in the decade to 2015 in response to the China boom to substantially grow production. But once the price collapsed, they went into cash preservation mode, famously described by Rio’s CEO as ‘value over volume’, massively reining in costs and slashing investment.

“So, for example, Rio Tinto in 2009 was talking about increasing its overall global iron ore capacity to 600 million tonnes,” Eames said. “It built capacity of 360 million tonnes and it’s currently operating at 327 million tonnes. So it’s actually over 10 per cent below capacity and there’s been no significant change in Rio’s output since 2015.”

BHP’s production, meanwhile, has been running essentially flat since 2017 at around 270-280 million tonnes. Vale was aiming to get to 400 million tonnes, but despite its massive investment in the new S11D mine is only producing about 310 million tonnes annually.

Fortescue also had big ambitions during the boom, at one point saying it wanted to reach 355 million tonnes by June 2017. However, its guidance for this year is only 170-175 million tonnes.

“Effectively what’s happened is the production has all stalled,” Eames said. “There’s been limited new production, no additional mines of any scale and therefore, essentially as you’d expect, the majors just don’t have the ability to pump out much more tonnes despite high prices.”

This is expected to impact supply over the longer term. Market intelligence firm Fitch Solutions predicts production growth will slow to 0.7 per cent each year from 2020 to 2029, down significantly from the 8.7 per cent annual growth witnessed each year in the prior decade.

That is despite BHP, Rio and Fortescue all bringing new mines into production next year, because these additions are just replacing mines that have come to the end of their lives.

Paul Bartholomew, head of metals news and insight, Asia-Pacific for S&P Global Platts, believes iron ore supply will remain fairly tight in the years ahead as supply outside of the major players is unlikely to come on.

He told Stockhead there were also still question marks around Brazilian heavyweight Vale’s export volumes, and there could be further tightening if tonnes from mine replacement projects in the Pilbara didn’t keep up with the tonnes they were replacing.

At the same time, China is starting to fire on all cylinders again.

“We think Chinese crude steel production could still recover from any coronavirus impact and grow by 1-2 per cent to reach 1 billion mt [metric tonnes] this year, so see iron ore as being well-supported in the medium-term,” Bartholomew noted.


Supply choke points

The bottlenecks in the iron ore supply chain were once a logistics issue, but that has shifted to an actual mine issue, with production not growing and reserves running out.

“For example, most of the $10bn Rio spent up until 2015 was spent debottlenecking its rail and port capacity,” Eames said. “And that’s fine, it did a great job, but actually it’s not been able to use all of the capacity in part because of mine operational challenges and it won’t get to 360Mt system capacity until it builds a new mine at Koodaideri in about two years time.

“It’s actually about having the reserves and being able to mine at high rates. That’s where the challenges are now starting to emerge.”

Rio has just over 2 billion tonnes in reserves at existing operations, which at an annual production rate of 327 million tonnes is just six years worth. Fortescue, meanwhile, has total reserves at a slightly bigger number at 2.3 billion tonnes of hematite, but again that is still only around 12-13 years of reserves at its current production rate.

“We’re starting to see some supply depletion pressures in Australia and in the southern system in Brazil,” Eames said.

“The problem here is not only have miners been slow to invest with a ‘value over volume’ strategy and their capacity hasn’t gone up, but there’s a bigger problem here in mining, if you don’t invest eventually your mines are going to run out and that’s exactly what is confronting some of the big players now.”


Very few mines to fill the gaps

And you can count the number of explorers working to bring iron ore mines into production on one hand.

The problem at the junior end of the market, and even with players like Fortescue, is that there are very few companies with mines that can produce a high-grade product.

Iron ore may be fetching just over $US80 per tonne at the moment, but that’s only for the stuff that grades 62 per cent. The lower grade stuff is usually sold at a big discount to that price, while anything higher than 62 per cent usually attracts a nice premium.

And with China’s push to clean up its environmental act still very much in play, the Asian powerhouse is increasingly going to be looking to higher grade iron ore to cut its emissions.

This is also expected to see more polluting operations shut down, further denting the country’s iron ore production and global supply.

So the players that can produce 62 per cent or higher grade material have a clear advantage.

As the opportunities to mine direct shipping ore (DSO) — the stuff that you can just dig up and ship — decrease, buyers are now looking to processed ores like magnetite.

Magnetite Mines is developing the “globally significant” 4-billion-tonne Razorback magnetite mine in South Australia.

There is a common misconception among investors that they should steer clear of magnetite plays. But in actual fact magnetite can be very profitable for a company.

Particularly for a company that can produce extremely high grades. It is actually not that hard to upgrade magnetite to a higher-grade material using magnetic separation – basically you just grind the material and place it under a big magnet that captures the magnetite in a concentrate. And these deposits usually have a very long life.

Lab tests undertaken by Magnetite Mines have already demonstrated it can produce grades of nearly 70 per cent, making it one of the highest-grade iron ore projects in the world.

This is a grade not even the majors can produce – BHP and Rio produce 62 per cent or lower, while Vale produces around 65 per cent.

“Grade is becoming more and more of a challenge,” Eames said.

“Whereas most of the average production out of the Pilbara probably 15 years ago was about 62 per cent Fe or 63 per cent Fe, we’re now back down to probably an average out of Australia of about 59 per cent.

“What’s happening is, as that occurs, effectively if you’re a steelmaker you’re faced with a choice — you’ve either got to use expensive coke and coking coal to melt out that extra amount of silica and alumina or you could move to processed ores.

“So we’re starting to see some more development of magnetite and other processed ores coming into the marketplace.

“There’s actually a bit of a market window developing as grades decline in the direct shipping orebodies (DSO). We’re seeing that there’s actually an opportunity for other players to come in.”


The high-grade players right now 

There are very few juniors that can produce high-grade direct shipping ore, but one that can is Mt Gibson Iron (ASX:MGX).

Mt Gibson ships DSO from its Koolan Island operation and lower grade iron ore from its Mid-West operations in Western Australia.

It sold 1 million tonnes of iron ore in the March quarter and banked $82m in revenue. The average grade of Mt Gibson’s Koolan Island ore during the quarter was 65.5 per cent.

Meanwhile, Champion Iron (ASX:CIA) is producing a 66.5 per cent iron ore concentrate from its Bloom Lake operations in Canada. It produced nearly 2 million tonnes in the final quarter of the 2020 financial year.

Fenix Resources (ASX:FEX) is advancing towards production from its iron ore project in the Pilbara, which will mine DSO material.

The company’s goal is to produce a high-grade product approaching 65 per cent iron content from the Iron Ridge project, which hosts a total resource of 9.2 million tonnes at 64.1 per cent iron.

Fenix is in the final stages of the permit approval process and expects to proceed with production and shipments by the end of this year.

Other juniors advancing iron ore projects include Strike Resources (ASX:SRK), which is moving closer to potential early cash flow at its Paulsens East project in the Pilbara, and Legacy Iron Ore (ASX:LCY).

The tightening supply constraints are expected to have a positive impact on prices.

Fitch has revised its 2020 iron ore price forecast to an average of $US85 a tonne from $US80 a tonne previously.

The market intelligence firm says strong demand from China’s steel industry as the government continues to stimulate the domestic construction industry in the face of a slowing economy, and more recently the coronavirus epidemic, will prevent prices from collapsing.


Virtually no sovereign risk

While there is plenty of iron ore in countries like Africa, there is also plenty of sovereign risk and endless red tape.

However, Australia also has an abundance of iron ore and the industry is a major contributor to the economy — meaning a whole lot less red tape for miners to get caught up in.

“While there’s a lot of good iron ore in Africa, whether it’s investment risk or market price or uncertainty or difficulty in operating with the host governments, essentially Africa has really been practically unable to deliver any increase in iron ore,” Eames said.

“In Africa, while it’s always had a lot of promise, it’s remained just that, it’s still just a promise. In my view it’s years away from getting any significant additional production out.”


Marginal cost of production

While the majors have spent years getting their cost of production down to deliver them a decent margin, it’s an expensive task to bring new mines into production.

Eames says it’s always been a game for miners with “deep pockets” because of the remote nature of the deposits and the extensive infrastructure, like haul roads and ports, required.

That’s where lower cost mines can be much more competitive and have a greater chance of making it into production.

Magnetite Mines’ Razorback mine has all the right ingredients to make it a lower cost development project than other mines. The resource is at surface, so stripping ratios are low.

A low stripping ratio means there is less waste ore to move to get to the profitable stuff.

The project has some distinct advantages over other magnetite mines, particularly those in Western Australia which tend to be harder rock. (Softer rocks are much easier to process).

And grid-generated electricity (coal-fired and renewables) is much cheaper on the east coast than the west coast.

Razorback also has the advantage of being located close to rail, port and power infrastructure and has access to enough water to sustain a wet processing operation.

At Stockhead, we tell it like it is. While Magnetite Mines is a Stockhead advertiser, it did not sponsor this article.