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Must-know: An overview of the iron ore industry

Part 10
Must-know: An overview of the iron ore industry (Part 10 of 13)

Must-know: The basics of the cost curve for miners

What is the cost curve?

The cost curve is basically the curve that shows cost per ton of production on the Y-axis and cumulative quantity of production on the X-axis. The width of the bar indicates the quantity of production by a mine or company. The height of the bar shows the cost of production per ton. Companies are arranged in the order of lowest cost producer to the left and highest cost producer to the far right side. So, the farther on X-axis and higher on Y-axis a mine or company is, the costlier it is to produce iron ore for that mine or company.

Cost curveEnlarge Graph

Why is cost curve so important for miners?

For any mining company, its position on the cost curve is very important, because it’s what determines how effectively it will be able to weather the ups and downs of the commodity cycle. The cost curve also sets the floor for the price because if price falls below the cost of production of some players, those players will be out of the market. The previous chart shows that players producing at cost above the spot price, the red line for this chart, won’t be able to sustain for long if these circumstances prevail. The quality of the ore and the scale of the business are two major determinants for the cost or ton for a player. Rio Tinto (RIO) has 40% of its production falling into lower grade, BHP Billiton (BHP) has 35%, for Cliffs Natural Resources’ (CLF) bulk of the production is less than 60% content, and Vale (VALE) has most of its production above 60% content grade. This impacts companies’ cost of production and ultimately determines their position on the cost curve. The previously mentioned companies form 18% of the iShares S&P Global Materials Sector Index Fund (MXI) .

Expected cost curve

The cost curve is expected to flatten going forward because the majority of the new supply is from low-cost producers of Australia (BHP, RIO, and FMG) and Brazil (VALE). As this supply  crowds out the high cost Chinese domestic production, albeit factors as outlined in section on supply, the cost curve will get flattened at the right end. Also, as available mines get more and more exploited, the quality of grade keeps on getting worse and the cost or ton incurred to mine and process the ore increases. As a result, the cost or ton would go up for companies at the left hand side of the curve and flattening would occur from both of the ends.

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