Termination of supply agreement
Cliffs Natural Resources (CLF) reported on October 6, 2015, that it has terminated a pellet sale and purchase agreement with Essar Steel Algoma. The company stated that this decision was made due to Essar Algoma’s multiple and material breaches under the agreement. Cliffs is the only supplier of pellets to Essar Algoma with annual shipments of ~3 million tons.
Cliffs added that while the agreement has been terminated, it remains open to discussion to supply Essar Algoma with pellets on commercially reasonable terms consistent with a just-in-time iron ore supply agreement.
In response, Essar Algoma announced on October 15 that it has secured an alternate, interim iron ore supply.
Who can supply to Essar Algoma?
Cliffs has logistical advantages shipping pellets to Essar Algoma in the Great Lakes area of the United States (SPY). While United States Steel (X) is another pellet producer that has excess capacity at its Minnesota operations and could potentially ship to Essar Algoma, it’s also Essar Algoma’s competitor. So that might reduce the probability of Essar securing supply from United States Steel.
Nucor (NUE), Steel Dynamics (STLD), and ArcelorMittal (MT) are other steel competitors of Essar Algoma in the United States. If Essar Algoma is securing supply from any supplier outside the Great Lakes area, that would add substantially to freight costs, which should not be sustainable for very long.
Going forward, either Essar Algoma could secure iron ore from Cliffs on a short-term basis and pay more, or it could negotiate for a long-term contract to get the discount. Securing a long-term iron ore supply contract from any other supplier doesn’t seem sustainable given the high freight costs if the supplier is outside the Great Lakes area and the fact that United States Steel is a competitor. So the chance of securing iron ore for the long term seems sort of improbable.
Investors should watch for more on this in the earnings call from Cliffs management.