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Essar Steel Minnesota’s Plant Impact on Cliffs Natural Resources

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Essar Steel’s project

A $1.9 billion mining and processing facility, Essar Steel Minnesota is constructing an iron ore pellet plant with the capacity of 7 million tons per year. Essar expects its plant to start operations sometime in late 2016.

This will be the first new facility in the last 40 years on Minnesota’s Mesabi iron ore range. The project has been fraught with problems since its inception in 2007, and Essar has received $70 million in state grants and loans since then. The above chart depicts the iron ore pellet capacity in the US for 2014.

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When will it be completed?

Although Essar has maintained that the plant has reached the 85% completion level and should start producing pellets in the second half of 2016, Cliffs Natural Resources (CLF) has a different point of view. In the company’s 3Q15 earnings conference call, Lourenco Goncalves, Cliffs’ CEO and president, noted that Essar’s plant was “on record saying that they will be producing pellets mid-2016 or second half of 2016. I would give them December 31, 2016. December 31, 2016, they will probably not have their pellet plant with a roof yet.”

Goncalves added, “It is Cliffs’ position that Essar Minnesota should be required to immediately repay its construction subsidy due to Essar unilaterally changing the scope of its project.” Some press reports suggest that Essar still owes its contractors money for work done in 2015.

Bad timing?

This project comes at a time when steelmakers in the US such as US Steel (X), AK Steel (AKS), and Steel Dynamics (STLD) are retrenching workers and idling facilities in the US (DIA). These actions are occurring in the face of weaker demand and increasing steel imports into the region.

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Economic viability?

Essar plans to serve the Great Lakes Area with this production. The take-off contracts in the US are long-term, and this project could only be beneficial if it is able to lock in a long-term contract with ArcelorMittal (MT). ArcelorMittals’s iron ore pellet contract with Cliffs comes up for negotiation in late 2016 and early 2017. If Essar’s project is completed by that time and it is able to compete with Cliffs for Arcelor’s contract, only then will it make economic sense.

A delay in this project’s ramp-up would be positive for Cliffs. The progress on contract negotiations should be one of the single most important catalysts for Cliffs’ share price over the next year.

In Cliffs’ 3Q15 earnings call regarding the renewal of these contracts, Goncalves noted, “We have partnerships with our clients, by and large, with 100% of the ongoing clients for sure. And things are in great shape with ArcelorMittal.”

Essar Steel’s progress on its taconite facility and the general steel market sentiment could impact the outcomes of the contract negotiations. While it is in the low iron ore price scenario, ArcelorMittal is expected to have higher bargaining power. In the event of a late start to Essar’s pellet facility, ArcelorMittal may not have many options but to buy from Cliffs. However, the negotiated prices could be lower.

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