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Can Lack of External Competition Relieve Cliffs’ Earnings Pressure?

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Cliffs’ US focus

Cliffs Natural Resources (CLF) is the largest and lowest-cost supplier of iron ore pellets in the US. Cliffs accounted for ~44% of annual rated capacity in the US in 2014. Most of the rest of the iron ore pellet capacity is owned by backward integrated steel players such as US Steel (X) and AK Steel (AKS). CLF is moving toward becoming a pure-play US producer.

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Competition from external players

For the iron ore producers based in Brazil and Australia, it is very difficult to compete with local iron ore players due to logistical issues. Cliffs had a cash production cost of $50 per ton in 3Q15 for iron ore pellets. Any producer from outside the US must be unloaded at the mouth of St. Lawrence River, where it must travel through multiple locks before reaching a port. After reaching port, it must be transported internally.

This could easily add $30–$40 per ton to the cost of delivered pellets in the US. According to Cliffs’s estimates, any potential competition from outside has a break-even cost of $95–$100 per ton. Moreover, the Great Lakes market is effectively closed for three months in the winter, as the lakes are frozen. This makes any external competition very difficult.

New local supply

While the competition from outside the US remains muted, Cliffs Natural Resources (CLF) has many domestic issues to address. The Essar Steel Minnesota plant could heat up competition in the local market. However, in order to be considered a real threat—or at least a credible competitor—any new entrant must become a reliable producer and supplier of pellets at Cliffs’ high-quality level by 2016. This is due to a major contract renewal with one of Cliffs’ customers, ArcelorMittal (MT), in 2016.

A strengthening US dollar (UUP) and falling oil prices (USO) could also add to Cliffs Natural Resources’ woes.

In the next part of this series, we’ll see how Essar Steel Minnesota’s steel plant is progressing, which can help us gauge the impact on Cliffs’ volumes and margins going forward.

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