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Could DRI Be the Next Growth Opportunity for Cliffs?

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Jun. 20 2016, Updated 5:37 p.m. ET

Electric arc furnaces versus blast furnaces

Currently, mini-mills, which use electric arc furnace (or EAF) technology, produce ~60% of US steel. Mini-mills, which use scrap metal to make steel, have performed better than blast furnace operators on average. Blast furnaces (or BF) have higher fixed costs and less flexibility to respond to market changes in the short term to medium term.

Nucor (NUE) and Steel Dynamics (STLD) produce steel through EAFs. These companies also primarily use steel scrap to produce steel. Conversely, U.S. Steel (X) and ArcelorMittal (MT) mainly use iron ore for steel production. Currently, Nucor makes up 2.6% of the Materials Select Sector SPDR ETF (XLB).

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Shift from BF to EAF

In a not-so-high steel price scenario, companies that use EAFs do better than their BF peers. U.S. Steel is shifting to EAFs at its Fairfield Works to replace BFs, which will be taken offline when the EAF is complete.

As other steel producers’ blast furnaces reach the end of their useful lives, they also might be inclined to shift to EAF. This might mean the decreased use of iron ore pellets, which are used in blast furnaces.

Implication for Cliffs

Cliffs Natural Resources (CLF) has communicated its intention to venture into direct reduced iron (or DRI) long back. The company has already completed production of the first industrial-sized trial round of 60,000 tons of direct reduced grade pellets on Minnesota’s North Shore. After receiving environmental permits to produce DR-grade pellets, Cliffs is actively pursuing commercial opportunities with companies who have or who are planning US DRI operations. Cliffs’s CEO told AMM that while it would prefer to partner with another company on DRI, it could find a way to build such a plant alone. He said, “If I don’t get the equity partner soon, in the short time frame that I want, I will find ways to do it on my own.”

The company’s venturing into DRI could provide a significant growth dimension to Cliffs’s investment case. Any announcement by the company in this regard could prove to be a significant positive catalyst for the stock both in the short term and the long term.

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