Iron ore miners cannot sustain cost cuts, say fund managers

Iron ore’s collapse through $US50 a tonne overnight has thrust an uncomfortable spotlight back on the cost cutting race most of the sector is running to survive, but fund managers are questioning whether the rapid cuts are sustainable.

Tim Schroeders, resources fund manager at Melbourne-based Pengana Capital, said the market needed to be cynical about how much of the cost cutting would stick.

“The sustainability of the current cost environment has to be called into question,” he said.

Many miners were fighting two battles as they tried to hammer down costs – depleting mine life on the one hand and their cash on the other.

“Shortcuts are taken. When you are trying to artificially lower your costs for a short period, in two years’ time some of your reserves won’t be able to be mined because you’ve changed your mine plan.”

“Some of the efficiencies stay around, but you have to be a bit cyncial about how much is going to stick five years out.”

The sector had enjoyed a few months of slight relief, where iron ore clung to the $US60 mark, but the pressure is again mounting on Australia’s juniors. Iron ore has staged a steep decline since Thursday last week to crash below $US50 a tonne overnight Tuesday. It has fallen about 22 per cent from its recent peak in June.

Katana Asset Management portfolio manager Romano Sala Tenna also questioned whether some of the cost reductions in the sector could be sustained.

“There are a few key cost reduction measures used that aren’t sustainable – high grading deposits by cherry-picking areas with low strip ratios and low impurities has impacts on production down the track. And the other worry is low capital expenditure, there’s not a lot of money going into these operations.”

He said the next year would bring more iron ore mine closures.

The threshold for higher cost players to fall out of the market, or close operations is getting pushed lower, Mr Schroeders said.

“Six or eight weeks ago, the likes of an Atlas looked like falling off the cost curve but new life has been breathed into them.

“BHP, Rio and Vale really are not going to stop at current prices, so you are going to have to push the price a lot lower for more pain to be felt, and for closures to be forced. The threshold (for closures) is heading lower.”

Atlas Iron founder David Flanagan told Fairfax Media on Tuesday that he was confident the miner could pull off a $180 million capital raising in the next week, despite the iron ore price racing back down towards $US50 a tonne. Atlas has so far raised $15 million from existing investors, and its contractors have committed $43 million.

UBS analyst Glyn Lawcock told Fairfax Media last week that even as Fortescue races to hammer down production costs, the leaner miner faces the prospect of becoming the marginal producer of the large iron ore players, once Brazil’s Vale brings its new mega expansion project online.

UBS is tipping Gina Rinehart’s Roy Hill project will come onto the market later this year with a lower break-even than Fortescue’s, which will likely start creeping up in one to two years as sustaining capital costs and strip ratios increase.

Reducing waste stripping is a measure being used by players to hit cost targets, but analysts are concerned that it will see the miners’ strip ratios rise over the longer-term, affecting costs and product quality.

Mr Lawcock puts Fortescue’s breakeven at $US44 a tonne, while Fortescue says their breakeven is $US39 a tonne.

Atlas said this week that its breakeven was $US52.50 to $US53.50, but that would fall to about $US50 by December. While that puts Atlas’ production underwater at current spot prices, Mr Flanagan said the company was making money on the ore it shipped because it had locked in prices for its cargos to China as far ahead as December at around $US57 to $US58 a tonne.

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