Iron ore price plummet brings trouble to Labrador Trough

Peter Koven | Oct 1, 2012 8:07 AM ET | Last Updated: Oct 2, 2012 11:29 AM ET
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Short of the oil sands, there is no Canadian resource getting more foreign attention than the Labrador Trough.

The red-tinged ground that permeates the Quebec-Labrador border region hints at the massive iron ore riches that lie below, and the construction activity around Schefferville (along with much larger booms in nearby Wabush and Labrador City) points to the huge investments to come.

A small army of mining companies are moving ahead with iron-ore projects that could pour tens of billions of dollars into the region. Since most of these firms are juniors and could never finance these projects on their own, they have secured Asia’s largest steelmakers as backers. Iron-ore giants Rio Tinto Ltd., Cliffs Natural Resources Inc. and ArcelorMittal are also in the midst of production expansions.

The Trough only churns out about 40 million tonnes of iron ore a year right now — a pittance in a global market bigger than one billion tonnes. Both the Asian steelmakers and Canadian investors are counting on those numbers to rise substantially in the years to come.

Which is why they were so stunned at what just happened.

With virtually no warning, the iron ore price fell off a cliff in August, plummeting about 30%. It was below US$85 a tonne by early September, compared with almost US$200 a tonne in 2010.

It was due to events in China, where iron ore demand vanished overnight as steelmakers went on a buyer’s strike and liquidated their inventories. This was the first major blow to the iron-ore market since the 2008 financial crisis, and it provided a hint of what a prolonged Chinese slowdown could mean for this sector.

The drop rattled investors in the Labrador Trough. At what point, they wondered, would this price volatility become a threat to the billions of dollars of planned investments in the region?

They didn’t have to wait long to get one answer. Labrador Iron Mines Holdings Ltd., a junior that is already in production, halted all capital spending in early September and stopped operating one of its processing plants.

“It was something that we had to do, and we did it quickly and decisively,” chief executive John Kearney says. “The month of August was surreal.”

Mr. Kearney was relieved to see the price rebound in the last couple of weeks: it is back to almost US$100, which is viewed as an unofficial floor price that makes Trough projects viable. His company will turn on the spending taps again if the bounce continues.

But Labrador Iron Mines is a small producer. For the companies planning much bigger operations, the current price is well below what they anticipated. There is already speculation about deferrals if the market does not pick up.

“If you see a prolonged period of prices in this range or lower, you will see deferrals. There’s no question,” says Allen Palmiere, CEO of Adriana Resources Inc.

All the same, he and most other executives of Labrador Trough companies express little concern about the price turmoil. One reason is that they are still far from making construction decisions. And the other is because so many of them have Asian backers.

By securing those partners, the miners have no need to access the capital markets anytime soon — for the most part, they don’t have to worry about raising money until they are into construction. Given the state of their stock prices, raising capital would be incredibly possible.

“I don’t like where my stock price is, but I don’t really care in the short term because it doesn’t mean anything to me,” says Mark Morabito, chairman of Alderon Iron Ore Corp., which controls the US$1-billion Kami project near Labrador City. “I don’t have to sell my paper to generate money. For companies that do, they’re in big trouble.”

Alderon’s Asian partnership is typical for the Trough. The company sold 60% of its future production, along with 25% of its project, to Hebei Iron & Steel Group, China’s largest producer. In return, Hebei is investing $194-million in Alderon and the Kami project.

The other benefit of partnering with Asian steelmakers is that the Canadians get unique market insights. They all say that the Chinese firms believe the market volatility is temporary, and that pricing should return to US$120 or US$130 a tonne in the coming months as China begins an aggressive economic-stimulus program. When China implemented a stimulus in 2009, it drove the iron-ore price from roughly US$60 to US$180 in a matter of months.

“For the most part, everybody believes the marginal cost of producing iron ore in China is quite a bit higher than the current spot price. And if that’s the case, then the long-term equilibrium has to be higher than it is today,” Mr. Palmiere says.

Obviously, a worse-than-­expected Chinese slowdown could change that dynamic quickly. But for now, the miners are standing behind the commodity that got them this far.

Another big believer is Canadian National Railway Co., which is doing a feasibility study on a US$5-billion rail line and port facility to transport iron ore out of the Labrador Trough (supported by several miners and the Caisse de dépôt et placement du Québec). The project is expected to be ready by 2016 or 2017, though CN wants to see a number of iron mines move forward before it starts construction.

“It’s not easy [in iron ore] at the moment. But these are long-term projects. You can’t look at today’s prices and make those decisions. It’s a two-year permitting process [for the railway], then it’s at least a two-year construction process,” CEO Claude Mongeau says.

Like everyone along the Quebec-Labrador border, his only course of action is to keep an eye on China and see what happens.

With files from Scott Deveau