http://www.theaureport.com/pub/na/13850

...

TGR: Let's move to iron. On June 28, BHP Billiton was offering 80,000 metric tons (mt) iron ore grading 62% for $137/mt on the globalORE trading platform. The best bid was $129.50/mt, which says something about iron ore demand. Overall iron ore prices were down 8% in the second quarter, mostly on weak demand from Chinese steelmakers. Do you expect that price weakness to continue in the near term?

Michael Scoon: Yes. The summer is a seasonally weaker period for all industrial commodities. Low-volume trading activity in the spot market can result in price volatility on any given day, but year-to-date the price has averaged about $145/mt. And, as you said, prices are down about 8% over the quarter. However, I saw a report this morning that the spread between bid and ask-on-the-spot exchange has narrowed substantially.

TGR: The iron ore market used to be governed by yearlong contracts, but Chinese steelmakers would default on those in order to take advantage of lower near-term prices. Do you think we'll get back to the point where the prices are set for a year or will the spot market continue to dominate as it is now?

MS: The spot market is here to stay for the foreseeable future. It was quite an undertaking to change the term of the contracts. Today, there's a substantial amount of iron ore transacted on either monthly or quarterly pricing. Shorter-term contracts are going to be the way of the future.

TGR: What's Stifel Nicolaus's forecast for iron ore prices through 2013?

MS: I forecast prices softening in the summer months in line with the 8% decline over the 2Q12. I see prices remaining soft in the third quarter, but recovering in the fourth quarter to average around $140/mt in 2012. Prices could fall in 2013 to $131/mt, but settle around $125–130/mt in the long term, based on the marginal cost of production.

Over the course of the next five years, new supply from the three major producers—BHP, Vale, Rio Tinto Plc (RIO:NYSE; RIO:LON; RIO:ASX)—may push the high-cost producers off the cost curve into uneconomic territory. However, the Big Three will be incentivized to keep that marginal cost of production high as they sell more iron ore into shorter-term contracts.

TGR: The Big Three carry a reasonably high dividend—at least relative to the mining space. In 2009 and 2010, and even into 2011, steelmakers were going downstream and buying iron ore companies to control the cost of their raw materials. Does that trend have any momentum left?

MS: That trend does have some momentum left in it. The number of transactions has slowed as steelmakers aren't as active as they were. However, large new sources of iron ore supply are coming from risky jurisdictions, such as West Africa. Steel producers will continue to look for joint ventures or to own projects in safe jurisdictions to help control their supply. Steel producers want to avoid being caught in a supply squeeze. It's to their benefit to secure 30–50% of their iron ore requirement through joint venture partners and offtake agreements in order to derisk their businesses.

TGR: There are a number of players in Québec's north, which is considered a safer jurisdiction. What are their prospects for being taken over or developing into producing assets?

MS: There are a number of development-stage companies in the Labrador Trough, the most advanced of which is Alderon Iron Ore Corp. (ADV:TSX; AXX:NYSE.A). It has a partnership with Chinese steel producer Hebei Iron and Steel Co Ltd. (000709:SHE) to develop its Kami iron ore project near Cliffs Natural Resources Inc.'s (CLF:NYSE) operations. Its preliminary economic assessment suggests 8 million tons per year (Mtpa). Hebei is committed to offtake 60% of that. The prospects for development for Alderon are quite good as it's the most advanced of its peers and it has a joint venture partner established.

TGR: How favorable to Alderon were the terms of that joint venture agreement?

MS: Alderon did commit a lot of its future sales to secure the partnership. However, Kami is a project that can be expanded. If it can prove that it can expand to 16 Mtpa, then it may have the ability to attract another steel producer or further investment from Hebei.

TGR: Does it have enough at 60% that a takeover wouldn't be prudent?

MS: Hebei does have a toehold in the project. However, if Kami can be expanded to 16 Mtpa, then the offtake falls to only 30% of production, which wouldn't be a hindrance to a takeover by a third party.

TGR: Indeed. What are some of the other players in that area?

"There's been a tremendous selloff in the equities, so much so that most of the commodity stocks are very cheap relative to metal prices."

MS: I prefer projects in the southern trough for their easier access to infrastructure. Champion Minerals Inc. (CHM:TSX) has a project located near ArcelorMittal's (MT:NYSE) operations. It has a very similar development timeline to Alderon, with the potential to produce 8 Mtpa growing to 16 Mtpa as it develops proximal land next to its key Fire Lake North asset.

And there are others. Labrador Iron Mines Holdings Ltd. (LIM:TSX) and New Millennium Iron Corp. (NML:TSX.V) are located further to the north. Labrador Iron Mines is in production. New Millennium is in construction. Even further to the north is Oceanic Iron Ore Corp. (FEO:TSX.V; FEOVF:OTCQX), which has a very large project, but is more infrastructure-challenged. Oceanic proposes to export from a port that it will construct itself from the northern shore.

TGR: Could Oceanic Iron Ore have a joint venture partner build a port facility given the substantial cost?

MS: There is an opportunity for Oceanic to bring a strategic partner to help absorb some of the upfront capital costs. However, it does come with a degree of uncertainty. There is a fixed pool of potential partners out there. If I were one of those steel producers, I would first consider projects with more familiar technical challenges.

TGR: Do you think Oceanic has an advantage in terms of grade and size of project that could be particularly alluring to a suitor?

MS: Most definitely. It does have a very large resource that has the potential to produce a lot of iron ore. However, it is located in the north. On paper, that large-scale production may seem more feasible than it will prove to be, given the rather harsh working conditions and challenging shipping....