Iron ore continues to be in the news in a major way.

There are arguments and counter-arguments with respect to the near to medium-term price outlook, with varying degrees of optimism and scepticism.

If you read some of the reports about in the financial press you could be forgiven for thinking that the iron ore industry must be in the midst of a catastrophic crisis, with prices plumbing all-time lows as demand plummets and supply surges.  

The reality, once one looks past the dramatic headlines accompanying recent developments, is vastly different.

The chart below puts everything into perspective. Whilst the iron ore price has retreated from its pre-GFC peak, it is still trading at a price that’s almost seven times higher than the $20 per tonne price that it averaged for more than two decades between 1980 and 2004.

 

This provides an enormous margin for iron ore players, particularly when compared to the margins that the industry had become accustomed to during the course of the preceding decades.

BHP, Rio and Fortescue

From a local perspective, Rio Tinto (ASX: RIO), BHP Billiton (ASX: BHP) and Fortescue Metals Group (ASX: FMG) – the world’s second, third and fourth biggest iron ore miners behind Brazil’s Vale – plan to add a combined 235 million tonnes of new mine capacity by 2015, nearly equal to Rio’s total output in 2012.

In terms of the outlook for demand, Rio Tinto forecasts steel demand will grow by about 3 per cent  a year for the next decade, which is well down on 10 per cent  growth rates during 2009 – 2011, but in my view reflective of a more realistic and sustainable demand scenario.

Rio Tinto, which derives more than two-thirds of its revenue from iron ore, is counting on its premium ore and low operating costs to provide hefty profit margins despite any cyclical downturn in the iron ore market. Rio’s economies-of-scale allow it to mine iron ore at a lower production cost than anyone else in the iron ore business, as the chart below demonstrates.

What’s also significant is how much iron ore production would be wiped out at an iron ore price of $80/t or lower – much of it Chinese.

 

The iron ore business has typically been dominated for decades by three major players – Rio, BHP and Vale – which together have accounted at one stage for as much as 80 per cent of the world’s seaborne iron ore trade.

And there’s a simple reason for this – iron ore is a bulk commodity, which means it’s typically a low-margin business, where the stuff has to be dug and moved in enormous volumes in order to generate a reasonable profit.

Being a bulk commodity, infrastructure costs are huge, with returns generated over a lengthy period of time.

The fundamental characteristics of the iron ore business – high capex/ low-margins/large volumes/massive funding requirements/medium to long-term pay-back – are not features that typically attract smaller players into the industry.

As a result, iron ore is predominantly the domain of mining heavyweights that can utilise their sizeable balance sheets to minimize exposure to potentially crippling debt levels.

Chinese Production a Major Factor

Falling grades and volatile prices are making life difficult for China’s iron ore miners and threatening to push them out of business.

It is estimated that as much as 40 per cent of China’s more-than-a-thousand iron ore producers shuttered production during the course of 2012 when iron ore prices slumped.

China’s mostly small-scale miners produce around a third of the raw material for the country’s steel industry.

The chart below highlights exactly how big an iron ore producer China is, which is probably a surprise to many.

 

China is typically a swing producer and its mines rely on strong iron ore pricing above $120 in order to remain viable.

However, despite the critical role their output plays in determining China’s need for imports, the fragmented nature of the industry makes it difficult to estimate how deeply the miners were hit when iron ore prices fell to three-year lows below $87 a ton during September 2012.

Any future price weakness will once again place significant pressure on China’s iron ore producers.

Pricing Outlook

Iron ore will always tend to be a relatively low-margin business. The ultra-high pricing environment of the past decade, which encouraged smaller hopefuls into the sector, is in no way typical.

Prices will eventually level-off and begin to recede as supply catches up with demand. However as we highlighted earlier, iron ore prices are around seven times higher than their average over the preceding two decades – and are unlikely to retreat back to these former levels.

The key from my perspective is how much supply effectively becomes uneconomic if the iron ore price falls below $80/t.

Indeed, let’s cast our minds back to the latter stages of 2011 and 2012, when iron ore prices fell below $100/t to see the panic that was generated in iron ore markets.

The one thing we can be sure of is volatility, with the bulk of iron ore sales based on the volatile spot market, rather than the certainty of an annual fixed price as had been the case for decades.

The iron price hit a 16-month high of $158.90/t on February 20 this year, but has since dipped to be currently trading around $110/t.

The production cost for the smaller Chinese miners is around $100 – $120/t, about three times more than the major producers in Australia and Brazil.

With respect to BHP and RIO’s Pilbara production expansions, the new capacity is aimed at meeting demand surges and minimizing the strong price spikes that can be disruptive to the industry.

In many instances the larger producers have touted major capacity expansions that have eventually translated into production on timeframes markedly longer than initial estimates.

 

A BHP presentation on 29 May forecasts China’s steel production to peak in about 2025 at about 1.1 billion tonnes per annum. Steel production growth is forecast to moderate as steel intensity per unit of GDP declines.

The market consensus view is firmly of the opinion that iron ore is easing in price and may have further to fall, as Chinese steel mills run down inventory before restocking.

Both Morgan Stanley and Macquarie believe this to be the case and have published similar reports over the past fortnight. They believe iron ore prices will weaken further over the coming months (from current seven-month lows around $110/t), before rebounding during H2 2013.

This is no great surprise, as it is merely a reflection of typical annual Chinese buying habits.

As the annual summer holiday season approaches, China’s steel mills typically run down inventories as production levels decline. They then look to take advantage of the low iron ore price environment to replenish inventories.

The move over the past few years away from annual contract pricing and towards spot pricing has resulted in a correspondingly higher level of price volatility, which accentuates underlying price movements.

Pressure on Fortescue

The problem for Fortescue is that circumstances are to a large degree beyond its control. Its future is solely dependent on the maintenance of strong iron ore prices. It’s a one-commodity company, without the earnings diversification of BHP and RIO.

Exacerbating the problem is the fact that FMG has taken on massive debt levels to compete with BHP and Rio Tinto in terms of size and scale. Unfortunately, they operate better assets, produce product at a much lower cost and are in a much sounder financial position.

Fortescue was initially fostered and supported by the Chinese in a similar fashion to the way the Japanese during the 1970s fostered and financed many Australian coking coal producers in order to try and break the market dominance of the key coal industry players, with the aim of sourcing cheaper product.

Whilst Chinese and Indian steel producers have been vocal supporters of independent iron ore players like Fortescue, which have the potential to break the market dominance of the sector leaders, they won’t pay a higher price to purchase iron ore.

Steel producers are going through enormously tough times and will accordingly purchase the lowest-cost product available.

BHP and RIO’s lower-cost operations and hence capacity to operate in a lower-price environment puts tremendous pressure on FMG position over the medium to longer-term.

Summary

I believe prices will average around $125 per ton during 2013, with prices easing further during the course of H2 2013, before recovering on restocking during late 2013. For 2014 I anticipate prices will average around $115 per ton, which will still provide robust margins for the major iron ore producers; albeit not as lucrative as pre-GFC levels.

Gavin Wendt is the founder of MineLife, publisher of the MineLife Weekly Resource Report

ONE OFF THE WOOD: Predictive Discovery (ASX: PDI) managing director Paul Roberts dropped by to tell us how the company is progressing at its gold prospects in eastern Burkina Faso.

 

You recently announced drilling and metallurgical results from your Bongou prospect, what light do they shed on the Predictive Discovery story?

The Predictive Discovery story is about taking a strong technical approach to exploring one very large, 95 to 100 per cent-owned ground position in two adjacent highly prospective greenstone belts which contain abundant artisanal gold workings.

We hold some 1600 square kilometres in Burkina Faso, which has recently emerged as an established gold mining hub.

Our exploration has achieved encouraging drill results from multiple prospects. We are now accumulating those prospects with the intention of turning them into a large mining operation feeding a central mill.

What can you tell us about the recent results?

By most standards it was a small program of drilling but it delivered big in terms of results including 48 metres at 4.3g/t gold, including 16m at 9.7g/t gold and 23m at 6.9g/t gold, including 16m at 8.9g/t gold.

These are close to true width intercepts, and importantly, correlate to previous intercepts of 20m at 4.8g/t gold and 10m at 7.4g/t gold.

These seem to appear in a panel of high-grade mineralisation open at depth and potentially plunging to the east.

Geochemical results indicate we may find more Bongou-style mineralisation nearby, expanding potential for discovering substantial, good grade gold mineralisation in a small area.

Is Bongou your main focus?

It’s where we’ve achieved the best combination of continuity, grade and width.

Saying that, we have many prospects we believe have potential to deliver economic resources.

It’s really a matter of knitting them together to create a significant mining operation.

What about your other prospects?

We’ve achieved good results at the Dave prospect, a big system with gold mineralisation over about 5km of strike that remains open, eight kilometres from Bongou – but they’ve been in the moderate-grade category.

 

We have Dave-style mineralisation from other areas of bedrock geochemical anomalies in the 20km long Laterite Hill Grid in prospects such as Laterite Hill itself and Prospect 71.

We’ve also drilled the Solna and Tambiri prospects up at Bangaba some 60km to the north and acquired the Bira ground, a similar distance to the north east that shows consistent 20m widths over at least 500m of strike with good mineralisation continuity and grades of 1 to 2g/t gold.

What results have you been able to achieve at Bongou?

We recommenced our activities this field season determined to focus on grade.

We focused our first round of drilling on prospects most likely to deliver the most favourable combination of continuity, grade, and width.

We obtained good results from several prospects, but realised Bongou fitted those criteria the best, so we focused most of our work there.

Our March drilling produced the best drill results we’ve seen so far, displaying a consistent pattern of high-grade gold mineralisation on the contact between granite and gabbro at Bongou, which is open to depth.

The known Bongou gold mineralisation is limited to around 150m of strike, leading us to step our exploration outwards to try and find more Bongou-style anomalies in the surrounding areas.

Geochemical drilling suggests we’re getting those anomalies 500m or more from Bongou, but we’ve still a long way to go to test the whole area.

What has the Bongou drilling told you?

We have a zone of high-grade mineralisation, which is averaging about 10m in true thickness, which, at a 3g/t cut-off, contains an average grade so far of around 10g/t.

We have, what you could describe as, a nice slab of high-grade mineralisation anyone would be able to mine profitably; as long as follow-up drilling proves it continues with consistency to depth.

We then have lower-grades of gold along the high-grade’s southern margin, so the true width of the gold mineralised part of the system averages, maybe, 25m but ranges up to nearly 50m, which should offer good stripping ratios for open pit mining.

Geological mapping along the fault zone at Bongou identified outcrops of granite, what is the significance of this?

The Bongou mineralisation is new for this area as it’s hosted in a granite body surrounded by mafic rocks.

There is a series of small granite outcrops surrounded by a wide plain of soil and alluvial cover along strike to the east and west, which is important as a number of granite-hosted Bongou-like ore deposits could be sitting under thin cover nearby.

These granite outcrops lie close to a large, deep 43km long fault within our permits, which we are certain is the fault that has delivered the fluids to form the Bongou gold mineralisation.

 

We want to determine where that combination of granite and the major fault may reappear, especially when the granite is in contact with mafic rocks like at Bongou.

In the immediate vicinity of the drilled area, we’ve identified several areas of interest within about 2km of strike.

Adding to this, we have identified other targets on the major fault through mapping and geophysics 4km and 10km to the northeast.

What did your recent exploration work at Bongou include?

An electrical geophysical survey, covering about 2.5km of strike, as well as bedrock geochemical drilling of the electrical geophysical anomalies.

This geochemical drilling turned up more Bongou-scale anomalies, one of which is definitely in altered granite. We are now trenching that granite to see how it looks.

We also carried out metallurgical testwork, not only at Bongou, but also on other prospects, including the Dave prospect nearby and the higher grade Tambiri and Solna prospects to the north.

What did that metallurgical testwork return?

It gave us high-gold recoveries from all of the prospects we tested.

The Bongou prospect returned recoveries of 94 per cent gold while the Solna and Tambiri tests recovered 96 per cent and 92 per cent gold respectively.

At Dave, we focused on the possibility of heap leach gold recovery from moderate grade oxide mineralisation.

At Dave there’s an average depth of oxidation of about 50m where there could be quite a lot of material that could be put on a heap.

The testwork indicated heap leach is possible. Bottle roll cyanide leaching of reverse circulation drill chips and powder gave us 89 per cent recovery.

An economical heap leach operation should be recovering more than 60 per cent of the gold. While there is a long way to go yet, with agglomeration, we think this may be achievable at Dave.

You did the metallurgy early, were you pleased with those results?

Absolutely; it reduced a big risk element in some of our key prospects.

We’ve seen no evidence of refractory gold, which can be cause for concern in some West African gold deposits.

We can also see the possibility of recovering gold economically from some of the lower grade material as a supplement to standard CIL treatment of higher grade material from such places as Bongou and Tambiri.

If we can find more mineralisation with the same characteristics as Bongou, it gives us the opportunity to rapidly drill out resources with above average grades, which can get us started with high profitability and rapid capital payback earlier.

In the current, very difficult, investment climate, my picture of the near future is that we should aim to build on the Bongou results to identify enough reserves to get started with high-grade ore production, possibly not with a huge mill throughput to begin with.

This could keep initial capital costs relatively low and provide a springboard for increasing gold production as time goes on.

Producing and being profitable allows you to move onto the lower grade material?

That’s right and a heap leach operation on a prospect like Dave would be a classic case in point.

Getting started and producing gold would also allow time to progressively develop other prospects in our large ground holding.

We’ve always said we’re aiming to get more than two million ounces at over 2g/t here and we believe we have the ground position to deliver that.

CONFERENCE CALLER: Australia’s Azure Minerals (ASX: AZS) says it will commence a mining study in the second half of this year with the intention of commencing first mining by 2015 at the company’s advanced and high-grade Promontorio copper gold project in Mexico.

Addressing the first day of the Paydirt 2013 Latin America Down Under resources conference in Sydney, Azure Minerals managing director Tony Rovira, said the completion of a positive scoping study had underpinned Promontorio’s potential to be a near-term producer.

 

Azure Minerals managing director Tony Rovira.

 

“Our focus is on developing the deposit so that we can become a copper-gold producer in Mexico – a province we regard as mineral rich and mineral friendly,” Rovira said.

“Mexico’s mining jurisdiction is important to us. It is the world’s fourth most favoured country for mineral exploration, has a simple, transparent mining legislation.

“It also has more than 300 mining companies operating in Mexico and that is the perfect environment for us as an Australian developer to bring a new copper gold mine into production.”

Located in central Mexico, Promontorio has a total JORC Indicated and Inferred resource of 840,000 tonnes at a grade of 4.1 per cent of copper equivalent.

“This is a ‘high confidence’ resource for us as 75 per cent of the mineralisation is already in the Indicated category and contained totally to date within two specific veins,” Rovira said.

“Our forward plan now is to commence a mining study and ore reserve work in the second half of 2013.

“We also plan to develop the exploration potential of the high grade copper zone at the Cascada prospect just 200 metres northwest of Promontorio but which we believe has strong potential to be a second major copper contributor to the project.”

A drilling program has already commenced on Cascada.

THE CONFERENCE CALLER: Australia’s junior mineral explorers and equipment suppliers have been encouraged to take a higher profile position and involvement in Latin America’s future mining industry.

Addressing the second day of the Paydirt 2013 Latin America Down Under resources conference in Sydney, Austrade chief executive officer Bruce Gosper said some 200 Australian junior resources companies were involved in Africa’s mining sector.

 

 “Yet only around 50 such Australian entities in the junior end of the market are involved in Latin America,” he said.

“The opportunities for these and other Australian companies to enter the growing Latin American mining market are significant as the sector there is keen to partner these Australian juniors in their mining, environmental, safety, technology and innovative mining techniques.”

Gosper said the application of mine water technologies was a notable opportunity.

“Australia’s mining sector consumes about four per cent annually of Australia’s national water consumption and has become very skilled in mine water management techniques,” Gosper said.

“Water is a real issue for Latin American mines including in  Peru and Chile and we will shortly be taking our water skillsets to Mexico so there is a strong opportunity there for Australian technologists in that space.”

Gosper said if junior resource plays needed any encouragement to move into Latin America, they only need look at the 60 per cent growth in two-way trade there in recent years to more than $8 billion annually in 2011-12.