The renaissance of the Canadian iron ore industry

The global iron ore phenomenon in the context of the commodity super-cycle currently being experienced is a result of the continuous growth of a very large emerging market – China.

China’s iron ore resources are poor (both in terms of grade and size) and its production cost is high in a global environment where the industry concentration in the upstream iron ore sector is very high (the Big Three oligopoly has about 60-70% of the market) while the downstream steel sector is very low (the top three producers constitute slightly above 10% market share).

Over the last decade, China contributed more than 90% to the growth of the global steel industry, representing 500Mtpa on the 566Mpta total increase of global crude steel production on an annual basis during this period. Behind that growth there has been a solid constant growth of the Chinese economy at a rate of approximately 10% throughout the last two decades based on solid industrialization initially, followed by the inevitable urbanization of this 1.3-billion-people country.

In the wider context, the emergence of China comes from a well-managed fundamental economic reform supported by a stable geopolitical system. China has allowed itself to effectively integrate into the global system of developed countries in terms of trade, investments and society at large. This process of integration was an important catalyst in making China initially, the ‘factory of the world’ (although to a certain extent it still is, but not entirely on account of low production costs) and developing a market so large that no major international company can ignore China. Through economic reform, channels through which foreign direct investments into China and Chinese enterprises’ access to international capital markets have been made possible, funding the rapid expansion of the Chinese economy on an unprecedented scale.

Traditionally, Australia and Brazil have been the major suppliers of iron ore to the seaborne trade because of their geographic proximity to the China market.

Slowly, however, Canada has been recognized as a viable alternative to supply of iron ore to China. The Canadian Labrador Trough was once one of the major iron ore sources of iron ore supply to the world, particularly during the post World War II rebuilding of Europe and the expansion of the American economy. Its resources, potential and proven, are great and it is a classic example of an iron formation.

Consolidated Thompson, for one, has shown that iron ore can be produced for China and has attracted WISCO to complete its funding to put Bloom Lake into production. Low hydro-electric rates, an abundance of fresh water supply, mining-friendly political regimes, competent work force, good infrastructure, including the deep water and the all-season Port of Sept-Iles, help compensate for the disadvantage of distance, cold weather and being farther from China.

The positive view of Canadian iron ore resources is further reflected by the recent aggressive expansion plans announced in Canada by such major Canadian operations as ArcelorMittal’s $2.1 billion expansion to 24Mtpa production by 2013 and IOC’s 50Mtpa target by 2016.

Adding to the major transactions in the Canadian capital markets, including the $5 billion acquisition of Consolidated Thompson by Cliffs and the $600 million acquisition of Baffinland by ArcelorMittal, the total investments and acquisitions in the iron ore sector in Canada alone amounts to some $15 billion within one year, which is a world record in its own right. And presently, Canada is not even a major iron ore producing country; accounting for less than 10% of that of either Australia or Brazil.

In the Canadian context, junior exploration companies generally have access to capital for exploration purposes through the Canadian capital markets including various tax incentives such as Flow-Through funds. However, once resources and reserves are identified, financing the pre-production expenses is often more difficult, including financing expenses of a bankable feasibility study, PEA, environmental assessment study, impact benefit analysis, consultations with First Nations and legal fees.

Many junior exploration companies still have difficulty raising capital for these pre-production expenses. The huge scale and capital cost of taking an iron ore company into production inevitably leads a junior to attract a major to finance its way through to production.

Century Iron Ore Corporation (TSX-‘FER’) is an example of where strategic partners came in early to the development of the projects. The model developed by Mr. Sandy S.K. Chim of Hong Kong was to ensure that Century had a majority of its funding in place early, all the way through to production, by attracting WISCO (25.9% of Century’s equity) and Minmetals (5% of Century’s equity) as equity and joint venture partners at the exploration stage of development of its projects. The strategic partners can also participate on a project level as joint venture partners, ensuring that the projects are well financed, and minimizing the dilution to Century shareholders.

At the same time, the strategic partners secure iron ore through market priced ‘off-take’ agreements.

By involving strong off-shore strategic partners ‘early‘ when the projects are below the Investment Canada Act and the Competition Act thresholds means there are no filings required under these Acts, as the projects have little economic value at the exploration stage and usually there have been no previous production or revenues on the properties.