The falling iron ore price has wreaked havoc on the mining sector over the last 12 months with some of the nation's smaller stocks having lost more than 90% of their market value. While the industry's bigger players have also been feeling the pinch it may not be all bad news for them, for example it has been argued that they could actually benefit from this low price environment.
As reported by The Australian Financial Review, UBS mining analyst Glyn Lawcock believes the world's four largest iron ore miners – being, BHP Billiton Limited (ASX: BHP), Rio Tinto Limited (ASX: RIO), Fortescue Metals Group Limited (ASX: FMG) and Brazil's Vale – are going for a "Goldilocks" price – one that is just right.
Each of the four miners maintain lower cost operations than the market's smaller players, meaning they can still profit even with the commodity trading down 50% over the last 13 months. While their cash flows and margins could certainly come under pressure in the near-term, the idea is that the world's higher cost operators would be priced out of the market, leaving the four biggest miners with a greater share.
Lawcock said: "The low cost incumbents at the bottom of the cost curve want a price that doesn't deter them from investing, that makes a good return for them, but not too good a return that it encourages new entrants and competitors… It's the Goldilocks strategy [on price] – not too much, not too little, but just right."
Get used to low prices
The iron ore price is hovering around its lowest price in more than five years. While the majors continue to ramp up their production levels (see BHP Billiton's and Rio Tinto's recent production reports, here and here), Chinese demand is waning. The basic supply and demand dynamics dictate that in such a scenario, prices will only continue to fall.
The announcement from Arrium Ltd (ASX: ARI) last week that it would be closing one of its two iron ore mining precincts in South Australia, whilst also reducing its capital expenditure by 30%, shows the suffering currently being endured by the high-cost miners. Even Fortescue Metals Group has been hovering around multi-year lows with the tumbling commodity price taking its toll on the bigger miners, too.
Although there were signs of the price stabilising earlier in the year, iron ore is likely to continue dropping over the next 12 months. While BHP Billiton and Rio Tinto are both well equipped to handle the low price environment (according to the AFR, BHP's and Rio Tinto's breakeven price is around US$34 a tonne, thanks in part to the falling currency), it could prove catastrophic for some of the industry's higher cost players. As such, investors would be wise to avoid the sector altogether, for now at least.
