The Iron Ore Oligopoly
It is a strong statement to say there is an oligopoly in the iron ore space, but the Big Three have owned the business since 2000 and will continue to do so for the foreseeable future. Is there enough iron ore in the world? Absolutely. Is there enough independent iron ore that can be profitably produced by new mines at $130 per tonne? Absolutely. The only way to keep the price over $130 per tonne without bringing in new suppliers is to have a couple of quarter-long market flush outs over the next 3-4 years.
The iron ore business is not constrained by operating costs. It is a capital-constrained business. Building large mines with the ability to move millions of tonnes of ore and waste cost at least $1 billion, which requires a stable iron ore market. Every time the price crashes, stability disappears and capital stops flowing to the smaller market players.
It benefits the oligopoly to let iron ore prices crash during economic slowdowns by killing all independent projects. If iron ore prices hit $100 per tonne or even $60 per tonne for three months, the oligopoly would lose short-term market cap and some profit. However, independent mines would face significant losses that would hinder their ability to raise capital.
By letting prices fall, the following can be achieved:
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Temporarily shut down marginal Chinese production.
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Remove weak traders from the business and consolidate control between mine and steel mill.
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Stockpiles can reach a point where the Chinese have little ability to regulate prices.
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Destroy the ability for new projects to finance and keep the mid-tier mining companies out of the business.
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Weaken competitors; I can see Anglo falling to BHP, Rio or VALE in this market cycle, which would take Kumba and the old MMX Minas-Rio and MMX Amapa iron ore assets out of play.
Iron ore is the profit driver of the global mining business. I think the iron ore market will have supply issues in the next 10-20 years, but I have faith that the Big Three will protect their market. I also think the Chinese are dynamic and will look to level the playing field. However, there are three major iron ore companies and 10+ material Chinese steel companies, so it will be difficult for the Chinese to negotiate successfully because they need the ore at whatever price the Big Three is charging.
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