It's impossible to ignore China, and in particular Chinese urbanisation, when considering the outlook for virtually any commodity today. It's estimated that China needs to construct a city the size of London every year to accommodate the 300m people that are expected to move from the countryside to its cities by 2025.
Chinese demand for steel to sustain this level of urbanisation has reinvigorated traditional iron ore producers in Australia and Brazil, and created a huge surge in new iron ore projects in Africa. RBC Capital Markets calculates that planned African projects could add over 500m tonnes a year of new iron ore production, at a capital cost of more than $50bn over the next eight years.
Chinese imports still rising
According to RBC, global demand for iron ore reached record levels in the five years to 2009, peaking at over 2bn tonnes in 2008 before slowing down slightly during the recent economic crisis. Chinese consumption increased during that period from 688m tonnes a year to nearly 1.3bn tonnes a year. That represents some 66 per cent of global demand – and is more than 10 times the demand in Western Europe and 25 times the demand in North America, according to analysts' estimates.
Commodities consultant CRU expects global demand to level off at 2.2bn-2.3bn tonnes a year, with China remaining flat at 2010 levels. However, that's not to imply Chinese imports will slow. China is not only the biggest consumer but also the world's biggest producer of iron ore – at 677m tonnes a year (representing 35 per cent of global supply), according to RBC. However, as a result of declining grades within China's fragmented domestic industry, RBC believes Chinese imports of iron ore will have to continue rising just to meet the forecast levelling off in actual consumption.
Intensity of steel consumption highlights further upside
Although analysts are cautious in their outlook for overall iron ore consumption, RBC points out that the intensity of steel consumption (steel consumed measured against per capita GDP) in China remains low compared with historical levels seen in the US and Germany, and significantly below the peak intensities seen in more recently industrializing countries, such as South Korea and Japan.
While the RBC analysts don't believe China's intensity of steel consumption will reach anywhere near the heights of South Korea or Japan, the comparison highlights clear upside potential, particularly in some of China's more populous provinces including Sichuan and Henan. And then there's India. Its intensity of steel consumption lags way behind China's but can be expected to emerge strongly over the next 10 to 20 years.
Iron ore checklist
■ THE RIGHT ORE - Haematite ore, which is the main output from the massive operations in Pilbara, Western Australia, mined by Rio Tinto and BHP Billiton, is generally preferred due to its higher grade and low levels of impurities. Magnetite deposits tend to be lower grade and have higher impurities, so processing costs are higher. Butthe relative scarcity of new near-term haematite supply means the market is increasingly looking to magnetite to fill the shortfall.
■ THE RIGHT GRAIN - Iron ore productsare distinguished by their grain size. In general, the larger the grain size, the betteraproduct performs in the furnace, so the higher the premium steel companiesare willing to pay. 'Fines' and 'lump' are the typical products produced from haematite mines, whereas 'pellets' and 'pellet feed' are the upgraded products from magnetite mines.
■ INFRASTRUCTURE - The tonnages involved are vast, so deepwater ports and rail lines to transport ore to them are vital. This often pushes capital costs into the billions.
■ CUSTOMERS, PARTNERSAND CREDITORS - Billion-dollar financings are beyond most junior miners. Many end up joint venturing with major miners such as Xstrata, or increasingly Chinese investors, who undertake to finance the mine and infrastructure in return for an equity stake and a share of the end product. These deals can underscore the quality of projects such as Zanaga (Xstrata/Zanaga Iron Ore), Putu (Severstal/Afferro Mining, formerly African Aura Mining) and Kalia (China International Fund/Bellzone Mining).
■ EARLY CASH FLOW - Iron ore minestake yearsto develop, particularly African magnetite projects. The presence in certain deposits of 'direct shipping ore', which doesn't require processing and therefore offers near-term cash flow potential, can greatly enhance project economics. Projects that offer direct shipping ore include Afferro's Putu project in Liberia and Bellzone's Forecariah project in Guinea.
Irons in the fire
Globally, the iron ore trade is dominated by just three companies: BHP Billiton, Rio Tinto and Brazil's Vale. But there are a host of interesting iron ore outfits on the junior market, too. These are our favourites:
Bellzone's Kalia project in Guinea has the potential to become one of Africa's largest. Drilling has already demonstrated a resource of 3.74bn tonnes based on exploring 6km across the permit. With mineralisation stretching for 39km, the company believes the total resource could reach 13bn tonnes, which would support planned peak production of 50m tonnes a year.
An agreement in principle with China International Fund (CIF) to finance most of the required infrastructure has substantially de-risked the project. CIF is to invest around $2.7bn to develop rail, port and associated infrastructure. In addition, it will present a commercial financing package to Bellzone for its share of the estimated $1.2m of mine development costs, in return for first refusal over all of Kalia's output at market prices.
Should CIF's terms not prove acceptable, Bellzone will have a right to 20 per cent of production to help it secure alternative financing.Bellzone retains a non-dilutable 10 per cent interest in the infrastructure company and retains perpetual access.
CIF and Bellzone will also jointly explore and develop other iron ore projects, the most advanced of which is Forecariah, located just 40km from the Guinea coast. This project will deliver 10m tonnes a year of direct shipping ore, with first production targeted in early 2012.
Afferro Mining holds the iron ore operations that have just demerged from the gold operations of African Aura Mining. Through its joint venture with Russian steel firm Severstal, the company has been exploring the Putu ridge in Liberia, along which mineralisation is believed to extend for 13km. The partners recently more than doubled Putu’s iron ore resource to 2.4bn tonnes and have still only explored half of the ridge. There's potential for direct shipping ore, and another 1-2.5bn tonnes of iron ore may lie below the current resource.
Afferro has also made excellent progress developing its 100 per cent-owned Nkout project in Cameroon, which has targets extending 20km. The company has announced a maiden resource of 1.04bn tonnes and is targeting an ultimate resource of 4bn tonnes. It is also investigating the potential for direct shipping ore.
Although African Aura has been one of the Alternative Investment Market's best-performing mining shares, the split into more easily understood and valued iron ore and gold entities should release further value as Afferro continues to progress these and other iron ore projects.
Ferrum Crescent is pursuing iron ore projects in South Africa that have remained relatively underdeveloped during the current iron rush. It holds a 74 per cent interest in the Turquoise Moon project, alongside a local mining partner. Turquoise Moon is quite small compared with West Africa's mega-projects, holding an initial resource of just 310m tonnes.
Although there is scope to enlarge the project through further drilling; the existing resource already supports 20 years of production and its smaller size should make financing significantly easier. Smaller size means lower capital costs, and the ore body's geology lends itself to lower operating costs. The mineralisation is shallow and therefore relatively cheap to mine. The ore contains low levels of impurities and grain size is coarse.
Ferrum also holds an interest in the De Loskop prospect located approximately 150km east of Moonlight. This has the potential to add a further 200 to 1,000m tonnes of iron ore mineralisation with favourable metallurgical characteristics similar to Moonlight.