Iron Ore Update Domestic iron ore prices have bottomed in the near term

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1 Iron Ore Update Domestic iron ore prices have bottomed in the near term PhillipCapital (India) Pvt. Ltd. 16 July 2013 We spoke to an iron ore trader to get an update on the domestic pricing and various factors impacting the same. The trader believes the domestic iron ore prices are close to a bottom in the near term however he expects iron ore lumps and pellets prices to be under pressure over the coming 1 2 years with new pellet capacities coming on stream (pellet capacities almost doubling over the next 4 years). Bottoming out of iron ore prices is a positive for players like NMDC however the monsoons will have an uncertainty over volumes. Lower pellet prices over the next 1 2 years will negatively impact players like JSPL however re alignment of rail freight on pellet exports will partly offset the said impact. Domestic iron ore prices bottomed out in the near term The trader believes domestic iron ore prices have bottomed out in near term and are not likely to see any material downside. Factors like export price arbitrage and monsoons leading to lower volumes are into play for the said argument. Export price arbitrage has seen a significant surge in export volumes Recent rupee depreciation and rising iron ore prices globally have seen the exports increasing from Orissa. As per various media reports, iron ore exports from Paradip port have increased almost 3 fold in Q1FY14 compared to the same period previous year. Iron ore export volumes from Paradip port has increased to 1.03mn tonnes in Q1FY14 from 0.371mn tonnes in Q1FY13. Iron ore price arbitrage: Domestic v/s Exports Vizag Port Paradip Port Via Road Via Rail Via Road Via Rail Distance from Barbil (kms) Iron ore 63.5% Fe grade CFR price (US$ / tonne) Less: Ocean Freight (US$ / tonne) Export tax (US$ / tonne) Net Realisation (US$ / tonne) Exchange rate Net Realisation (Rs / tonne) Less: Road Freight Rail Freight Loading at Railway Sidings Port Handling & Stevedoring exp % of FOB price Miscellaneous exp Net margin (Rs / tonne) Ex mine price (Rs / tonne) Arbitrage (Rs / tonne) Source: Bloomberg, Industry, PhillipCapital India Research, Prices as on July 11, 2013 The table above clearly illustrates higher margins in the export markets if iron ore is transported via road. However since majority of the movement happens through rail (where rail freight for exports acts as a deterrent), export volumes are not expected to rise substantially from here. Dhawal Doshi ( ) ddoshi@phillipcapital.in Dharmesh Shah ( ) dhshah@phillipcapital.in 1 of 6

2 Export price arbitrage and monsoons will see the falling iron ore prices bottom out benefitting players like NMDC Monsoon impacting volumes to support prices The trader believes the ongoing monsoons will lend support to the falling domestic iron ore prices due to lower availability of the material during the season. Infrastructure bottlenecks leads to lower sales during the period irrespective of the production. Bottoming out of domestic iron ore prices in Orissa will benefit NMDC which had to cut prices at various occasions in the recent past. Poor demand and competitive pricing from Orissa based miners had impacted the prices. NMDC prices (Rs / tonne) Lumps mm Lumps 6 40mm Fines Q4FY12 Q1FY13 Q2FY13 Oct 12 Nov 12 Dec 12 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Source: Company, PhillipCapital India Research Below is the landed cost comparison of iron ore lumps supplied by NMDC, pellet producers from Chhattisgarh and various miners of Orissa. Landed cost of iron ore lumps at Chhattisgarh steel / sponge iron plants (Rs / tonne) NMDC (6 40mm) Serajuddin Rungta * Pellets Chhattisgarh Orissa Orissa Chhattisgarh** Iron ore price (incl Royalty & Bonus Ex mines) CST / VAT Net freight to Sponge / steel plant Shortage 1% (average) Cost at plant Recovery (%) for 5 18MM 75% 92% 92% 98% Less: Realisation for iron ore fines Landed cost of iron ore Source: Steelmint, PhillipCapital India Research, * Loaded to wagons, ** from Raipur NMDC landed cost to Chhattisgarh steel producers still expensive than pellet supplies from the state and some small to medium sized miners from Orissa. Landed cost dynamics for NMDC s lumps is still not favourable compared to the pellet supply from Chhattisgarh and the iron ore lumps from medium sized miners in Orissa. However, the supply from Orissa is expected to be impacted due to the ongoing monsoon season which will ease the competitive pressure on NMDC. 2 of 6

3 Iron ore pellets: New capacities to impact prices; exports still not a viable option Upcoming pellet capacities over the next 2 3 years will have an impact on the iron ore pellet and lumps prices. Existing pellet capacities (captive as well as merchant) are expected to almost double over the next 4 years, however the strong returns from pellet plants will see the merchant capacities more than double over the next 2 years. This will see a downward pressure on the pellets and lumps prices; however the same is expected to support and firm up the iron ore fines prices. Pellet capacities to grow at a CAGR of 17.4% over FY13 17 however merchant pellet capacities to grow at a CAGR of 26.5% over the same period Pellet capacities are expected to jump from 49mn tonnes as on FY13 to 93mn tonnes by FY17, a CAGR of 17.4%. However the merchant pellet capacities are expected to grow at a CAGR of 26.5% over the same period from 16mn tonnes as on FY13 to 41mn tonnes as on FY17. Pellet Capacities mn tonnes Upto FY13 FY14 FY15 FY16 FY17 Pellet capacities Source: Industry, PhillipCapital India Research Merchant Pellet Capacities mn tonnes Upto FY13 FY14 FY15 FY16 FY17 Merchant Pellet capacities Source: Industry, PhillipCapital India Research Higher rail freight a deterrent for pellet exports Steep jump in the pellet capacities coupled with fewer export opportunities will see an impact on the pellet and lump prices over the next 2 years. Higher freight expenses acts as a major deterrent for the pellet exports except for a few port based capacities which have exported some pellet consignments. This is reflected from the table below which highlights the arbitrage earned in the domestic markets over the export markets. 3 of 6

4 Iron ore Pellet price arbitrage: Domestic v/s Exports Paradip Port Via Road Via Rail Pellet realisations (CFR China) (US$ / tonne) Less: Ocean freight FOB realisation (US$ / tonne) Exchange rate FOB realisation (Rs / tonne) Less: Port handling charges Handling 1% Freight from Barbill Margin Domestic realisations (Rs / tonne) Arbitrage (Rs / tonne) Source: Bloomberg, Industry, PhillipCapital India Research, Prices as on July 11, 2013 Differential freight charges by railways for the pellets used for domestic industry and for exports is a primary reason behind no major pellet exports. However some pellet producers like KIOCL have requested for the correction in the said anomaly which will enable them start exporting pellets. With the new pellet capacities coming on stream, the trader believes the above anomaly in the rail freight will be removed to incentivize pellet exports as was done by the export duty rationalization (export duty on pellets 0%, export duty on iron ore 30%). Players like Essar Steel & JSPL to benefit in the event of rationalization of rail freight for export and domestic purposes The said move will be a positive for existing players like Essar Steel and JSPL who have made significant investments in pellet capacities. Essar Steel currently has a pellet capacity of 14mn tonnes which will be expanded to 20mn tonnes. However the existing plants are not operating at capacity due to the problems in sourcing iron ore. JSPL currently has a 4.5mn tonnes pellet plant and will commission an additional 4mn tonne plant by December As per various media reports, JSPL is also in talks with Stemcor to buy the 4 mn tonne pellet plant owned by its wholly owned subsidiary Brahmani River Pellets Ltd. Rationalization of rail freight for pellet exports will benefit the pellet producers significantly and will help offset the price pressures once the new merchant pellet capacities come on stream. Shah Commission investigation unlikely to see a blanket ban however mines could be categorized as in Karnataka. Buffer zone around wild life sanctuaries can impact mining Regulatory overhang: not a significant risk to the Orissa iron ore The trader believes the iron ore industry in Orissa is not at a significant risk as seen in Karnataka and Goa. He believes the outcome from the Shah Commission investigation would not result in a blanket ban as the quantum of irregularities are far lower than what was seen in Karnataka & Goa. Further the steps taken by the Orissa government to keep a check on the illegal mining also plays an important part for the above argument. The trader believes, mines in Orissa will be categorized into 3 categories (A, B & C) as done in Karnataka with very few mines getting included in Category C. The trader however believes the Buffer zone issue (1km, 2kms or 5kms) around the wild life sanctuaries could impact production from the state; however it is difficult to estimate the impact of the same. Orissa currently has 18 wildlife sanctuaries. 4 of 6

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