High fuel, input costs to lessen LatAm miner commodity price benefit

A continued increase in iron ore and steel prices due to the disruption in global supply following Russia’s invasion of Ukraine will augment Latin American mining sector cash flow from already high levels, but elevated fuel and raw material costs may lessen the benefit, says Fitch Ratings.

Higher cash flow will give issuers additional flexibility to further strengthen balance sheets and invest for growth.

Capital allocation is an important consideration for most issuers’ ratings as high profitability in 2021 and a dearth of projects allows them to use excess cash flow to reduce gross debt. Companhia Siderurgica Nacional has been lowering debt for the past few years and is in a unique position among rated peers, with a Positive Outlook.

The price of iron ore for the 62% benchmark CFR in Qingdao was elevated during 2021, averaging USD156/ton, an increase from USD105/ton in 2020. Prices dipped in 2H21 before rising in November and December as the Chinese government response contained worries related to stressed construction developers. Iron ore prices continued to rise after Russia invaded Ukraine, increasing to USD147/ton on March 7 from USD124/ton on Feb. 24.

Russia and Ukraine exported about 4.5% (70 million tons) of seaborne iron ore and 30% (24 million tons) of pellets in 2021. Per CRU Group, 55% of Europe’s pellets and 27% of its iron ore imports came from Ukraine and Russia last year. Producers in Russia and Ukraine have declared force majeure and closed plants while trade has been disrupted by sanctions. Freight rates have further increased, as the conflict has made transportation across the Black Sea difficult.

“We do not expect South American iron ore miners to increase production to cover the shortfall in supply. Vale recently reiterated its production guidance of 320Mt-335Mt for 2022. CSN and Usiminas also recently confirmed production expectations,” Fitch said.

Supply lost from Russia and Ukraine is mostly magnetite-concentrate iron and pellets. Similar production exists in Latin America but producers have little flexibility to increase production in the short term, likely leading to higher premia for high-grade ore and pellets. This will benefit high-grade iron ore producers, such as Vale, CSN, Usiminas, and Chile’s CAP, Fitch said.

Higher energy-related costs will offset some of the pricing benefits to iron ore miners, particularly those with limited hedge positions. Vale estimated a USD10/barrel increase in the Brent oil price will affect diesel-related C1 cash costs to USD0.2/ton of iron ore, whereas a similar increase will affect bunker-related freight costs by USD0.9/ton of iron ore.

Steelmakers will be negatively affected by the rise in raw material costs, as coal prices are also up. Higher iron ore prices are typically reflected in production costs in two to three weeks, after lower-cost inventory is depleted, while coal prices may not be absorbed until later, as inventory tends to last four to six months.

“We expect producers indexed toward mining to manage through inflationary pressures better than those focused on steel, as steel prices would likely have to remain high for at least two more quarters for some Brazilian steelmakers to benefit from greater export demand. Issuers with competitive global business profiles, high-grade products, modern logistics, and relatively stable electricity provision contracts should also be better able to withstand higher costs,” Fitch added.

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