The Wall Street Journal reported that loaded with debt and faced with plunging iron ore prices, Australian miner Fortescue had to do something. But a plan to cut production may just be storing up problems for later.
Fortescue scaled down its target of 155 million tonnes of annual iron ore output by June 2013 to just 115 million tonnes, and said it would cut several hundred jobs and reduce other costs too. In all, the world's fourth biggest iron ore miner plans to reduce its budget for capital expenditure in 2013 by 26% to AUD 4.6 billion. That should help deal with debt of more than AUD 10 billion that is weighing on the balance sheet.
But slowing output creates another issue. An influx of iron ore supply is coming onto the market over the next few years. Wood Mackenzie says excess seaborne iron ore will jump from less than 20 million tonnes in 2013 to more than 100 million tonnes in 2015 because producers committed to expanding supply when prices and demand were high. Fortescue's reduced output target means less of its production is scheduled to come to market before the glut arrives.
Fortescue's rivals, meanwhile, aren't slowing down production in the near term. Iron ore giant Rio Tinto said yesterday its plan to expand iron-ore output to 353 million tonnes a year by 2015 from about 225 million tonnes last year is still on track. BHP plans to expand its iron ore production in the Pilbara to 240 million tonnes over the next few years, from some 175 million tonnes in the year to June.
In the short term, the slumping iron ore price could stage a recovery if high cost Chinese producers are forced out of the market. Citi estimates the price could rise from about USD 89 a tonne now to USD 100 a tonne in the fourth quarter if that happens. Prices also would get a boost if China's economy picks up or Beijing introduces more stimulus.
At current prices, though, Fortescue has little or no cash flow from each tonne of output. A response was needed, but the company's options were limited. Adding more debt to the pile would have been costly. Issuing equity would dilute shareholders. Asset sales take time. That meant slowing production and capital expenditure. A tough choice and one that will have lasting consequences.
Source - The Wall Street Journal
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