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Cliffs Natural Resources (NYSE:CLF) decided to suspend its $3.3 billion chromite project Ring of Fire, in Ontario, Canada by the end of this month for an indefinite period. It is going to halt all technical work, including the feasibility study and exploration. This is due to uncertainty about developing transport infrastructure. Cliffs has already spent about $500 million, out of which it spent $350 million to obtain mineral rights of three chromite deposits.

Ring of Fire has great potential and it has the potential to hold minerals worth $48 billion. Cliffs is also optimistic about this project. However, it's facing a major logistic challenges due to lack of rail lines and highways. Cliffs planned to build an all-weather road to its deposits, but it didn't receive permission from Ontario's land and mining commissioner. The company's monthly expense on this project development is around $4 million, and without proper infrastructure for transportation, the company cannot start mining.

Global increase in iron ore supply will hurt the company

China is the largest iron ore consumer with annual consumption of more than 1 billion metric tons. Up to now, the country has imported about 746 million metric tons in 2013, and in November itself, it imported 77.84 million metric tons. Based on the continuous demand in China, most of the global iron ore miners are increasing their production capacity. Vale SA (NYSE:VALE) is increasing its annual production capacity from 306 million metric tons to 346 metric tons by ramping up its production in the mine located in Carajas, Brazil by 40 million metric tons in 2014. Rio Tinto (NYSE:RIO) and BHP Billiton (NYSE:BHP) have also ramped up their production in their mines in the Pilbara region of Western Australia. Rio Tinto has increased its annual production capacity to around 292 million metric tons this year and plans to increase it to 360 million metric tons by next year. BHP has increased its annual production capacity to 212 million metric tons from 187 million metric tons last year.

However, analysts are predicting that this excessive iron ore supply will lead to surplus. According to the analysts, demand will be 25 million tons higher than supply in the first half of 2014, but in the second half of the 2014, supply will be at a 49 million ton surplus. Due to excessive supply, iron ore prices are expected to fall. Most of the analysts have predicted the average iron ore price in 2014 will be in the range of $115/ton to $120/ton.

Fall in iron ore prices will hurt Cliffs significantly; it generates around 81% revenue from iron ore. Its Eastern Canadian and Asia Pacific business will be affected because both are dependent on China's demand. The company has given its realized revenue per ton and sensitivity per ton estimation based on 2013's first three quarters' average iron ore price of $135 per ton.

Cliff's segment wise realized revenue per ton and sensitivity

Segment

Eastern Canadian iron ore

Asia Pacific iron ore

Revenues per ton

$110 to $115

$110 to $115

Sensitivity per ton (+/- $10 change in iron ore spot price)

+/- $2

+/- $2

Source: Company's report

As estimated by the company, with every $10 decline in iron ore price, the company will earn $2 per ton less. If we go by the estimations given by analysts, the expected price in 2014 will be in the range of $115 per ton and $120 per ton. Considering Cliffs' sensitivity analysis, the company will earn about $3.50 per ton to $4 per ton less next year. Therefore, on every ton, Cliffs 's Eastern Canada and Asia Pacific business revenue can fall about 3.5%.

The company can counter this loss with cost cutting initiatives already underway. The company is focusing on reduction of its selling, general, and administration, or SG&A, expenses under its enterprise cost reduction program. Under this program, Cliffs is optimizing its workforce through early retirements as well as voluntary and involuntary reduction in the number of personnel. It helped the company cut its third quarter SG&A expenses 13% year over year, and it is expecting these actions will help it reduce its 2014 SG&A expenses further.

Conclusion

Cliffs is cutting down its employees across all regions, and the company is halting its Canadian chromite project. Taking into account the risks associated with this project, the company has taken a prudent step by suspending this project.

One factor that can overshadow Cliffs' developments is the rate at which global iron ore miners like Vale, Rio Tinto, and BHP are increasing their production capacity. This excessive supply may lead to a fall in iron ore prices and iron ore is major contributor to Cliffs' revenue. Considering the uncertain future, I recommend investors hold their positions on this stock, and cautiously watch the future developments.

Source: Macros Not In The Favor Of Cliffs Natural Resources