Cliffs lands key long-term contract, putting Essar's future in doubt

Lourenco Goncalves

Cliffs Natural Resources Inc. (NYSE: CLF) has entered into a new long-term commercial agreement with ArcelorMittal USA to supply tailor-made iron ore pellets for the next 10 years through 2026.

The pellets will be manufactured at United Taconite, which was temporarily closed in July of 2015 due to unfavorable market conditions. Employees are being notified that work will resume there in mid-October, which is earlier than expected, Cliffs' Chairman, President and CEO Lourenco Goncalves said in a telephone interview.

Further, Cliffs will make a $65 million capital expenditure at UTAC so it can manufacture the "Mustang" premium fluxed pellet, he said. The investment, which will create work for area construction workers, will be spread across 2016 and 2017.

ArcelorMittal's decision might have sealed the near-term fate for Essar Steel Minnesota. In 2013, the company announced it had entered into a long term iron ore pellet supply agreement with ArcelorMittal. That 10-year agreement called for the supply of pellets to begin during the second half of Essar’'s fiscal year ending March 31, 2014. With Essar unable to open its plant and meet supply requirements, Cliffs obtained a short term extension of its earlier ArcelorMittal supply accord. Essar's Nashwauk processing plant is still months away from completion, and without financing available to resume construction, it now has lost ArcelorMittal's business for a decade.

Cliffs' new agreement will replace two existing contracts expiring in Dec. 2016 and Jan. 2017 and fill the entirety of ArcelorMittal's pellet purchase requirements from the previous contracts. The new commercial agreement includes ArcelorMittal's total purchases of iron ore pellets from Cliffs up to 10 million long tons and preserves Cliffs' current position as ArcelorMittal USA's sole outside supplier of pellets. Accordingly, Cliffs will continue to be the sole pellet supplier of ArcelorMittal's Indiana Harbor West and Cleveland Works steelmaking facilities, while maintaining the current level of pellet supply to ArcelorMittal's Indiana Harbor East facility.

The new contract establishes a  minimum tonnage of pellets of 7 million long tons, which is higher than the current minimum level from the two previous contracts combined.

"Cliffs is pleased to announce a major accomplishment within the execution of our strategy, which is the signature of a new 10-year pellet supply agreement with ArcelorMittal. We arrived at a mutually beneficial agreement, as both companies recognize the importance of bringing sustainable value to our respective businesses," Goncalves said in a prepared statement.

Cliffs now has supply contracts in place until 2022 or later for all of its mines. The company also owns or manages Hibbing Taconite and Northshore Mining Co. on the Iron Range and the Tilden mine in Upper Michigan.

During a March presentation in Virginia, Goncalves linked the reopening of United Taconite (UTAC) in Forbes and Eveleth to successfully securing the ArcelorMittal contract. With the Empire mine near Marquette, Mich., reaching the end of its life, its superflux pellet is set to be replaced by the new “Mustang” pellet to be manufactured at UTAC. 

"The signing of the new supply agreement confirms what we have always stated regarding the strength of the business relationship between Cliffs and ArcelorMittal USA," Goncalves said in the May 31 announcement. "The new contract also removes any remaining uncertainty about Cliffs, and supports our conviction in the bright future of our company, its employees, its shareholders, and all other stakeholders, including the communities in which we operate."

Pricing for the pellets under the agreement will be adjusted by the price of steel in the U.S. domestic market, and iron ore market based and general inflation indices. A similar pricing clause was included in the past contract between the parties.

"That’s the way it should be. When the client makes money, we make money," Goncalves said.

Based on current market levels, Cliffs anticipates an improvement in overall United States Iron Ore realized revenues per ton in 2017, when compared to the company's current guidance for 2016.