Samarco Mineracao SA, the world’s second-largest producer of iron ore pellets, will halt production, which could impact iron ore prices in the short term.

On the 9th, BHP Billiton, Australia’s leading iron ore producer, issued a public statement saying that the company is reviewing its iron ore production plan for fiscal year 2016. The review comes after two tailings dams at a mine in Minas Gerais state, southeastern Brazil—owned by the company—burst on the afternoon of the 5th local time, releasing approximately 62 million cubic meters of tailings water mixed with mining slag. The disaster has left numerous people dead and injured. Local prosecutors have described this accident as the most severe environmental disaster in history and the direct cause of the shutdown of Samarco Mineracao SA’s mine.

Samarco Mineracao SA is a joint venture between BHP Billiton and Vale. In a statement released late on the evening of the 7th local time, the company announced that it would suspend production and shipments of iron ore pellets at its Ubu subsidiary in the state of Espirito Santo once its existing inventory is depleted. Its Germano subsidiary in the state of Minas Gerais has already ceased operations. In a research report on the 6th, Deutsche Bank analyst Paul Young stated that local mines would remain shut down until fiscal year 2019. BHP Billiton said it would reassess its plan to produce 247 million tons of ore by July 2016.

In a research report released on Monday, Citigroup analyst Ivan Szpakowski noted that the disruption in supply from this Brazilian mine could help support the premium for pelletized iron ore. Since pelletized iron ore accounts for a relatively low proportion of steel costs in iron and steel smelting, its impact on overall steel production costs is relatively limited.

The Samarco Mineracao SA mining accident in Brazil will affect iron ore production by between 25 million and 30 million tons, which, according to a research report released by Citigroup on Monday cited by Bloomberg, is more likely to support iron ore prices around $50 per ton by year-end rather than pushing them further down to $40. Citigroup noted that, given China’s substantial reduction in steel production after the Spring Festival, iron ore prices could resume their downward trend at that time, potentially falling below $40 per ton. Ivan Szpakowski said, “We still expect iron ore prices to experience greater volatility after the Chinese Spring Festival.” So far this year, iron ore prices have fallen by as much as 32%.

Currently, depressed ore prices have prompted some high-cost miners to cut production in response. However, last month, Arnoud Balhuizen, BHP’s Head of Marketing, stated that despite some competitors being hit hard by low commodity prices, BHP will not reduce production, as its related businesses continue to generate cash flow for the company—and cutting production may not necessarily lead to higher prices.

Major mining companies such as BHP and Rio Tinto remain profitable in the iron ore business thanks to their lower costs. In August of this year, Rio Tinto reported that although its first-half EBITDA profit from iron ore fell by 49% to $4.09 billion, the company’s average profit margin still stood at a robust 54%.

Alan Chirgwin, Vice President of Iron Ore Marketing at BHP, stated that iron ore prices will continue to decline gradually until they reach a new equilibrium below $50 per ton. Depending on the cost structures of mining companies and their ability to cut costs, this price level will represent the upper limit of the breakeven point for major mining companies in Australia or Brazil.

This accident has prompted local protesters to demand the revocation of the company’s mining license for its local mine. BHP stated that the company is closely monitoring its third tailings dam at the local mine.

Currently, iron ore prices are at their lowest level in a decade. This accident has not only led to the shutdown of the affected iron mine, but the associated cleanup costs—as well as potential lawsuits over fatalities, injuries, and environmental damage—will place immense financial pressure on Samarco Mineracao SA. According to estimates by Deutsche Bank, the company’s cleanup costs could exceed US$1 billion.

On Monday, BHP's share price on the Sydney Exchange widened its decline, falling by more than 5.2% to A$30.75. In addition to the aforementioned incident, earlier reports from AFP indicated that BHP had extended the payment terms for some supplier contracts from 30 days to 60 days.

At this stage, different parties are reporting varying figures for the number of casualties and missing persons. In a public statement released on Monday, BHP said that at least one person has been confirmed dead and 13 miners are missing. The Miners’ Union in Mariana, a city not far from the iron ore mine, reported that the incident has left at least 15 people dead and 45 others missing. According to AFP, citing fire department officials, 17 people have been confirmed dead, 50 injured, and more than 40 remain missing. Meanwhile, the Associated Press, citing reports from some local officials, reported only 2 deaths, 4 injuries, and 13 missing persons.

Brazilian local prosecutors have already filed a request to launch a public civil investigation into the aforementioned accident.

Source: Wall Street Insights