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Major miners iron ore domination

Giant iron ore miners will continue to dominate the supply of iron ore, despite the push by junior miners to become alternative suppliers to steelmakers.

Rio Tinto Limited (ASX: RIO), BHP Billiton (ASX: BHP) and Brazilian iron ore giant Vale are the major players, with some of the lowest production costs in the world, which makes them more resistant to falls in the prices of iron ore.

After recovering from prices below US$90 a tonne in September 2012, iron ore recovered to trade above US$150 a tonne, but has been sliding in recent weeks, last trading below US$140 a tonne.

Rio recently said that it expects the price to fall by 50% to around US$100 a tonne. UBS analysts are much more bearish, suggesting prices will dive to US$70 a tonne, which will place enormous pressure on mid-tier and junior miners. Even Fortescue Metals Group (ASX: FMG) would struggle to be profitable at those prices, thanks to high debt levels and interest costs.

In 2008, Mount Gibson Iron (ASX: MGX) suffered a near death experience after three Chinese customers defaulted on offtake agreements, while another two wanted shipping delays. The company’s shares fell from over $3 to around 20 cents and Mount Gibson was forced to conduct a capital raising, which also saw an opportunistic investment by China’s fourth largest steelmaker. That may have kept Mount Gibson alive, but saw close to half the company revert to foreign ownership.

We could see much worse damage this time if prices fall, as many more junior resource companies have moved into iron ore, and several of them could be lucky to survive. While a very short-term crash would not be catastrophic, the amount of iron ore supply coming onto the market in the next few years suggests that the price could linger at much lower levels for a longer period of time.

Foolish takeaway

The giant iron ore miners can control prices to some extent, by cutting back production, giving them the leverage to decide where the market goes, and the impact it has on smaller miners. Juniors like Mount Gibson may be totally reliant on the largesse of the majors for survival.

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The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.  This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool writer/analyst Mike King owns shares in BHP.

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