On Friday in the US, or Friday night in Australia, the spot iron ore price fell over 2% to US$114 a tonne, an 8-month low. Iron ore last traded at a similar price in June 2013, before accelerating to over US$140 a tonne by mid-August, taking the share price of the major Australian mining stocks with it.
Between August 2013 and January this year, iron ore traded in a fairly narrow range between US$130 and US$140 a tonne, allowing companies like Fortescue Metals Group Limited (ASX: FMG), BHP Billion Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) to deliver bumper profits, having realised terrific margins during the half.
But what happens if the iron ore price falls further?
As we saw in 2012, when the iron ore price fell from US$137 per tonne to US$87 per tonne in the space of five weeks, we can expect the share price of mining companies, particularly those with plenty of debt, to fall heavily. Fortescue's share price plunged from $6 in early 2012 to below $3 by mid-September due to concerns that it was making a loss on ore exports and would shortly default on its (sizeable) loans.
What should happen this time?
There's still every chance that an iron ore price plunge could happen this year, however I doubt that share prices will fall as heavily as they did in 2012 and 2013. Our big miners are much stronger now than in either of the previous two years; debt is lower and falling, capital expenditure costs are much lower and operating costs are falling.
In Fortescue's case, having already paid off the majority of debt due before 2019, there is much lower risk of a default, cashflow is extremely strong and break-even iron ore costs are expected to fall from US$103 per tonne in 2013 to US$83 per tonne in 2014, before gradually reducing to US$69 per tonne by 2018.
For what it's worth, the majority of forecasters expect the iron ore price to remain above $90 for the foreseeable future. The breakeven points for BHP and Rio are well below that of Fortescue, and as such they represent safer investments.
Foolish takeaway
I view any substantial fall in the iron ore price as a short-term issue, and a potential opportunity to buy Australia's best mining companies at a discount. The three best opportunities are those mentioned above as they have the best management, healthiest balance sheets, and the best potential for shareholder returns over the next two to five years.
