Iron ore rock stars and the roadies

If the iron ore price continues to fall, ‘the roadies’ will be the first to feel the heat

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There has been a lot of speculation about the future for the iron ore miners, given the sudden and dramatic fall in the iron ore price from over US$130 a tonne to below US$110 a tonne this year.

The key concern, as with most commodities stocks, is the ‘break-even’ price level, where companies go from making a profit to a loss. While giant miners Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP) are estimated to have the lowest production costs globally at around US45 a tonne, Fortescue Metals Group Limited (ASX: FMG) is forecast to have lower production costs than BHP by 2015.

Credit Suisse analysts say Fortescue has slashed production costs by $15 a tonne, and by 2015, will be $3 lower than BHP’s. Credit Suisse attribute Fortescue’s lower costs to its modern port and rail infrastructure, which has benefitted from 40 years in rail advances over the majors.

Fortescue’s break-even price is estimated to be around $70 a tonne, but would fall in to the $60s, if costs continue to fall.

As a result, Fortescue, Rio and BHP are unlikely to suffer permanent losses even if the iron ore price was to suffer a massive drop. These are the rock stars of the iron ore world.

The juniors, including Atlas Iron Limited (ASX: AGO), Arrium Ltd (ASX: ARI) ex-OneSteel and Mount Gibson Iron Limited (ASX: MGX) combined produce less than a third of Fortescue’s annual production, and so have higher production costs.

Credit Suisse say Atlas Iron’s cash flow ‘evaporates’ if the commodity’s price falls to US$90 a tonne, while Mount Gibson has the highest costs and lowest margins. If iron ore prices fall that low, Mount Gibson could tough it out until 2017, when costs will fall sharply says Credit Suisse. The company certainly has enough cash, with $484 million (around 44 cents per share) sitting in its bank accounts and minimal debt.

Foolish takeaway

Should iron ore prices continue their recent falls, the junior miners with higher production costs will be the first to be hit, making them the ‘roadies’ of the iron ore business. But even the rock stars will lose some of their shine if prices fall, despite their recent production increases.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

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