Iron Ore Cost Curves

21 August 2013 Americas/United States Securities Research & Analytics
Iron Ore Cost Curves

Connections Series
Global Update and a Closer Look at China

We expect the iron ore price to move lower in coming years as new projects from Australia and Brazil hit the seaborne market. As this happens, investor attention is likely to focus on the cost curve, and the role it plays in supporting the iron ore price. This report explores the subject in some detail.
Exhibit 1: Global Cost Curve, 2013 Estimate
Red=Consensus 2013 price, Blue=Credit Suisse 2013 price, Grey=Credit Suisse 2012 cost curve
160 140
US$ per dry metric tonne
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Equity Analysts Nathan Littlewood 416 352 4585 Paul McTaggart 61 2 8205 4698 Matthew Hope 61 2 8205 4669 Ivano Westin 55 11 3701 6318 Liam Fitzpatrick 44 20 7883 8350 James Gurry 44 20 7883 7083 Neelkanth Mishra 91 22 6777 3716 Semyon Mironov 7 495 662 8510 Trina Chen 852 2101 7031 Fixed Income Analysts Marcus Garvey 44 20 7883 4787 Andrew Shaw 65 6212 4244
120
100
80 60 40 20
0
0 100 BHP.AX 200 CLF 300 400 500 KIOJ.J 600 700 800 900 1000 1100 1200 1300 Million tonnes per annum RIO.AX VALE.N China Other Reported Cash Cost (FOB)
All-In Cash Cost (FOB) All-In 62% IODEX equiv (CFR)
FMG.AX
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities Research estimates.
Perhaps the most differentiated section of this report is our analysis of the Chinese domestic cost curve. We provide reason for investors to query consensus thinking on Chinese volumes, and demonstrate the importance of considering domestic freight from a cost curve perspective. Our Rest of World analysis identifies ~140mtpa of existing supply which would be uneconomic by 2016 at $90/t; however, we believe that the economics of 'Big 3' expansion tonnage from Australia and Brazil is robust at, or even slightly below, the same $90/t level. Please refer to our separate equities report for a discussion of specific stocks. If the supply side behaves rationally, then consensus price forecasts correlate pretty well with our cost curve model over 2014-2016, but our own price forecasts cut well into the 80-90th percentile of the cost curve. We demonstrate how ones view on China can generate 2016 price expectations anywhere from $76 to 119/t based on cost curve support.
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21 August 2013
Table of Contents
Summary Global Iron Ore Cost Curve Review Three sections to this report Commodity Price Implications China Summary Questioning the price elasticity thesis The Freight Barrier The Grade Debate China's Cost Base is Price Elastic A Closer Look at Freight Impact of a Larger and Lower Cost China Rest of World Existing supply Growth projects Cost Curves Appendices Definitions Standardization of Key Assumptions China Iron Ore and Steel Production by Province Authors & Contributors 3 3 3 4 6 6 6 8 11 12 13 17 18 18 19 21 27 27 28 29 30
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Summary
Global Iron Ore Cost Curve Review
This report provides an update of the Credit Suisse Iron Ore cost curve, which we first published in December 2012 (click here). Our new forecasts are based on our analysts' latest company models. As a reminder, we feel our approach to building an iron ore cost curve is a little different to others due mainly to the adjustments we make for realized pricing (applied as a cost offset). Both the December 2012 report and the Appendix to this report discuss our methodology and underlying assumptions in a little more detail.
Exhibit 2: 2016 curve (China: 250mtpa, excl domestic freight)
Blue = CS price fcst, Red = consensus price, Black = demand
160 140
Exhibit 3: 2016 curve (China: 360mtpa, incl domestic freight) ROW cost support doesn't kick in until $77/t
160 140 120 100 80 60 40 20 0
120 100 80 60 40 20 0
100
200
300
CLF
400
500
600
700
800
900 1000 1100 1200 1300 1400 1500 1600

Other
Reported Cash Cost (FOB) All-In Cash Cost (FOB) All-In 62% IODEX equiv (CFR)
100
200
300
CLF
400
500
600
700
800
900 1000 1100 1200 1300 1400

Other
BHP.AX
FMG.AX
KIOJ.J
Million tonnes per annum RIO.AX VALE.N China
BHP.AX
FMG.AX
KIOJ.J
Although we've not explored the impact of FX in this report, it is clearly an important driver of iron ore economics at the moment, and something a lot of investors are asking us about. All of the curves we present are based on our 'base case' macro assumptions (refer Appendix) but our model does allow us to test spot, or any other scenario. Please contact your Credit Suisse sales person for data requests.
Three sections to this report

This report has three sections: (1) China: We test consensus thinking on China price elasticity, and demonstrate why China could be a i) much larger and ii) much lower cost producer on a long term basis than the consensus thesis currently suggests. Our scenario analysis explains how we could generate a 2016 cost curve which looks more like Exhibit 3 than the 'regular' cost curve shown in Exhibit 2. (2) Rest of World: Our global analysts' cost estimates have been leveraged to review tonnages in our S/D model which are at threat in a $90/t price environment (current CS long term view). We split this into i) growth and ii) existing supply. The most material 'growth' projects from our S/D model are from Australia and Brazil, and these projects generally have robust economics at, or even slightly below, $90/t. We believe the 'Big 3' will keep building. Perhaps the more interesting finding is that we have ~140mtpa of existing ROW supply, which based on current estimates is uneconomic in a $90/t price environment. (3) Cost Curves: For each year (2013-2016) we show the cost curve with and without the Chinese domestic freight cost adjustment (mentioned above, and discussed in further detail below). Our estimates are all provided on a nominal basis. China may be bigger, and lower cost, than current consensus thinking suggests
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Parallel 'Equity Implications' report Parallel to the cost curve report you are currently reading, we have also published a global equity implications report today entitled 'Iron Ore Equities: Equity Implications of our Cost Curve Update', containing our top picks in the space, highlighting our most differentiated calls, and discussing how our cost curve analysis impacts the individual companies. Parallel 'Equity Implications' report for sector top picks
Commodity Price Implications

Exhibit 4: Credit Suisse Iron Ore price forecasts relative to consensus range and mean
140
130
US$/t (62% IODEX)
120 110 100 90 80 Q4 13 Q1 14 Q2 14 Q3 14 2013 2014 2015 2016
Source: Bloomberg, Credit Suisse Commodity Research estimates
Perhaps the most differentiating feature of this report is the analysis we have done on Chinese domestic freight costs. This analysis is discussed in detail below, and the potential impact is summarised above in Exhibit 2 and Exhibit 3.
Exhibit 5: Cost curve intercepts using 'regular' curve (ignores China domestic freight)
170 150 130 118 94 157
Exhibit 6: Cost curve intercepts using 'adjusted' curve (includes China domestic freight)
170 157 150
128
108 86
124 98
78
119 93
130 110 102 90 70 50
114
110 90 70
50
106 93 79 92 76
76
89
101
89
76
2013
100th percentile CS fcst
2014
2015
2016
75th percentile
2013 100th percentile CS fcst
2014
2015
2016 75th percentile
90th percentile Consensus fcst
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities Research estimates
Source: Company data, Credit Suisse Securities Research & Analytics and Commodities Research estimates
Exhibit 5 and Exhibit 6 summarise the commodity price read-throughs on each of these two cost curve scenarios: In our view, the consensus price (red line) seems to fit pretty well with our 'adjusted' cost curve. This scenario requires uneconomic excess supply in China and elsewhere to turn off in a disciplined and orderly fashion, thereby avoiding a supply surplus. If the supply side behaves rationally, then the Credit Suisse price deck is probably too bearish. The Credit Suisse price deck implies deep cuts into the top end of the cost curve, that provide a more dramatic signal for excess supply to shut down. Depending on the cost curve model used, our price deck over the next few years cuts as far down as the 80-90th percentile of the cost curve.
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In our view, the most important question iron ore investors should be asking is whether or not China's domestic volume will be price elastic. This will have more impact on your LT view of pricing than mulling over 'Big 3' ramp up profiles. If the answer is 'yes, entirely', then Chinese domestic supply falls to 120-126mtpa (from CSe 360mtpa in 2013, 62% equiv) There's only 10-20mtpa of excess ROW supply in our model, and The 2016 cost curve support sits at $101-119/t, depending on your view of Chinese costs
China's domestic supply is should be investors' focus
But if the answer is 'no', then: Perhaps Chinese domestic supply stays flat at current ~360mtpa There's around 260mtpa of excess ROW seaborne supply by 2016, and The 2016 cost curve support sits at around $77/t, for the highest cost non-China supplier
The correct answer lies somewhere in between. Exhibit 7 might assist with framing these questions and their commodity price implications.
Exhibit 7: Where does iron ore cost curve support sit in 2016? Do you believe we ought to net domestic freight off Chinese mine gate costs to generate a China cost curve? Yes No Cost curve support is at $101/t Cost curve support is at $119/t Chinese production falls to ~126mtpa Chinese production falls to ~120mtpa (62% equiv) (62% equiv) ROW excess supply of less than ROW excess supply of less than 20mtpa 10mtpa
Do you believe that China's domestic supply is price elastic?
Yes No
Chinese curve support remains at $119/t, as above However if China is price inelastic ROW cost curve support is more relevant, and this doesn't kick in until $77/t Chinese production remains at 2013 levels of ~360mtpa (62% equiv) ROW excess supply of roughly 260mtpa
Although there is no end to the desk top analysis we can do on this subject and the range of scenarions we can create, there is really only one conclusion we can have absolute conviction on The supply side will not behave rationally Although our excel model might forecast the 'perfect world', game theory suggests that many sub-economic producers will continue to use shareholder capital to oversupply the market. This will depress pricing for the entire market, and we would not be shocked to see short term price fluctuations down to as low as $50/t at some point in the next 2-3 years. Unprofitable supply will continue to operate for much longer than it should. Labor commitments, infrastructure commitments, and supply contracts all complicate the game theory decision making process. All we know for certain is that the supply response will not be rational
21 August 2013
China
Summary
The consensus thesis on Chinese domestic iron ore production says that it is highly price elastic, and longer term Chinese domestic supply shrinks and makes way for growth from the first and second quartile (mainly Australia and Brazil). The objective of our 'China' section below is to i) show that there are a number of reasons why investors should query the price elasticity thesis, and ii) illustrate the impact that a non-price elastic China can have on the cost curve and hence iron ore pricing (i.e. how to get from Exhibit 8 to Exhibit 9).
Exhibit 8: 2016 curve (China: 250mtpa, excl domestic freight)
160 140
With contributions from: Scott Chui - China Capital Goods Research (Hong Kong) Wenzhe Zhao - Global Strategy research (New York)
Exhibit 9: 2016 curve (China: 360mtpa, incl domestic freight)

160 140 120 100 80 60 40 20 0
120 100 80 60 40 20 0
100
200
300
CLF
400
500
600
700
800
900 1000 1100 1200 1300 1400 1500 1600

Other
100
200
300
CLF
400
500
600
700
800
900 1000 1100 1200 1300 1400

Other
BHP.AX
FMG.AX
Million tonnes per annum KIOJ.J RIO.AX VALE.N China
BHP.AX
FMG.AX
Questioning the price elasticity thesis

This time last year most industry watchers were focused on the idea of "Chinese cost curve support" and why the iron ore price could never fall below $120/t. Iron ore subsequently fell to $87/t, and while there was some volume response from China in 2012, the '$120/t floor theorists' have been notably absent in 2013.
Exhibit 10: Chinese domestic iron ore production and 62% IODEX
140
210
180
Monthly domestic Chinese production (mt)
120 100 80 60 40 20 0 Jan 09 Jan 10 Jan 11 Volume Jan 12 Iron Ore Jan 13
120 90 60 30 0
Source: Bloomberg, TSI, Credit Suisse estimates
Iron Ore (US$/t)
150
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At the extremes, we have seen estimates for long term Chinese domestic supply ranging from 200mtpa up to 550mtpa i.e. a 350mtpa spread. One's view on China's domestic industry is comparable in magnitude to 100% of Vale, the world's largest iron ore producer. We'd suggest that an analysis of China's domestic iron ore industry is more relevant to forming a view on the long term commodity price than debating bullish/bearish scenarios for Big 3 ramp up. Reasons why investors should question China's price elasticity We can see a number of reasons to question the traditional Chinese price elasticity thesis: The freight barrier. Although most iron ore investors are accustomed to thinking about mine to port rail costs and seaborne freight, we are surprised that Chinese domestic freight doesn't get as much attention. The cost of freight in China does however 'shelter' a large portion of the domestic industry (~160mtpa of 62% equivalent supply comes from inland provinces), effectively creating a barrier to entry for import competition. The Grade Debate. Statistical evidence to support a price / production relationship is weak, and we hypothesize whether China's observable grade depletion trend could in fact be a reversable trend. If so, mining at higher grades will structurally change the shape of the cost curve as we know it today. China's cost base is price elastic. Although we think the price elasticity of Chinese volumes is low, a look at regional cost structures shows that the price elasticity of China's cost base is probably one of the highest in the world. 40% of the China cost base is a function of the iron ore price. As prices move lower, these price-linked costs will decrease. Reasons to question the consensus thinking on China
Each of these topics is discussed in more detail below. A more comprehensive analysis of this subject would also look at the growing importance of captive SOE supply. Although the ownership structure of the iron ore industry is a little different to that of steel, steel investors will be well aware that when it comes to China a lack of profitability is not sufficient to see excess capacity removed. China does not always behave as a market based economy.
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The Freight Barrier

Iron Ore growth has been inland, not along the coast It is well known that over the past 5 years China's steel industry has been moving towards the coast (Exhibit 11). Less well known, but an equally relevant trend in our view, is that growth across China's Inland iron ore provinces has outpaced that of coastal provinces. The consequence of this inland iron ore growth is that Coastal provinces now only contribute ~55% of domestic supply, down from over 70% just a few years ago.
Exhibit 11: Percent production from Coastal provinces
75%
Exhibit 12: YoY growth in coastal / inland iron ore volumes 100%
Contribution from Coastal Provinces
70%
65% 60%
80%
60%
40% 20% 0% 2005 2006 2007 2008 2009 2010 2011 2012 2013 -20%
Coastal
Source: Bloomberg, Credit Suisse estimates
55%
50% 45% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Iron Ore Steel
Inland
Iron Ore investors should appreciate the importance of freight when understanding mine economics. While many of us are quite used to making freight adjustments between the mine and port, or the port (FOB) and the customer (CFR), most investors neglect to consider freight and logistics costs at the customer end of the supply chain. Ignoring freight costs within China is akin to assuming that the entire country fits on the head of a pin. In our view, an understanding of China's domestic freight industry is critical to understanding the longer term competitive dynamic between imported and domestic material. Consider the following illustrative example: Imagine 'Mine A' which has mine gate costs of $150/t and typically services a local steel mill. Due to being located thousands of kilometres inland, transport costs between Mine A and the nearest port are say $100/t. Traditional thinking would suggest that in a $90/t CFR world our $150/t mine is $60/t out of the money, and we'd take it out of our S/D model, but For imports to actually compete with, and displace, Mine A their delivered cost is 90 + 100 = $190/t (Exhibit 13). In other words Mine A is actually $40/t in the money (190 150).
Alternatively, if we wanted to accurately depict the economics of competing supply on a CFR (coastal) basis, we could remove the same $100/t freight cost to get a CFR equivalent cost for Mine A of $50/t (Exhibit 14). Again, this puts Mine A $40/t in the money relative to our $90/t imports. The $100/t freight example above is just an example and actual costs are actually considerably lower. At the end of this section we develop a province by province freight cost model and show what the cost curve looks like with / without this adjustment (i.e. we replace the $100/t with proper estimates for each province).
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Exhibit 13: We ought to add freight to imports

200 150 100
Exhibit 14: Alternatively remove freight from domestic costs if you want to create a CFR (coastal) cost curve
200 150 100
50 0
Mine A
Source: Credit Suisse estimates
50 0
Transport Imports, CFR Mine A
Source: Credit Suisse estimates
Transport
Imports, CFR
Demographic Considerations Although China's demographic landscape is well understood by most, we will briefly recap for the benefit of those less familiar: GDP per capita in the inland provinces is generally a fraction of that observed along the coast (Exhibit 15), and we'd suggest that it is the inland provinces where much the urbanization / GDP catch up opportunity resides within China. Remember there are two ways to urbanize a country; you can take the people to the city, or the city to the people. Cultural ties to the land and willingness of the population to migrate are beyond the scope of this report, but might also be relevant to a more in depth analysis of this subject. Steel / iron ore is a high tonnage industry, and it is often not economic to transport these materials over thousands of kilometers, so if the population growth is inland, then the optimal location for the steel mill and the iron ore mine is inland as well. Clearly there are some geological considerations here though, which we touch on over page.
Our Demographics Research team recently published a piece titled 'Chinese Demographics Labour mobility, migration, urganisation and reforms' (click here) which is worth a look too, and was the source for the below charts.
Exhibit 15: GDP per capita by province (2011 RMB pp) Exhibit 16: Population by province (2011)
Source: NBS, Credit Suisse Demographics Research
Source: NBS, Credit Suisse Demographics Research
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Geological considerations Globally, iron ore is dominantly related to banded iron formation (BIF), which is essentially repeated thin layers of iron and silica one on top of the other. BIF is exclusively found in ancient Precambrian rocks (and mainly formed in the time period of 2500 to 1800 million years ago the Archean and early Proterozoic eons). BIF will not be found in younger rocks. Hebei, Shandong and Jilin Provinces have BIF along the Northern China Platform, and this is the major centre of iron ore production and exploration in China. Coincidentally, this iron ore province is also proximal to the coast. The pink 'Archeozoic' areas in Exhibit 17 illustrate the exposures of ancient rocks that can host BIF.
Exhibit 17: Geological Map of China
Source: China Geological Survey
Other less voluminous, but useful iron ore in China is found in skarn deposits, which are small but high grade. These are widespread, and being high grade will be widely exploited. Thirdly there are the magmatic deposits exemplified by the mighty irontitaniumvanadium Panzihua deposit in Sichuan. Panzihua is billions of tonnes in size and mined by a number of companies for all three minerals.
Given the importance of Panzihua and the BIFs for Chinas iron ore production, we lik ely already know the locations of Chinese iron ore mines which will be in operation 5 or even 10 years from now - as they will be defined by geology, and not demographics. We'd be surprised if iron ore production from China's Inland provinces will be decreasing as we look forward. Our broad assumption is that inland mines are servicing inland steel mills, and for various reasons it can be difficult for imports to penetrate these markets in volume. We estimate that over 160mtpa of China's 360mtpa (62% equivalent) domestic supply (45%) is coming from these inland provinces at the moment, so any conversation about China's price elasticity longer term should arguably be constrained to coastal volumes. Of the ~200mtpa being produced along the coast, a large portion will be SOE owned and a large portion will have better costs than imports. For the same reasons that
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the steel industry hasn't responded to a lack of profitability, coastal iron ore mines may not respond to a low price environment either.
The Grade Debate

Historical analysis suggests that China's domestic ore tonnes mined are somewhat price elastic (Exhibit 18). Perhaps unsurprisingly given our comments above, there is a higher degree of price elasticity (slope of the trend line) for coastal provinces than there is inland provinces.
Exhibit 18: Ore Volume against Iron Ore Price 70 y = 0.1539x + 37.482
60
Exhibit 19: Contained Iron against Iron Ore Price 15.0

Contained Iron Volume (mt)
12.5 y = 0.01x + 8.4792
Ore Volume (mt)
50 40
10.0
7.5 5.0
30
20 10 50 75 100 125 150 Iron Ore Price 62% IODEX Inland 175 200 y = 0.1216x + 22.227
y = 0.012x + 4.6374
50 75 100 125 150 Iron Ore Price 62% IODEX Inland Coastal 175 200
2.5
Coastal
There is another adjustment that can be made to this data however. Rather than just looking at crude (as reported) ROM tonnes (Exhibit 18), we can adjust for contained iron (i.e. grade) as well, as per Exhibit 19. Although the low correlation coefficients don't really change much, the interesting thing about Exhibit 19 is that the price elasticity is far lower. In fact it is pretty close to zero (again, we are referring to the slope/gradient of the trend line here).
Exhibit 20: Chinese domestic iron ore grades against commodity price 70%
Implied domestic ore grade
60%
Exhibit 21: Global gold grades and commodity price
Average Global Gold Grade (g/t)
40
2.2
50%
40% 30% 20% 10%
62% IODEX - INVERTED
80 120 160 200
2.0
1.8 1.6
300
600 900
1.4
1.2 1.0 1992 1997 Grade g/t 2002 2007 2012 Gold Price $/oz
1,200
1,500 1,800
0%
Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan 03 04 05 06 07 08 09 10 11 12 13
Grade % Fe 62% IODEX US$/t
240
Source: Wood Mackenzie, Credit Suisse estimates
The data seems to suggest that as the price of iron ore fluctuates, the ore tonnes change, but the contained iron does not. We suspect this observation may be the aggregate effect of a number of drivers: Low grade / high cost mines enter the market on an opportunistic basis when prices are high, dragging down the average head grade across the country.
Gold Price - INVERTED
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To the extend possible, mine plans are modified to exploit lower grade/high cost tonnes when prices are high and the mine can remain cash flow positive. On a longer term basis, we could also be observing a deliberate reallocation of mining resources from high to low grade mines in response to price.
Similar price / grade relationships can be observed in most other commodities. Exhibit 21 illustrates the point with gold. Just like any other iron ore region we've no doubt that depletion plays a part, but remember China is one of the largest iron ore producers in the world. The country holds billions and billions of tonnes in iron ore resources. Given that the average head grade from the Pilbara has fallen by perhaps 1 percent over the past decade, it seems improbable that China's multi-billion tonne resource base has fallen by 15-20% over the same period. The grade/tonnage curve simply can't be that steep. If part of China's observed grade trend can be reversed, then costs are likely to fall. A mine that extracts ore at say 15% ROM (run of mine, i.e. unprocessed ore) and produces a 64% Fe concentrate for cash costs of say $120/t, could produce the same 64% concentrate at $70-80/t if it was mining 25-30% ROM ore. We do not capture the impact of a changing grade profile in our cost curve. Our numbers essentially assume grade is kept flat.
China's Cost Base is Price Elastic

Not only could a change of mined grade have a favorable impact on Chinese production costs, but we think that in an absolute sense a lower price environment will do the same.
Exhibit 22: Cost Structure break down, by country
100% 80% 60% 40% 20% 0% Australia Brazil Canada China Mining Costs ($/tonne) Pelletising Costs ($/tonne) Royalty and Levies ($/tonne)
Source: Wood MacKenzie, Credit Suisse estimates
Guinea
India
Liberia Russia
Sierra Leone
South Ukraine Africa
USA
Processing Costs ($/tonne) Port Costs ($/tonne)
Transport Costs ($/tonne) Overheads ($/tonne)
According to Wood Mac estimates, roughly 40% of China's average production costs are associated with 'overheads, royalties and levies'. We consider most of this likely to be a derivative of the commodity price. 40% price-linked costs is higher than any other country in the world except maybe India, with the global average being closer to 20% (Exhibit 22). We suspect that a lot of this 40% represents 'price participation' on behalf of the authorities, much of which is likely opportunistic in nature and likely to reduce as prices fall and margins reduce. Anecdotes from China iron ore mine visits include people standing on the side of the road charging a toll to truck drives because they know they can afford it. When the price falls the truck driver can't afford the toll, and the person on the side of the road goes away and does something else. Simply put, the cost structure of the Chinese iron ore industry is probably one of the most price-elastic iron ore cost structures in the world. If you believe iron ore prices are lowering, you should expect all-in Chinese costs to more lower as well. For the purposes
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of our cost curve model we do not capture any of this cost elasticity. For conservatism, we in fact model 5%pa inflation on Chinese costs.
A Closer Look at Freight

The previous few pages have hopefully given readers cause to see why longer term China might not only be a bigger producer, but also a lower cost producer than consensus thinking suggests. Not only do we expect Chinese production costs to fall much more quickly than ROW putting more supply back in the money, but further we feel that the relevance of price in determining Chinese production decisions (elasticity) is overstated. China is not a market-based economy. The following section illustrates the potential cost curve impact of our domestic freight discussion above. Carrying on from the $150/t Mine A example with the $100/t freight costs, the following section actually derives provincial level estimates for both. Estimating the impact of domestic freight costs
Exhibit 23: Chinese freight transport, by mode Exhibit 24: Chinese 'Metal Ores' transported by rail
100%
400 350 300 250 200 150 100
80%
60%
40%
20% 0% 1970 1980 1990 2000 2008 2012
50 0
1992 1995 1998 2001 2004 2007 2010
Source: CEIC, Credit Suisse Equity Research (18 June 2013)
Railway
Highway
Waterway
Air
Pipeline
Source: Company data, Credit Suisse Equity Research (18 June 2013)
Although Waterway and Highway freight has taken significant market share from rail over the past few decades (Exhibit 23), we suspect that rail remains the main method for transporting iron ore over long distances given that: Rail is significantly faster than water Highway / trucking is the main method used over short distances, but over longer distances its costs are likely prohibitive.
Trucking is used extensively in Shanxi and the western part of Hebei, and our China team estimate this could cost as much as $10-20/t.
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Rail costing model With the help of our China Industrials team we've built a simple Chinese rail cost model, as summarized below.
Exhibit 25: Chinese Rail Freight costing model
Haulage Distance km 50 100 500 1000 Base rate 1 (variable) Rmb/t Rmb/t/km 13.8 0.28 13.8 0.14 13.8 0.03 13.8 0.01 Base rate 2 (fixed) Construction fund surcharge Rmb/t Rmb/t/km Rmb/t Rmb/t/km 3.77 0.08 1.65 0.033 7.53 0.08 3.30 0.033 37.65 0.08 16.50 0.033 75.30 0.08 33.00 0.033 Electrification surcharge Rmb/t Rmb/t/km 0.60 0.012 1.20 0.012 6.00 0.012 12.00 0.012 Loading/unloading Total Total
Rmb/t Rmb/t/km Rmb/t Rmb/t/km US$/t US$/t/km 22.4 0.45 42.22 0.84 6.90 0.138 22.4 0.22 48.23 0.48 7.88 0.079 22.4 0.04 96.35 0.19 15.74 0.031 22.4 0.02 156.50 0.16 25.57 0.026
Source: China Ministry of Railway, Credit Suisse estimates
Over short distances, the loading/unloading costs associated with rail are likely to make trucking more attractive, however on a pure operating cost basis rail looks more attractive for haulage in excess of 100km.
Exhibit 26: China Railway Map, from 12 Five Year Plan
th
Source: Chinese Ministry of Railways
The Three Gorges dam and lock system allows penetration of imported ores all the way up to Chongqing in 10kt vessels. BHP.AX does in fact sell its seaborne marketing into Sichuan province via this route. We don't have a waterway cost model, but it is our understanding that barging costs are in the order of $0.02 per tonne km. Nominating the mode of transport might therefore be relevant for capacity/volume based analysis, but for our high level economic based analysis the comparable costs mean that we do not need to differentiate between the two. The final step in our domestic freight cost analysis is to estimate distances. Rather than getting lost in the detail, we've done this on a provincial basis by considering the most likely port option for each province. Clearly in some cases there are multiple options, and for some of the larger provinces there would be significant
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variance from one side of the province to the other, but the averages we've used are summarized in Exhibit 27. Exhibit 26 is the Ministry of Rail map from China's 12 th year plan, and so far as possible we've tried to keep 'googlemaps' routing consistent with rail routing.
Exhibit 27 combines our estimated distances with our freight costing model (Exhibit 25) to generate a $/t rail cost / net back estimate for each province. Were imported material to be competing with domestic material in each of these provinces, the below seems to be a reasonable assumption regarding potential routing. This final freight column below has been removed /netted off our mine gate cost estimates in the scenarios which follow.
Exhibit 27: Chinese domestic freight costs Credit Suisse estimates
Province Anhui Beijing Fujian Gansu Guangdong Guangxi Guizhou Hainan Hebei Low/Mid Hebei High Heilongjiang Henan Hubei Hunan Inner Mongolia Jiangsu Jiangxi Jilin Liaoning Low/Mid Liaoning High Qinghai Shaanxi Shandong Shanxi Sichuan Xinjiang Yunnan Zhejiang Mean (volume weighted) ROM 2012 Output (Mt) 46 20 14 11 22 4 1 6 184 347 5 15 23 8 92 2 19 17 25 129 2 12 154 81 163 29 26 2 Port Shanghai Tianjin Quanzhou Qigdao Guangzhou Zhanjiang Zhanjiang Basuo Tianjin Tianjin Dalian Rizhao Liangyungang Xiamen Tianjin Shanghai Xiamen Dalian Dalian Dalian Tianjin Rizhao Qingdao Tianjin Rizhao Tianjin Zhanjiang Shanghai Distance (km) 470 140 200 1,830 50 330 880 50 334 334 935 575 840 870 620 150 690 690 360 360 1,720 1,000 100 550 1,750 3,200 1,100 170 571 Freight (US$/t) 15 9 10 43 7 13 24 7 13 13 25 17 23 23 18 9 20 20 13 13 40 26 8 17 41 70 28 9 17
The same data is shown in Exhibit 28, and in the Appendix to this report we have a map of China which shows both iron ore and steel production by province. Regarding Exhibit 28: The diagonal lines illustrate the divide between material which is economic and material which is not (based on the freight net back from coast) at $80, $100 and $120/t. y axis value less x axis value = grey line. On a 2013 basis, our methodology implies that 36% / 129mtpa of Chinese domestic tonnage is uneconomic at $100/t, 49% / 177mtpa at $90/t, and 70% / 251mtpa at $80/t A more comprehensive analysis of this subject would look at ownership structures (i.e. SOE v private) and raw material switching costs for the steel mill. As any steel analyst will tell you, just because an industry is unprofitable in China doesn't mean it will cease to produce.
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Also recall our earlier discussion of cost elasticity. To demonstrate the sensitivity to costs, consider a scenario where the entire Chinese industry were capable of lowering their cost base by 20%. The volumes quoted above become 0.5% / 2mtpa at $100/t, 2% / 9mtpa at $90/t, and 37% / 132mtpa at $80/t.
Exhibit 28: Chinese provincial iron ore production Bubble diameter represents production (mtpa), and 80/100/120 lines indicate the theoretical divide between tonnage which would be economic, and tonnage which is not
180 160 140 120 100
$120
$100 $80
Mine Gate Cost (US$/t)
80
60 40 20
10
20 30 40 50 60 70 Estimated freight net back, from closest port (US$/t)
80
Mine verse Steel Mill net back? We have 'netted back' the China domestic freight costs based on the mine location, and not the steel mill location. Readers would be right to query whether this is the best approach, given that it is the steel mills' location which determines the clearing price for iron ore and it is at the steel mill that the imports v domestic raw material battle takes place. Our broad assumption is that inland mines are servicing inland steel mills. Exhibit 11 shows that there is only a 7% difference between the volume of iron ore produced by coastal provinces (53%) and the volume of steel produced by coastal provinces (60%). Therefore using a steel mill rather than iron ore mine net back would only change our overall freight overlay by 7%, which we consider less than our forecasting error.
In the next section of this report we use our in house model to demonstrate how the above concepts may impact the cost curve.
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Impact of a Larger and Lower Cost China

Using our 2016 cost curve as a case study, we set out four basic steps: Step 1 / Exhibit 29: start with a 'regular' iron ore cost curve (in which domestic freight costs are ignored). We've used the Credit Suisse 2016 estimates as a case study. The Step 1 data is repeated on Step 2 4 charts as a grey outline. Step 2 / Exhibit 30: Adjust Chinese domestic production for domestic freight costs i.e. net them back to a CFR equivalent cost
Exhibit 30: Step 2: Adjust China Cost base for domestic freight
160 140
Exhibit 29: Step 1: Start with a 'regular' 2016 cost curve (ignores China domestic freight)
160 140
Cost curve support at $120/t
120 100 80 60 40 20 0
120 100 80 60 40 20 0
100
200
300
CLF
400
500
600
700
800
900 1000 1100 1200 1300 1400 1500 1600

Other
100
200
300
CLF
400
500
600
700
800
900 1000 1100 1200 1300 1400 1500 1600

Other
BHP.AX
FMG.AX
BHP.AX
FMG.AX
Step 3 / Exhibit 31: Instead of shrinking Chinese supply to 250mtpa (as per our existing S/D model), keep it flat at 360mtpa (CSe 2013, 62% equivalent). Step 4 / Exhibit 32: make room for the extra 110mtpa of Chinese domestic material by removing 200mtpa ROW supply
Exhibit 32: Step 4: Remove excess ROW supply to balance supply with demand
160 140
Exhibit 31: Step 3: Keep Chinese production flat at 360mtpa (rather than reducing to 250mtpa)
160 140
Cost curve support at $120/t or $77/t for ROW
120 100 80 60 40 20 0
120 100 80 60 40 20 0
100
200
300
CLF
400
500
600
700
800
900 1000 1100 1200 1300 1400 1500 1600 1700

Other
100
200
300
CLF
400
500
600
700
800
900 1000 1100 1200 1300 1400

Other
BHP.AX
FMG.AX
BHP.AX
FMG.AX
KIOJ.J
Clearly there are some fairly significant implications to ROW iron ore supply and the commodity price here: The 'regular' cost curve (Step 1) suggests cost curve support at $119/t, but Our adjusted cost curve (Step 4) doesn't show ROW support until we get to around $77/t for ROW. If China is price inelastic then the top of the China cost curve at $120/t is irrelevant.
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Rest of World
The 'Rest of World' section of this report is split into two sections: Existing supply. We look at supply/demand surpluses in the next section of this report, but we've leveraged our cost curve to demonstrate how much of the tonnage currently in our S/D model which is out of the money under various pricing scenarios. We can see around 375mtpa of 2016 supply which is out of the money at $90/t iron ore, 140mtpa of which is ROW/ex-China. New projects. The new project tonnage estimates, dominated by Australia and Brazil, appear fairly robust. Our analysis has involved a review of 465mtpa of 'growth' capacity, for which we have looked at outstanding capex, anticipated operating margins, and from the two derived an estimated ROI. This analysis suggests that the economics of most Australian and Brazilian growth projects appear fairly robust, even at price levels slightly below $90/t, however by the time we get down to around $70/t the volume of economic expansion tonnage does fall off quite quickly. Our separate titled 'Iron Ore Equities: Equity Implications of our Cost Curve Update' discusses individual companies and their expansion projects in a little more detail and should be read in conjunction with the below.
Existing supply
Exhibit 33: Existing GLOBAL supply which become UNeconomic in 2016
400
Existing supply UNeconomic (mtpa)
350 300
250 200 150 100

50 0 135
Although we can see why the market focuses on '$120/t' we query whether this is really a 'floor'
$105 - 115/t appears to be a more notable resistance level
130
125
120
115 110 105 62% IODEX (US$/t)
100
95
90
China
Australia
North America
Brazil
Europe
Our 62% IODEX normalized cost curve provides a convenient tool with which to assess the economics of existing supply. In a theoretical world, 'out of the money' supply from ROW should turn off in an orderly fashion and prices should stabilize at the top end of the cost curve. As we noted earlier though, about the only thing we can be sure of here is that the real world will not operate the same as our theoretical world. Exhibit 33 and Exhibit 34 illustrates the existing 2016 supply volumes from our S/D and cost curve models that becomes uneconomic at various pricing points. Although we can see why the market has become emotionally attached to $120/t level, as discussed earlier in this report we feel that the manner in which China will respond to this pricing level has been over stated. A more significant 'cost floor' based on our modeling exists within the $95-110/t range. Within this range almost 120mtpa of existing ROW
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supply becomes uneconomic across Australia, North America and Europe. By the time we get to $90/t, we see just over 140mtpa of ROW supply which is out of the money.
Exhibit 34: Existing ROW supply which become UNeconomic in 2016
Capacity which is uneconomic (mtpa)
160 140 120 100
80
60 40 20 0 110 105 100 62% IODEX (US$/t) North America Brazil 95 90
Australia
Europe
All of our cost analysis is done on a CFR China basis. Although the intent is to create a consistent and level playing field in order to compare economics globally, this approach is arguably a little unfair to European producers. Very little European supply actually makes it all the way to China, and although the economics don't look very appealing when we add a hefty freight charge to 'normalize' it to China, the economics are far more attractive when the actual freight costs (for local delivery) are used. Most of the 59mtpa uneconomic European supply shown in Exhibit 34 (CFR China basis) actually is economic when delivered into local markets. The same logic might apply to some of the Brazilian and North American supply too.
Growth projects
Our analysis of growth projects has involved a review of around 25 global iron ore projects. For each project we consider incremental supply added, outstanding/uncommitted capex, and anticipated operating margins. The margin divided by the (outstanding) capital intensity is then used to calculate a pre-tax ROI for each project. By applying a 25% ROI hurdle, we generate Exhibit 36. Australian and Brazilian growth forecasts generally appear robust at, or even slightly below, $90/t. This is supportive of the long term thesis on iron ore; which says that the Big 3 (BHP, RIO, Vale) will continue to add capacity displacing more and more of the third and fourth quartiles. Australian and Brazilian growth economics start to look shaky at $70-80/t, but this is below our current LT price forecast. This very crude analysis says that Africa (Simandou) needs >$100/t iron ore to generate a 25% ROI. India and European growth projects are a 'drop in the ocean' relative to the tsunami impact of Australia and Brazilian growth.
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Exhibit 35: Market share of Top 3 and Top 10 producers, by commodity

100 90 80 70 60 50 40 30 20 10 0
Nickel
Palladium
Platinum
Copper
Silver
Top 10
Top 3
Source: Wood Mackenzie, Company data, Credit Suisse Securities Research & Analytics
We expect iron ore to remain an oligopoly. Although we are confident that Big 3 growth projects will happen, we are less confident on the timing. The oligopoly can (and will) hold back supply in order not to flood their own market. The game theory discussions which take place at board meetings must be fascinating
Exhibit 36: New supply growth generating >25% ROI
New supply which is Economic (mtpa)
500 450 400 350 300 250 200 150 100 50 0 70 75 80 85 90 95 100 105 110 115 120 125 130 62% IODEX (US$/t) Brazil Africa Europe India
Australia
Source: Company data, Credit Suisse Securities Research & Analytics
Metallurgical coal
Zinc
Iron Ore (seaborne)
Thermal
Aluminium
Iron Ore (total)
Lead
Gold
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Cost Curves
The third and final section of this report provides an update of our annual cost curves. Coverage and Commodity Price Implications Our cost curve model has an estimated 91 - 94% 'coverage' of our supply/demand model. The 6 9% shortfall is tonnage which we can see fairly easily in various trade data sources (and hence include in the S/D model), but which we have been unable to confidently estimate costs for.
Exhibit 37: Cost Curve coverage
2013 Supply China Domestic Production (62%) Seaborne Supply Cost curve target Cost curve target Cost curve actual Cost curve coverage Uncosted tonnes Demand World Steel Production China Steel Production Seaborne demand China Domestic Production (62%) Total demand Total demand (scaled for CC coverage) Excess supply mt mt mt (dry) mt (dry) % mt (dry) 360 1,211 1,571 1,497 1,362 91% 134
2014 320 1,381 1,701 1,620 1,488 92% 132
2015 300 1,500 1,800 1,714 1,608 94% 107
2016 250 1,603 1,853 1,765 1,647 93% 118
mt mt mt mt mt mt (dry) mt (dry)
1,575 755 1,205 360 1,565 1,352 10
1,634 779 1,295 320 1,615 1,408 81
1,683 806 1,348 300 1,648 1,468 140
1,730 833 1,436 250 1,686 1,493 154
Given that we are missing 111 139mt of supply from our cost curve model in any given year, in order to show a 'demand' line on our charts we've had to scale our raw demand numbers by the cost curve coverage factors (91-94%) as shown above. This 111 139mtpa of uncosted supply is pretty important to understanding the supply response in coming years. By 'scaling' our demand number to match our 91-94% coverage, the implicit assumption is that this uncosted tonnage is distributed evenly across the cost curve. The reality, we suspect, is that most of it would reside within the third and fourth quartiles. Through 2013 2016 we can see 6 to 148mtpa of excess supply, which will obviously cut into the top end of the cost curve. In a theoretical world, this excess 'out of the money' tonnage would turn off, and price would stabilize. Exhibit 38 and Exhibit 39 summarise the commodity price read-throughs on each of these two cost curve scenarios: In our view, the consensus price (red line) seems to fit pretty well with our 'adjusted' cost curve. This scenario requires uneconomic excess supply in China and elsewhere to turn off in a disciplined and orderly fashion, thereby avoiding a supply overhang. If the supply side behaves rationally, then the Credit Suisse price deck is probably too bearish. The Credit Suisse price deck implies deep cuts into the top end of the cost curve, that provide a more dramatic signal for excess supply to shut down. Depending on the cost curve model used, our price deck over the next few years cuts as far down as the 80-90th percentile of the cost curve.
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In our view, the most important question iron ore investors should be asking is whether or not China's domestic volume will be price elastic. This will have more impact on your LT view of pricing than mulling over 'Big 3' ramp up profiles. If the answer is 'yes, entirely', then Chinese domestic supply falls to 120-126mtpa (from CSe 360mtpa in 2013, 62% equiv) There's only 10-20mtpa of excess ROW supply in our model, and The 2016 cost curve support sits at $101-119/t, depending on your view of Chinese costs
China's domestic supply is should be investors' focus
Exhibit 38: Cost curve intercepts using 'regular' curve (ignores China domestic freight)
170 150 130 118 94 157
Exhibit 39: Cost curve intercepts using 'adjusted' curve (includes China domestic freight)
170 157 150
128
108 86
124 98
78
119 93
130 110 102 90 70 50
114
110 90 70
50
106 93 79 92 76
76
89
101
89
76
2013
100th percentile CS fcst
2014
2015
2016
75th percentile
2013 100th percentile CS fcst
2014
2015
2016 75th percentile
But if the answer is 'no', then: Perhaps Chinese domestic supply stays flat at current ~360mtpa There's around 260mtpa of excess ROW seaborne supply by 2016, and The 2016 cost curve support sits at around $77/t, for the highest cost non-China supplier
Do you believe we ought to net domestic freight off Chinese mine gate costs to generate a China cost curve? Yes No Cost curve support is at $101/t Cost curve support is at $119/t Chinese production falls to ~126mtpa Chinese production falls to ~120mtpa (62% equiv) (62% equiv) ROW excess supply of less than ROW excess supply of less than 20mtpa 10mtpa Chinese curve support remains at $119/t, as above However if China is price inelastic ROW cost curve support is more relevant, and this doesn't kick in until $77/t Chinese production remains at 2013 levels of ~360mtpa (62% equiv) ROW excess supply of roughly 260mtpa
Exhibit 40: Where does iron ore cost curve support sit in 2016?
Do you believe that China's domestic supply is price elastic?
No
Yes
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The correct answer lies somewhere in between. Exhibit 40 might assist with framing these questions and their commodity price implications. Although there is no end to the desk top analysis we can do on this subject and the range of scenarions we can create, there is really only one conclusion we can have absolute conviction on: The supply side will not behave rationally Although our excel model might forecast the 'perfect world', game theory suggests that many sub-economic producers will continue to use shareholder capital to oversupply the market. This will depress pricing for the entire market, and we would not be shocked to see short term price fluctuations down to as low as $50/t at some point in the next 2-3 years. Unprofitable supply will continue to operate for much longer than it should. Labor commitments, infrastructure commitments, and supply contracts all complicate the game theory decision making process.
th th th
All we know for certain is that the supply response will not be rational
Exhibit 41: 2016 cost curve, highlighting the 75 / 90 / 100 percentiles as discussed above
Blue = CS price fcst, Red = consensus price, Black = demand, Grey = cost curve without China domestic freight adjustment
160 140
100th
90th 75th
120 100 80 60 40 20 0
excess supply
100
200
300
CLF
400
500
600
700
800
900 1000 1100 1200 1300 1400 1500 1600

Other
BHP.AX
FMG.AX
Refer Appendix for further discussion on methodology As a reminder, we feel our approach to building these cost curves is somewhat differentiated due to the pricing premium/penalty we use as an offset to the cost base. For further details on the methodology and our underlying assumptions please see the Appendix to this report.
23
100 80 60 40 20 0
100 80 60 40 20 0
Exhibit 42: 2013 Cost Curve (ignoring China domestic freight)

160 140 120
Exhibit 43: 2013 Cost Curve (with China domestic freight)

160 140 120 100 80 60 40 20 0
100
200
300
CLF
400
500
600
700
800
900 1000 1100 1200 1300

Other
100
200
300
CLF
400
500
600
700
800
900 1000 1100 1200 1300

Other
BHP.AX
FMG.AX
BHP.AX
FMG.AX

160 140 120

160 140 120 100 80 60 40 20 0
100
200
300
CLF
400
500
600
700
800
900 1000 1100 1200 1300 1400

Other
100
200
300
CLF
400
500
600
700
800
900 1000 1100 1200 1300 1400

Other
BHP.AX
FMG.AX
BHP.AX
FMG.AX
21 August 2013
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100 80 60 40 20 0
100 80 60 40 20 0

160 140 120
Exhibit 47: 2015 Cost Curve (with China domestic freight)

160 140 120 100 80 60 40 20 0
100
200
300
CLF
400
500
600
700
800
900 1000 1100 1200 1300 1400 1500 1600

Other
100
200
300
CLF
400
500
600
700
800
900 1000 1100 1200 1300 1400 1500 1600

Other
BHP.AX
FMG.AX
BHP.AX
FMG.AX

160 140 120

160 140 120 100 80 60 40 20 0
100
200
300
CLF
400
500
600
700
800
900 1000 1100 1200 1300 1400 1500 1600

Other
100
200
300
CLF
400
500
600
700
800
900 1000 1100 1200 1300 1400 1500 1600

Other
BHP.AX
FMG.AX
BHP.AX
FMG.AX
21 August 2013
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Exhibit 50: Supply/Demand Model (Last Updated June 2013) Mt 2011 2012 China Crude Steel Production 695 717 % Change 10.9% 3.2%
2013 755 5.3% 820 2.0% 1,575 3.6%
2014 779 3.2% 855 4.3% 1,634 3.7%
2015 806 3.5% 877 2.6% 1,683 3.0%
2016 833 3.3% 897 2.3% 1,730 2.8%
World ex-China Steel Production % Change World Steel Production % Change Chinese statistics Total Chinese IO Demand % Change Domestic Production (62%) % Change Iron Ore Inventories at Port % Change Seaborne demand (imports) China % change World ex-China % change World % change Seaborne supply (exports) Australia % change Brazil % change India % change Other LatAm % change South Africa % change Other Africa % change North America % change EU27 % change RUK % change Other % change World % change Required Market Adjustment
796 4.0% 1,491 7.1%
804 1.1% 1,521 2.0%
1,055 13.1% 418 16.8% 98 34.4% 7.4488569 687 11.0% 442 -0.3% 1,129 6.3%
1,088 3.2% 353 -15.6% 73 -25.7% 5.1014018 746 8.5% 404 -8.7% 1,149 1.8%
1,134 4.2% 360 2.0% 83 13.5%
1,163 2.6% 320 -11.1% 95 13.9%
1,197 2.9% 300 -6.3% 100 5.9%
1,230 2.8% 250 -16.7% 102 2.0%
783 5.1% 421 4.4% 1,205 4.8%
855 9.1% 440 4.5% 1,295 7.5%
902 5.6% 446 1.2% 1,348 4.1%
982 8.8% 454 1.8% 1,436 6.5%
439 9.2% 331 6.4% 81 -24.3% 26 7.1% 53 11.2% 12 16.1% 34 13.0% 9 1.1% 73 9.0% 71 31.5% 1,129 6.3% ---
494 12.5% 327 -1.3% 35 -56.8% 28 5.3% 54 1.3% 20 65.8% 36 4.9% 9 2.9% 73 0.3% 74 5.1% 1,149 1.8% ---
573 16.1% 321 -1.8% 5 -85.8% 29 3.3% 59 8.2% 34 69.3% 40 11.2% 10 5.1% 74 0.4% 69 -7.1% 1,211 5.4% 7
674 17.6% 361 12.4% 17 240.0% 32 12.3% 59 1.0% 42 23.8% 44 11.0% 10 10.4% 74 1.1% 68 -2.1% 1,381 14.0% 86
724 7.3% 415 15.0% 25 47.1% 32 0.0% 59 0.0% 53 27.7% 39 -10.5% 10 0.0% 74 -0.7% 69 1.9% 1,500 8.6% 152
791 9.4% 438 5.7% 25 0.0% 32 0.0% 59 0.0% 63 18.8% 40 1.2% 11 3.0% 74 0.7% 70 0.9% 1,603 6.9% 167
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Appendices
Definitions
To the extent possible, we have included three different cost categories for our global iron ore cost curve. It is the second, and particularly third of these categories which we believe makes our iron ore cost curve unique. Reported Cash Cost (FOB) represent cash costs as reported by the company (where available) or as derived by our regional analysts from site visits or company presentations. Iron Ore miners are often inconsistent with the items they chose to include in their reported cash cost number. Unlike some other metals industries, iron ore miners have not adopted Brook Hunt/Wood Mac conventions. Most industry consultants will typically only use costs to this level. All-In Cash Cost (FOB): Our all in cash cost assessment is the same as above except that we also include indirect operating items such as royalties, corporate costs and sustaining capital. This is essentially the all-in cost of doing business. It does not however include interest/financing costs or corporate taxes. All-In 62% IODEX Equivalent (CFR): The final cost element we show includes two further adjustments; being freight and pricing premium/penalty. The freight adjustment changes our units from FOB to CFR China. For every individual product and project we have also made an assessment of its pricing premium/penalty relative to the 62% IODEX fines price. Realized pricing premiums/penalties are subtracted/added to the CFR costs basetherefore we effectively normalize everything into 62% IODEX terms. This is akin to adjusting a gold cost curve for a copper by-product. We have not seen any other cost curves that do this, but we feel it is an essential step in order to accurately compare mine profitability. We are in effect constructing a margin curve rather than a raw cost curve, and it means that unlike others, we are able to draw a horizontal pricing line straight across our chart.
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Standardization of Key Assumptions

The Reported Cash Cost and All-In Cash Cost (both FOB) have been provided from our respective analysts, and are in nominal terms. Although quoted in US$, these assumptions use the house view on exchange rates, as summarized below. Key assumptions are standardized across all products and regions. We are very aware that the topic of iron ore pricing / VIU is a complicated one and depends on significantly more variables than grade alone. For the purposes of this exercise however, we have had to simplify it somewhat.
2012 Currencies US $1 = US $1 = US $1 = US $1 = US $1 = US $1 = Pricing Pellet Premium Grade premium (concs) Grade premium (fines) 62% IODEX 58% IODEX Freight Australia Brazil South Africa West Africa North America Norway 2013 2014 2015 2016
Exhibit 51: Key Macro Assumptions (Base Case)
AUD BRL CAD CNY EUR ZAR
0.97 1.96 1.00 6.31 0.78 8.17
0.98 2.20 0.99 6.30 0.76 9.63
1.09 2.26 1.00 6.37 0.79 10.00
1.15 2.31 1.01 6.47 0.83 9.50
1.17 2.37 1.02 6.55 0.83 9.00
$/t US$ per 1% Fe US$ per 1% Fe US$/t US$/t
20 2.93 2.93 125 114
30 2.5 2.5 119 109
30 2.6 2.7 96 86
30 2.7 2.9 97 86
30 2.8 3.1 97 85
China China China China China China
7.7 19.4 11.5 19.4 21.5 26.9
8.0 17.6 12.0 17.6 22.4 28.0
9.5 20.9 14.3 20.9 26.6 33.3
10.8 23.7 16.1 23.7 30.1 37.6
11.5 25.3 17.3 25.3 32.2 40.3
The third of the three costs that we show (All-In CFR) has been calculated by a standardized set of assumptions for freight and realized pricing across the entire group. Although our model allows us to flex these assumptions, our base case scenario which has been used for the charts in this report is summarized in Exhibit 51. A discussion of pellet/grade premiums is beyond the scope of this report, but our assumptions are consistent with the house view on the steel and iron ore industries and we are happy to discuss this topic with interested investors.
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China Iron Ore and Steel Production by Province

Exhibit 52: Chinese Domestic Iron Ore and Steel Production, by Province
100
Iron Ore production, by province

90
Steel production, by province
80
70
60
Short iron ore

50
40
30
20
Long iron ore
10
0
0 10 20 30 40 50 60 70 80 90 100
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Authors & Contributors

Exhibit 53: Contributors & Contributors
Equity Research - North America Nathan Littlewood Hubert Dagbo Equity Research - Australia Paul McTaggart Matthew Hope James Redfern Martin Kronborg Michael Slifirski Sam Webb Equity Research - Brazil Ivano Westin Marina Melemendjian Equity Research - India Neelkanth Mishra Ishan Mahajan Equity Research - London Liam Fitzpatrick James Gurry Michael Shillaker James Hanford Equity Research - Moscow Semyon Mironov Fixed Income Commodities Research Andrew Shaw Marcus Garvey Other Scott Chui Wenzhe Zhao
Source: Credit Suisse
Phone +1 416 352 4585 +1 212 325 4739 Phone +61 2 8205 4698 +61 2 8205 4669 +61 2 8205 4779 +61 2 8205 4369 +61 3 9280 1845 +61 3 9280 1716
Email nathan.littlewood@credit-suisse.com hubert.dagbo@credit-suisse.com Email paul.mctaggart@credit-suisse.com matthew.hope@credit-suisse.com james.redfern@credit-suisse.com martin.kronborg@credit-suisse.com michael.slifirski@credit-suisse.com sam.webb@credit-suisse.com
Phone Email +55 11 3701 6318 ivano.westin@credit-suisse.com +55 11 3701 6341 marina.melemendjian@credit-suisse.com Phone Email +91 22 6777 3716 neelkanth.mishrah@credit-suisse.com +91 22 6777 3894 ishan.mahajan@credit-suisse.com Phone +44 20 7883 8350 +44 20 7888 7083 +44 20 7888 1344 +44 20 7888 1551 Phone +7 495 662 8510 Email liam.fitzpatrick@credit-suisse.com james.gurry@credit-suisse.com michael.slifriski@credit-suisse.com james.hanford@credit-suisse.com Email semyon.mironov@credit-suisse.com
Phone Email +65 6212 4244 andrew.shaw@credit-suisse.com +44 20 7883 4787 marcus.garvey@credit-suisse.com Phone +852 2101 7152 +1 212 325 1798 Email scott.chui@credit-suisse.com wenzhe.zhao@credit-suisse.com
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Macro Research Disclosure Appendix

Important Global Disclosures
The analysts identified in this report each certify that with respect to companies or securities that the individual analyst covers the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail, please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: http://www.csfb.com/researchandanalytics/disclaimer/managing_conflicts_disclaimer.html. Credit Suisses policy is to publish research reports as it deems appropriate, based on developments with the subject issuer, the sector or the market that may have a material impact on the research views or opinions stated herein. Credit Suisse may trade as principal in the securities or derivatives of the issuers that are the subject of this report. At any point in time, Credit Suisse is likely to have significant holdings in the securities mentioned in this report. The analyst(s) responsible for preparing this research report received compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities. Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties.
Important Regional Disclosures

Singapore recipients should contact a Singapore financial adviser for any matters arising from this research report. Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report. For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit http://www.csfb.com/legal_terms/canada_research_policy.shtml. Principal is not guaranteed. Commission is the commission rate or the amount agreed with a customer when setting up an account or at anytime after that. Taiwanese Disclosures: This research report is for reference only. Investors should carefully consider their own investment risk. Investment results are the responsibility of the individual investor. Reports may not be reprinted without permission of CS. Reports written by Taiwan-based analysts on non-Taiwan listed companies are not considered recommendations to buy or sell securities under Taiwan Stock Exchange Operational Regulations Governing Securities Firms Recommending Trades in Securities to Customers. For Credit Suisse disclosure information on other companies mentioned in this report, please visit the website at www.creditsuisse.com/researchdisclosures or call +1 (877) 291-2683 for Credit Suisse Equity Research disclosures and visit the website at https://firesearchdisclosure.credit-suisse.com or call +1 (212) 538-7625 for Credit Suisse Fixed Income Research disclosures. Disclosures and disclaimers continue on next page.
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21 August 2013 Americas/United States Securities Research & Analytics