Maybe big Nev trying to calm the ship From Macro business...

Maybe big Nev trying to calm the ship
From Macro business overnight
On the of great Australian corporate stories is drawing inexorably to its conclusion. Fortescue Metals Group is on the rack. A great achievement by a ballsy entrepreneur and generous billionaire is going down the dunny covered only in silence by a dumb and compromised media. Yesterday we saw a capitulation in Fortescue shares. The 8.5% fall to $3.03 took the share price to its long term terminal support: It is a brave man that asserts that this support is going to hold, though it’s sure not a break until it breaks. If it does, technically at least, the next stop is $1.80, some way below Charlie Aitken’s recent $4 call. And so, what is the future here? Will FMG shut? Will it be bought? FMG is the emerging marginal cost producer. 350 million tonnes per annum (mtpa) of cheap new supply is coming to market through 2017. There is 100mt above FMG on the cost curve that will go (and we saw Atlas collapse 17% yesterday in preparation for that). We can be confident that Chinese production will lose 100mtpa over the period and if we’re lucky new demand will soak up 50mtpa. That leaves most or all of FMG production as the swing producer in the market. The timing is a vital question for the broader iron ore market. The outperformance of BHP and RIO among iron ore equities is now approaching the supernatural as markets kill everyone except them. Here is the relative performance chart of iron ore related prices since October 2013:
Given the looming supply glut, this can only make sense if the market sees high cost production exiting relatively swiftly but not FMG. FMG is profitable to the lows $70s more or less. Even then it could issue rights, pay down some debt, and get its breakeven into the high $60s. That implies iron ore must go much lower yet, to $60 to break it. The equity market still isn’t pricing the end for Andrew Forrest but when it does the major iron ore miners are going to have to fall heavily as well. Current consensus forecasts for RIO’s EBIT is in the range of $14-17 billion in 2015, 16 and 17. Those can only be met if iron ore is at $80 and above. So, what will happen to FMG? There are three scenarios: equity holders are steadily decimated and it is eventually seized by its bankers and sold off with debts written off and its more expensive production shut down. The buyer might be Gina Rinehart, whose Roy Hill project is adjacent to some of FMG’s better tenements or BHP, which could shut most of it, or the Chinese, though that would be decided in Canberra; Andrew Forrest does some kind of deal in advance of the coming flood with Chinese steel sponsoring a wholesale re-investment in gas, shipping and other mechanisms to get its costs into the low 60s. Let’s face it, it would be a much better idea for someone like a Baosteel than is the West Pilbara expansion. A similar plan could be launched by a private buyer like Glencore on a punt that the Australian dollar is going to crash versus the Brazilian real but if it doesn’t then that will leave the new owner as the marginal cost supplier. Either way, it’s going to hurt shareholders but not as much going out of business; China grows at 8% for five more years and iron ore returns to $100 per tonne. Perhaps there is some other miracle somewhere?