Iron-ore producer Cliffs Natural Resources (NYSE:CLF) has struggled in recent years as prices for the raw material for steelmaking have plunged and forced the company to take dramatic action to concentrate on its most promising opportunities. Yet even as Cliffs tries to find ways to appeal to its core customers, the recent termination of a supply contract with a key customer and subsequent statements concerning a related entity's potential competing production plant in Minnesota have presented what could become a costly distraction at a time when Cliffs needs to focus on its long-term viability.
Let's take a closer look at the recent series of events and what the implications are for Cliffs Natural Resources in the long run.
Ending a relationship
Early this month, shareholders reacted negatively to the news that Cliffs Natural Resources had terminated a supply contract with steelmaker Essar Steel Algoma, with which it has historically had an extensive relationship. Throughout much of 2015, the two parties have had a rocky relationship, as Cliffs had filed a lawsuit alleging breach of contract due to Essar's failing to accept several iron ore shipments. After obtaining a temporary restraining order that prevented Cliffs from terminating the contract, Essar chose last week to withdraw the order, citing that it had secured an alternate supply of iron ore for interim purposes. Nevertheless, Essar Algoma CEO Kalyan Ghosh said, "we will address the matter of Cliffs' breach of contract in due course."
Cliffs said in its initial statement that it stood ready to discuss an alternative supply arrangement for iron-ore pellets on a just-in-time basis, so some might have thought that the two companies would figure out a way to continue working together. With Cliffs supplying about 3 million tons of iron ore pellets to Essar, the iron-ore provider arguably stood to lose more than Essar from ending the relationship. Yet more recently, Cliffs has chosen to comment on another Essar project in a way that suggests the animosity between the two entities could last for quite a while.
Fighting against a Minnesota foothold
Yesterday, Cliffs Natural Resources issued a press release concerning Essar Steel Minnesota, a related entity that shares the same ultimate corporate parent as Essar Steel Algoma. The release said Cliffs thinks Essar Minnesota's claims about the status of Essar's taconite construction project are "substantially overstated," and Cliffs called for the company to repay a $73 million construction loan subsidy because of "Essar unilaterally changing the scope of its project" away from supporting construction of a new steel mill. Cliffs believes the project in its current form will only exacerbate iron-ore pellet overcapacity in the region.
Earlier reports had gone further, quoting Cliffs CEO Lourenco Goncalves as saying, "if [Essar Minnesota] goes online, I will shut down a plant up there the same day." Cliffs' press release emphasized that the company has no current plans to permanently idle or close any mines in Minnesota, but tensions are clearly high, and Goncalves had compared the state subsidy for Essar's taconite pellet plant to "illegally subsidized foreign steel coming into the country."
Analysts generally believe that any alternate source of iron ore that Essar Algoma has tapped is likely economically unsustainable, with local sources like U.S. Steel (NYSE:X) likely choosing not to supply the company for competitive reasons, and with sources outside the region bearing additional shipping costs that will make steel production uneconomical. Part of Cliffs' overall strategy has been to be the optimal provider of high-grade iron ore to steel mills throughout the region, and its success in focusing on that particular niche will make it hard for Essar Algoma to sustain production without Cliffs.
If Essar Minnesota comes online next year, that dynamic could change, with Essar essentially vertically integrating its operations to ensure adequate local iron ore supplies. Yet most see the ongoing dispute merely as a way for Essar to gain leverage over Cliffs in a situation in which supply and demand give Cliffs a natural advantage.
At this point, Cliffs is taking the Essar threat seriously, which could in turn take management's attention away from other pressing concerns the company needs to address. With the stock still close to multi-year lows, Cliffs Natural Resources needs to defend itself while still looking at other efforts to try to get a long-term turnaround on track.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool owns shares of Cliffs Natural Resources. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.