Black Iron restarts in Ukraine three years after Russian invasion

In the three years leading up to Russia’s invasion of the Ukraine in 2014, Black Iron (TSX: BKI) was making headway at its flagship Shymanivske iron ore project, 330 km southeast of Kiev.

It completed a bankable feasibility study, brought in Metinvest — the largest company in the Ukraine — to finance half the mine’s construction, and was in the midst of speaking to steel mills and large trading houses about offtake agreements.

“There was a large trading house that had visited the site several times to initiate commercial discussions with us on a prepaid offtake agreement, and with the offtake agreement in place we would have had all the equity lined up, but during the negotiations Russia invaded Ukraine,” Black Iron CEO Matt Simpson said in an interview on Oct. 31. “We had to put the project on care and maintenance. We had no idea where the frontline of the war was going to go.”

Since then the frontline of the conflict in Ukraine — 450 km from the project — has not advanced and the company says it’s now time to re-engage.

“That frontline hasn’t significantly moved since the original invasion three and a half years ago, and in my view there is no reason why it would move,” Simpson said, describing the situation as a “frozen conflict.”

“They achieved what they wanted when they got the Crimea, the island where the Russian naval base is located … and if Russia wanted to take over all of the Ukraine, they would have done it three years ago … people have moved beyond it with issues in other parts of the world, like Syria, and there isn’t anything that Russia would gain. It would be just more headaches and sanctions.”

Moreover, during trips to the project over the last few years, Simpson says it’s been “life as usual.”

“Mom and dad go to work, kids go to school. You wouldn’t be aware that something was going on in the country.”

The timing is right to proceed for a number of other reasons, too, Simpson argues, including a rebound in the iron ore price since October 2016; stricter pollution controls in China that have created demand for higher-quality raw materials used in steelmaking; a more favourable exchange rate; and a view held by some international companies and funding agencies that it’s safe to invest again in the region.

Black Iron’s Shymanivske iron ore project in the Ukraine, 330 km southeast of Kiev. Credit: Black Iron.

As an example, Black Iron cites ArcelorMittal, which recently announced its intention to invest US$1.1 billion over the next few years into its iron ore mine and steel mill, 1 km north of Shymanivske. It also notes that the European Bank for Reconstruction and Development recently approved a long-term senior loan of up to €350 million to finance ArcelorMittal’s capital investment at its Ukrainian plant.

But rising iron ore prices are equally important. Since late last year, benchmark 62% iron content prices jumped from US$37 per tonne in November 2016 to US$95 per tonne in February 2017, and in the last eight months have averaged US$74 per tonne. Currently prices are US$60 per tonne.

The higher prices, Simpson says, largely owe to increased global demand for steel.

At the same time, the iron content premium and corresponding penalty relative to the benchmark price also increased materially. Historically, the premium/penalty per 1% iron above or below 62% iron was charged at US$3 to US$4 per percent, Simpson says. But that premium/penalty is now US$7 to US$8 per percent.

The higher number comes from a lot of factors.

First, premiums for high grades typically go up when steel mills are profitable because they are trying to boost their output by using more productive raw materials.

Second, demand for high-grade iron ore usually goes up when coking prices rise, as steel mills try to lower their fuel rates by using better quality ore.

Third, China is forcing steel mills to curb their emissions, which has driven a preference in that country for high-quality raw materials.

Shymanivske is expected to produce a high-grade 68% iron content product that at today’s prices would sell for US$42 to US$48 per tonne more than the benchmark 62% iron content product, the company says, or a selling price today of US$105 per tonne.

“What happens with higher-grade iron ore is that you require less coal to make a tonne of steel, so that means less emissions to make a tonne of steel,” Simpson said. “It’s not just in China, but globally people are becoming a lot more environmentally conscious, and that’s what pushes the spreads higher. This is the highest they have ever been.”

The question is, do the spreads stay this high or do they go back down, and the answer to that, he says, depends on how big an emphasis is put on protecting the environment. In China, head grades at some mines can be in the teens, he says, compared to those at Shymanivske, which are 30%. (Black Iron plans 68% concentrate grades.)

“In China you’re mining almost twice the amount of material to get the final product, so it’s a lot more emission intensive to mine in China,” he said. “That also means they’re going to have to import more and choose to continue to import the higher-grade material, because there’s also pressure on the steel mills to keep their emissions in check.”

Mining trucks at Black Iron’s Shymanivske iron ore project in the Ukraine, 330 km southeast of Kiev. Credit: Black Iron.

Simpson also pointed to a Reuters report in September, which quoted a Chinese mining association official speaking at a conference, as saying that China plans to cancel a third of its iron ore mining licences, mostly belonging to small polluting mines.

A more favourable exchange rate in the Ukraine hasn’t hurt the Shymanivske project’s prospects, either. When Black Iron completed its feasibility study in 2014, the exchange rate was 8 Ukrainian hryvnia to one U.S. dollar. At press time the rate was 27 hryvnia to the dollar — thanks to the International Monetary Fund’s bailout provisions that Ukraine unpeg the hryvnia from the U.S. currency.

In July, Black Iron commissioned a preliminary economic assessment (PEA) of Shymanivske based on the more favourable exchange rate and on a smaller scale, phased build-out. The bankable feasibility study was based on a 10 million tonnes per year, while the PEA will examine a development plan that starts with producing 4 million tonnes a year and ramp up to 8 million tonnes a year using cash flow to fund the expansion.

The PEA is due later this month and the company anticipates good economics, partly because it doesn’t need to build major infrastructure like rail, power lines or a port facility.

“What’s unique in our case is that the rail and power lines are literally right beside the property — 2 km away — and there are five different ports we can access, so we don’t have to build such a big project,” Simpson said.

Looking east at Black Iron’s Shymanivske iron ore project in the Ukraine, 330 km southeast of Kiev. Credit: Black Iron.

By contrast, most iron ore projects are designed around high production rates because the cost to build rail, power and or ports means they have to go really big to make the economics work, he says, adding that rail costs US$3 million per kilometre, power lines US$1.5 million per kilometre, and in many cases, these mines are several hundred miles away from a port or rail.

Doing a PEA rather than a feasibility study makes more sense, he continues, not just because a PEA costs a tenth of a feasibility study and can be done in one-third the time, but also because the company wants to get the economics out to potential investors as quickly as possible to test the market appetite among investors “to get serious about Black Iron again.”

“We’re also using part of the information to re-engage with potential offtake partners, people who won’t just buy the ore but will prepay for it to reduce the equity needed to start the mine. So we want to do that now, in parallel to doing the feasibility study, and start debt talks to try to get most of the financing arranged over the next year, and then look to start construction.”

Simpson pointed out that Black Iron divested Metinvest’s position in the company in January 2016 and owns 100% of the project. He also noted there has been a huge amount of work completed on the project already, and at a share price of just 10¢ (down from $1.40 per share at the time of the company’s international public offering in 2011 and 20¢ per share around the time of the Russian invasion), investors are getting a real bargain.

“In reality this company was largely de-risked and was almost ready to go into production, but because of the invasion and iron ore price falling, it’s an opportunity for people,” he said. “That’s where we are … we have an interesting story to tell, and it’s a great time for people to start looking seriously at us again.”

The company has 160 million shares outstanding for a market cap of nearly $16 million. Over the last year its shares have traded in a range of 3¢ per share in December 2016 and 16.5¢ per share in February 2017.

Shymanivske has 355.1 million tonnes grading 32% total iron and 19.5% magnetic iron in the measured category, and another 290.7 million tonnes grading 31.1% total iron and 17.9% magnetic iron in the indicated category. Inferred resources add 188.3 million tonnes grading 30.1% total iron and 18.4% magnetic iron. The resources were based on a 10% magnetic iron cut-off grade.

The project, in central Ukraine and in the southern part of the KrivBass iron ore mining district, is less than 2 km from two open-pit iron ore mines owned by ArcelorMittal and Metinvest-Evraz Steel, which are mostly magnetite quartzite deposits. There are seven operating open-pit mines in the district.