Cleveland-Cliffs Inc (CLF) 2018 Q2 法說會逐字稿

Good morning, ladies and gentlemen. My name is Leandra, and I'm your conference facilitator today. I would like to welcome everyone to Cleveland-Cliffs' 2018 Second Quarter Conference Call. (Operator Instructions)

The company reminds you that certain comments made on today's call will include predictive statements that are intended to be made as forward-looking within the safe harbor protection of the Private Securities Litigation Reform Act of 1995. Although the company believes that its forward-looking statements are based on reasonable assumptions, such statements are subject to risks and uncertainties that could cause actual results to differ materially. Important factors that could cause results to differ materially are set forth in report on Forms 10-K and 10-Q and news releases filed with the SEC, which are available on the company's website.

Today's conference call is also available and being broadcast at clevelandcliffs.com. At the conclusion of the call, it will be archived on the website and available for replay. The company will also discuss results, excluding certain special items. Reconciliation for Regulation G purposes can be found in the earnings release, which was published this morning.

At this time, I would like to introduce Tim Flanagan, Executive Vice President and Chief Financial Officer.

Thank you, Leandra, and thanks to everyone joining us this morning. I'll start the call with the discussion of our second quarter results and outlook before turning over to Lourenco for his remarks.

For Q2, we reported total company adjusted EBITDA of $276 million, representing more than doubling of our EBITDA performance in the prior year's second quarter. It was our best quarterly results since 2014. For the first time in over a decade, adjusted EBITDA only had 2 components: U.S. Iron Ore, Corporate/Other.

With the sale of the Asia Pacific assets announced in June, those results have been moved to discontinued operations, and are no longer included in our current or historical consolidated revenue, COGS and adjusted EBITDA. This leaves USIO as our sole EBITDA generating segment for the time being until the Toledo HBI plant comes online in 2020.

USIO generated $301 million in adjusted EBITDA for the quarter, a 5-year high watermark for this business compared to $162 million in the prior year quarter. This remarkable improvement was a result of increased sales volume due to higher actual demand for pellets from our customers as well as the higher prices customers paid for our pellets. These improved pellet prices are the direct result of the more advantageous contract structure we implemented, which de-emphasizes the influence of the IODEX as a metric and magnifies the impact of the strong market conditions for both pellet premiums and domestic steel prices.

While the Great Lakes shipping pace typically doesn't hit its stride until later in the third quarter, we are pleased with the demand for pellets during Q2, selling about 6 million long tons during the quarter, slightly ahead of our previous expectation due to increased appetite from certain customers. You recall, some of our customers elected to reduce their nominations for the fourth quarter of last year, and therefore, were light in inventory at the end of the winter.

In light of the strong demand for pellets, we have begun to increase our full year sales volume expectation at this time, from 20.5 million to 21 million long tons. We expect to sell between 6 million the 6.5 million long tons in the third quarter, with the remaining balance of that 21 million ton total to be sold in the fourth quarter.

Our Q2 pellet price realization of $113 per long ton represented a 16% improvement over the prior year. This amount also came in higher than our current year guidance range, largely due to the significant increase in hot-rolled coil steel pricing from our previous guidance and the associated adjustment recorded the true up of the number with the much higher full year expectations. We also saw a favorable customer mix in the quarter relative to what we expect on a full year basis. The positive impacts of higher HRC pricing and the favorable customer mix were slightly offset by higher freight rates and a lower IODEX average price during the quarter.

Year-to-date averages for our relevant metrics are: $826 per short ton for HRC, $69 per metric ton for the IODEX and $58 per metric ton for the Atlantic pellet premium. Assuming these averages would carry forward for the rest of the year, our full year USIO revenue realization would be approximately $105 million to $110 per long ton, representing a $3 per long ton increase from our previous guidance on each end of the range. As we've noted in the past, these figures do not reflect our internal view on pricing, and therefore, should not be considered as guidance.

Cost-wise, our cash costs were $62 per long ton compared with the $59 per long ton in last year's comparable quarter. The increase in cash cost was mainly driven by a favorable shift in product mix. Due to increased customer demand, we are producing a higher percentage of the higher cost, but also higher margin Mustang pellets than we originally expected. Cash cost was also impacted by higher energy, labor and royalty rates. This said, our original cash cost guidance of $58 to $63 per long ton is unchanged, and for the back half of the year, we expect cash cost to remain reasonably consistent with our Q2 performance.

As we enter into the heavier half of the shipping season, we'll begin to work off the finished goods inventory that we built in the first half of the year. With this favorable working capital release, after all expenditures, including the monies we will invest in the HBI project, we expect to generate around the $400 million of free cash flow in just the back half of this year.

As for the Asia Pacific sale, closure-related charges for contract terminations and severance as well as actual operating losses from our remaining sales during the quarter made up a majority of the $64 million loss from discontinued operations shown on our income statement. With that, nearly all the closure-related charges have been recorded, and we recorded our final shipments in June. Next quarter, with the closing of the sale from Mineral Resources and primarily due to the positive effect of the reversal of our currency translation adjustment, which is currently on the books for approximately $230 million, we expect to book a positive contribution to discontinued operations, which should be in excess of $200 million.

As for CapEx, we spent $44 million in the second quarter, $23 million of which related to the HBI project. We have now spent $81 million towards HBI this year. As we progressed with the placement of the bid packages, we have received more favorable terms in our payment schedule than we originally expected. The overall project budget remains the same, but we have lowered our expected outflow this year to $200 million, down from our previous assumption of $225 million. This is the positive result of our negotiations on the timing of disbursements, and does not affect the expected timing of completion and the startup of the plan in mid-2020.

From a tax standpoint, we reported a $2 million income tax benefit in the second quarter related to the reversal of reserve for uncertain tax position due to lapse in the statutes of limitations.

And last, but not least, our sizable NOL position. The unlimited deductibility of those NOLs and the ability to use percentage depletion as an offset to earnings has put us into an extremely enviable tax position. For the foreseeable future, we expect to be a 0% taxpayer, both on a cash and effective rate basis in nearly all net income scenarios.

On top of this, starting next quarter, we will begin to receive cash refunds related to the AMT credits. Next quarter's refund will be about $10 million, with the following years being approximately $110 million, and then another $110 million cumulatively over the next 3 years beyond that. These refunds, combined with our current and expected robust free cash flow generating ability, put us in a phenomenal position to not only bring our net debt below $1 billion, but also to allow us to return meaningful capital to our shareholders over the coming years.

With that, I'll now turn it over to Lourenco.

Thank you, Tim, and thanks to everyone for joining us this morning. Our second quarter results provide a clear picture of what Cleveland-Cliffs has become and what it will continue to be, a simple, clean, cash flow generating powerhouse.

Manufacturing in United States has been reestablished, and everything we have done to improve and evolve this company over the past 4 years has set us up to thrive during this manufacturing renaissance. Our USIO business as it is today, well protected by geographic and contractual barriers, is sustainable, and will carry us through the next 2 years as our money printing machine. Beyond that point, we will be adding HBI to the mix, a game changer event that will further strengthen the foothold we already have in our core Great Lakes market.

During the second quarter, we announced the sale of our Asia Pacific Iron Ore business, likely to close this quarter. After 4 years of successful asset divestitures, including all 5 core mines, Wabush, Bloom Lake, Chromite, [Nickel] and all other smaller projects. The sale of APIO was the final piece of our strategy-driven transformation.

We have said from the beginning that our objectives were a clean exit from Australia with minimization of liabilities. This transaction allowed us to accomplish both. We not only reduced our expected cash obligations by $70 million, but we also reduced the asset retirement obligations by another $50 million. The divestiture eliminated some of the uncertainties surrounding these obligations and gave us cash in the door from the equipment sales right away.

With the sale of APIO and with the recently court approval of the Bloom Lake and Wabush CCAA reorganization plan, we can now move forward completely focused and undistracted. From now on, Cleveland-Cliffs is a U.S.-centered business and a very profitable and sustainable U.S.-centric business. Actually the best one among all out there, including both private and publicly traded companies.

Cleveland-Cliffs is a central and vital component of the U.S. manufacturing sector, and we are the only company of our kind that does what we do. Our $276 million in Q2 EBITDA, our $113 per long ton revenue realization and our 45% EBITDA margin, let me repeat this one, our 45% EBITDA margin are clear evidence of our profit-generating power. By the way, these results were achieved in a quarter that the IODEX averaged just $65 per metric ton, clearly demonstrating that our business is not a proxy for the IODEX. Cleveland-Cliffs' current and future results are all about the commercial contracts we have in place with our customers. The domestic steel prices that are here to stay and pellet premiums that will continue to reflect high demand for pellets for the foreseeable future.

Regarding the sustainability of the business going forward, the steel market in United States is in great shape. Every single subsector is showing year-over-year growth, in some cases, substantial growth. The actions taken by the Trump administration, mainly tax reform, have brought a massive positive impact to the economy in general and to the steel business, in particular. Even without Section 232, the domestic steel market would be doing well. As far as Cleveland-Cliffs is concerned, because of how we have constructed our contracts, we have benefited directly and immediately from the rise in benchmark steel prices that we have seen this year. I can actually make the case that Cliffs benefits from the steel price rise more and more immediately than most domestic steel makers and service centers.

Based on the role we play in this industry and the ongoing dialogue we have with downstream steel manufacturers, I can tell you that the current strength in the market is not a onetime thing. Manufacturing in the United States is back. Tax reform is driving industry resurgency. And the base case scenarios for steel pricing must be rerated much higher than what we have seen so far. Because demand for pellets continue to increase. As we did last quarter, we once again increased our sales volume forecast, and now expected to sell 21 million long tons of pellets this year. With our sales volume and pricing outlook both increased, again, the ranges that we have provided imply EBITDA generation north of $800 million for this year. This $800 million number represents a 60% increase from 2017, which was actually a good year with $500 million EBITDA. Similarly, our forecast for 2019 is very positive. On top of our favorable contracts, we will have a large tax refund and no taxes to pay, thanks to tax reform, and no more negative impact from APIO. This will leave us with a lot of free cash flow to allocate both this year and next.

With that, I would like to make clear to the investment community what our capital allocation priorities are. Our first priority, the HBI project. This project, along with the corresponding Northshore upgrade, will provide better returns than anything else we can possibly do with our cash at this time. The project is fully funded. It's on time and on budget. The HBI project remains the number one focus of the entire Cliffs' management team.

Our second priority, the balance sheet. We have long said that our goal is to reach a net debt level of $1 billion. A long way from what we had in this company when I first started here 4 years ago. We like the $1 billion level, because it give us the comfort that we can navigate any cyclicality that the market throws at us. With our current cash on hand, combined with what we expect to bring in over the coming years, it doesn't make a lot of sense to refinance our 3 tranches of notes maturing, 2 in 2020 and 1 and 2021. Our bias at this point is to outright retire all these notes.

Our third priority, capital return to shareholders. A special dividend, a recurring dividend or a share buyback should be considered not too far in the distance. The route we'll ultimately take will continue to be evaluated and will depend on the market at the time we decide to move forward. That said, each day that will bring in more cash and make progress on HBI, we get one step closer to starting to return capital to our shareholders. It's my plan to next week in the board meeting to start making proposals to my board on how and when we will start to return cash to the shareholders.

An honorable mention would be, any strategic opportunity that could present itself unexpectedly. This happened 3x last year with our purchase of the respective minority interest in our Empire and Tilden mines in Michigan as well as land in Nashwauk, Minnesota.

During the last 4 years, we have built a strong track record of high return capital deployment. And we will approach any future opportunities with the same discipline. At this point, we do not see a whole lot of logical opportunities out there, but if an enticing one somehow pops up, we will be ready.

With that, I would like to drill down to priority number one, the HBI project. The second quarter was another successful one. As we continued to execute on our plan, we stay ahead of schedule and under budget. The primary accomplishment in Q2 was mostly foundation work. We installed the necessary underground utilities on site, finished the piling work for the furnace tower and begun laying concrete. All of this to put us in a position to begin steel erection in the third quarter.

Unlike other projects completed in the United States during the past several years, the same theme of Cliffs' employees in charge of the construction will be the team running the operation once we move into production in 2020. This helps us ensure that everything is being done right, in a safe and environmentally friendly manner. Not just a contractor cutting corners to get the job done and then handing the keys over to the operators. Furthermore, we are not undertaking a science project by any means. This is very much an off-the-shelf Midrex project, proving out by decades of several other successful Midrex plants.

For starters, Midrex is the unquestionable market leader in DRI and HBI technology. Our upfront feasibility study on this project, completed by Cleveland-Cliffs over a year ago, was clearly done right. It's now over a year since we announced the site selection, and our budget of $700 million remains intact. On top of that, our cash outflow schedule is more friendly than originally anticipated. We have $444 million of the total construction cost or 65% already contracted. And work packages and contractor bids have come in at or below our original expectations. At this point, it is already very evident that Cleveland-Cliffs is executing on a well-detailed plan to build the most efficient and most environmentally-compliant Midrex plant in the world, and everything is going extremely well.

In the meantime, our conversations with our future customers continue to give us comfort and excitement about the introduction of our HBI to the market. This is something that is desired by the customers and very much needed in the Great Lakes. And let's make it abundantly clear, Cliffs is the only company that can do it, because we are the only proven and capable producer of DR-grade pellets in the United States. Cliffs is the only one that has full control over feedstock, DR-grade pellets. And that's a decisive factor. The most important element in actually being able to produce a high-quality and cost-effective DRI HBI.

In the EAF space, we are seeing a migration to higher-quality HBI-like feedstock, similar to what we have seen with blast furnace towards higher-grade sinter feed ore and to ore pellets. The markets for pig iron and busheling butchering scrap continue to be healthy. With the market share of EAFs in United States now approaching 70% of the overall steel making production, and with the further advancements into higher-margin sophisticated steel grades, our HBI will be essential. Not to mention, the source of our units at Great Lakes EAFs are currently forced to rely upon from places like Russia, Ukraine, Brazil and Venezuela, are all undependable, not was made like ours will be and cost up to $75 per metric ton just to transport to the point of use.

All of this considered, HBI is a overwhelmingly accretive opportunity for us in both good and bad markets. First, we will have a major margin contribution from HBI. With pig iron and busheling prices are, both above $400, and with the benefit of cheap and easily available natural gas, our cash margin for HBI would be north of $150 per ton on 1.6 million metric tons of HBI, even paying market price for DR-grade pellets.

Second, our HBI segment will be paying our USIO business unit market price. More money for DR-grade pellets than what we currently sell conventional blast furnace pellets for. So not only will we be getting a huge EBITDA contribution from the HBI plant itself, but our USIO margins will further expand by replacing some of the blast furnace pellet business with higher margin sales of DR-grade pellets to our own facility. With our remaining blast furnace pellets, we will continue to support some integrated mills that will do well, while other steel mills, not served by Cliffs will lag behind.

In summary, Cleveland-Cliffs is now the company I envisioned 4 years ago; simple, efficient, focused, environmentally-compliant, safe and with a healthy and solid balance sheet. Investors should take notice that we command the highest margins among all comparable and competing investments among all U.S.-based businesses. And that includes all mini-mills, all integrated mills and all service centers in United States.

Furthermore, based on the letter of the contracts we have in place, this scenario will not change. It is here to stay. We are hitting multi-year highs in selling price even while the IODEX iron ore price sets, we will continue to reap the benefits of the healthy steel market while it lasts. And that is certainly the case for the rest of 2018 and the entire 2019. And by 2020, we will have a new business segment, HBI, with the higher and less volatile sales margin that will further enhance our earnings power.

With that, I'll turn it over to the operator for questions. Operator?

(Operator Instructions) And your first question comes from the line of Lucas Pipes with B. Riley FBR.

Congrats on a fantastic quarter and the progress in Australia, about executing that very nicely and then the good news on HBI. So I wanted to maybe first ask a question on your sales versus production guidance. Great to see that you're able to sell a little bit more in this environment. And some of the questions I think adding is can you put a multiple on that? In other words, would you be able to maybe increase production in 2019 close to that 21 million tons given that the demand is there?

First of all, thank you very much Lucas for your gracious comment. As far as the sales versus production guidance, we are increasing sales, basically because our clients, if you recall, at the end of last year, in the fourth quarter of last year, we were caught by surprise when a couple of clients decided to reduce their nominations within their allowances of -- that the contracts give them. So they were not doing anything out of the ordinary. It was just something that I was not expecting, because everybody knew in the business that 2018 will be a good year. So I thought they would be preparing themselves for that. Anyway, I'm not questioning or complaining about their decision. Everybody does what they feel like is the right thing to do. Anyway, they decided to reduce their nominations and they bought fewer pellets than they were planning to originally. So when 2018 came, and came the way it came for the domestic producers, they needed more pellets. So we are basically selling them the same pellets that we would be selling them in Q4 of 2017 and charging 2018 prices. So they are paying more for the same pellets than they could get for less last year. But hindsight is 20/20. So I'm sure that they are not going to make the same mistake again. So it all depends on how our clients will behave at the end of 2018. And then we'll see how much we're going to sell. At this point, they are really coming for the pellets, and we are happy to supply them with everything that we can possibly do. So we need to wait a little more to see how the nominations will play, and then we'll see how 2019 will be. It would be a good year no matter what. But it all depends on nomination in Q3 and Q4.

Absolutely. And maybe just a follow-up really quickly on this point. If you, let's say nominations continue to be strong, you cannot sell more indefinitely than you produce. So do you have the ability to squeeze out more tons from your mines?

Well, look, we always have a plan to produce more. We always have the ability to produce more, and this comes with cost associated. If you recall, last year, we acquired the minority positions in both the Tilden and Empire mines. Tilden is operational. So now we have full control of Tilden, and Empire is an investment idle. Michigan has been extremely healthy in terms of what we does to bring Empire back to operation, and we are giving serious consideration to that. At the same time, we acquired land in Nashwauk. And coming October, November, Minnesota will be a lot better because we are going to have a new government with new people taking care of business in that state, no matter the new governor will be a Democrat or a Republican, I already know that the governor will be better than the one that's there right now. So we bought land over there, we bought land over there to put it to use. But I'm not going to do anything with this land, that governor that cannot make a decision, that makes sense. So I'll wait for the new one, and I'm already talking to both sides. So we are preparing ourselves. So make no mistake, we will take care of the markets.

Maybe from me to wrap up, I think, Lourenco, in your prepared remarks you said HBI was ahead of schedule and on budget. Maybe you could just confirm that quickly? And then on those too -- on that point, can you remind us about the critical project pathways? Does that occur early '19, mid '19, later in the year maybe? And then secondly, you addressed the commercial strategy in your prepared remarks as well, but can you maybe share some thoughts as to when is the good time to enter into your first commercial contracts for HBI?

That's a long one. That's a very comprehensive question. I will try if my memory is good. First of all, we are ahead of schedule and below budget. So you said ahead of schedule and on budget. We stay on budget because we don't want to start getting ourselves under debt too much. But we're ahead of schedule and below budget at this point. And our budget was very conservative and well done because after more than a year, we haven't changed the number. We haven't done anything to complicate the outcome of the cash disbursements. So it looks like it's solid. And at this point, with more than 65% of orders placed, I can tell you that this budget will not change. So we are ahead of schedule, below budget. We should finish this ahead of schedule and on budget at the very least. As far as milestones, all the infrastructure and the foundation work is being concluded as we speak. We are going to start erecting steel in Q3, and we should start commissioning of the plant ahead of schedule. We are going to see the tower being -- start to -- started to be erected sometime later this year. And we are very confident that with the market so eager to start buying our product, we have more all incentives to finish ahead of schedule, doing everything correctly, everything in a safe manner, taking care of the environment, taking care of Toledo and the surrounding towns, making everybody happy in the area. But we are working hard to be able to start delivering HBI a little earlier than the original schedule of August of 2020. As far as commercial contracts, we are in deep negotiations with the most important clients that we are going to have, and the conversations are going extremely well. I have been keeping commercial very close to the vest, and I will continue to do so. But at this point, it's clear that the materials needed, the shift towards high strength steel's automotive use and things like that for mini-mills is reality, and they can't do it without our feedstock, particularly the Great Lakes, because there is no real high-quality iron substitutes arriving in the Great Lakes or being produced in a way that Great Lakes mini-mills can enjoy. So overall, conversations are going well. They know exactly what they are going to get. We are in discussions not only with commercial people, but also technical people within these future clients. And the operations people are already working with us in terms of detailing the specs that they want and everything that they're going to get from us. So going good, and we're very confident that this product, our HBI will not only be a big technological success, a breakthrough event for these mini-mills that are pursuing higher specs in the steel food chain, but also we have huge commercial counter, huge profitable products for Cleveland-Cliffs.

Your next question comes from the line of Seth Rosenfeld with Jefferies.

Starting out on outlook for cash cost, please. We've obviously seen those costs creep higher over the past couple of quarters. Can you give us a little bit more color to better understand the mix of areas where we're seeing upward cost pressure? And how much of a step-up can be attributed specifically to the higher cost Mustang shipments? I'll start there, please.

Seth, a lot of these costs are related to product mix because we are producing more -- in the second quarter, we produced more of the Mustang pellets than we had originally anticipated. And the Mustang pellet has a cost component that is higher than [acid] pellets for obvious reasons. We have to add -- it's a super-flex pellet. So we're doing more work. We are adding more raw materials to produce the Mustang pellet. This being said, the margin of the Mustang pellets is positive. So the costs are higher, but the price is much higher than the blast furnace pellets. So at the end of the day, it's something that's a net-net, very positive for us. But I'll let Tim Flanagan elaborate on a few other things.

Yes, Seth. The other piece is beyond the production mix of the Mustang, higher diesel prices with oil increasing, you're seeing higher labor rates, specifically around profit-sharing, and then our royalty rates in a particular mine are based on our realized revenue rates. So as profits go up, that higher sales prices drives a higher royalty rate. Outside of that, the one comment I would make on the diesel front, don't forget that certain of our customer contracts are tied to PPIs. And so there was fuel-related increases, we see a benefit on the revenue side as well offsetting some of that cost inflation.

Yes, Seth, one more thing about the Mustang pellet. At this point, the Mustang pellet is a big success in the market. It's considered the best pellet, probably in the entire world. So we are trying and selling Mustang pellet -- not only trying, but selling commercially Mustang pellets in other customers outside of the original customer that was designed -- the Mustang pellet that was designed for. That's also the reason why we are producing more Mustang pellets. So it's not limited by only one blast furnace of one client anymore. It's now our flagship product to sell to the one that really wants the best pellet available in the entire world.

And a separate question, please. I think you mentioned earlier in discussing the realized price strength in Q2. There was true-up again on higher prices. Can you just help us understand the size of this? I think it's a derivative gain to help us better understand the mechanics there?

Yes. Tim Flanagan, will give you an explanation on that. Tim, please?

Yes Seth, again, as all of our contracts are based on full year annual average prices, as we look out over the course of the year and the HRC prices have taken a step change from Q1 to Q2, that drives up our full year expected realized price. So therefore, we not only record that for the tons sold in the second quarter, but we have to look at the 1.6 million tons that we sold in Q1. So that's that true-up adjustment that we're talking about there.

Can you confirm the size of that gain in Q2?

It's about $4 a ton impact on that realized revenue rate.

Your next question comes from the line of Matthew Fields with Bank of America Merrill Lynch.

Lourenco, congratulations on the progress and in realizing your vision for the company. A couple of housekeeping questions and then a couple of bigger picture ones. I saw in the cash flow statement there was about $15 million used to repurchase debt in the quarter. Would you tell us what tranches or bonds you went after in the quarter?

We are basically pursuing the 2020, that we have 2 trances in the 2020. One in March, and one in -- matures in March, the other one matures in October. So we went after those. And we also got a deal with the 2021, the tranche that matures in April 2021, (inaudible) the short-term one. And at this point, we're going to generate so much cash that we are going to pay this once off out of the cash flow generation. So there is no transaction to refinance this thing by any set of imagination, we are going to continue to pay down. But every time someone calls in the treasurer and offers a deal, if the deal is good, we take it. So remember to bring down another $15.5 million in debt, saving some money in interest expenses and continue to chip away the short-term debt, which is in the bag. For me, it's a thing of the past already based on where are the cash flow that we're going to generate.

Okay, great. And then just to clarify Tim's remarks, the $105 to $110 per ton revenue guidance is based on an average year-to-date hot-rolled price of $826, is that right?

That's correct.

Okay. Great. I read in some Minnesota papers that Chippewa was able to get their mineral leases reinstated because they secured some funding. But when I looked at the Switzerland-based Riverdale Commodities lender, it looks like there is a lot of overlap personnel with Essar. I know, you might not want to comment a whole lot, but can you just comment a little bit about is that really what Tom Clarke is supposed to be doing? And any kind of dynamic for how you see that playing out?

Yes. With this entire ordeal, the most surprising thing that I saw and read, by the way, the way the finance came along did not surprise me at all, because who else would give money to a loser like Chewbacca? So there is no way he can get money from real sources. So it would be something like that. So no surprise. That's exactly what I was anticipating that would happen. With this being said, the most surprising thing is having the Assistant Commissioner of the DNR, Barb Naramore, going on record saying that Essar is not banned from doing business in Minnesota. That's amazing. That's unbelievable. How come the guy who stole money from Minnesota -- from Minnesotans and the people of Minnesota for the number of years that they did and procrastinate and did what they did, and now they are not banned from doing business in Minnesota. That's really intriguing. So there is no finance at the end of the day. There is nothing over there in safety. And there is no plan. There is no engineering. There is no nothing. And even if they had, they still had to execute. And executing a project of that magnitude is not for amateurs. It's not for fly-by-nights. It's for real companies. Look what we have been doing with our HBI. That's how things are done. And to make matters even worse, think about the scenario for competition for pellets in United States. You remember Matt, when U.S. Steel brought back Keetac Corporation without bringing back any blast furnaces. I'm sure that other than ourselves here at Cliffs, everybody else that follows the industry believed with conviction that they were long pellets and they would come and compete against Cliffs, and that would affect our business. Guess what? They brought back Keetac without blast furnaces on their own to use their pellets. And they did not sell pellets to anyone in the Great Lakes. Why is that? Number 1, because we have contracts that preclude them from doing that. And second, because at the end of the day, our clients like our pellets. Our pellets work. So we're still rightfully sold, started exporting pellets outside the United States. And rightfully sold, brought back their blast furnace, and now they have fewer pellets to export out of the United States. God bless them. They are doing the right thing. But they were not able to create any problem for us. So I don't see absolutely any problems coming from there. And don't forget, the land that we acquired in Nashwauk is still under consideration by the judge. The deal is there. We paid the money. GPIOP cashed the check. The deal was recorded in Itasca County, and the land is mine until someone else tells me that it's not. If someone else tells me that it's not, we will act accordingly. We will appeal. We will go to another level of court of law. But I'm going to fight that thing until hell freezes over. And that's it. That's the deal. I don't know if I'm clear enough, if I left anything not explained, I'll be more than happy to clarify.

I appreciate that color. If you'll indulge me one more bigger picture thing, a few analysts have written recently that they expect that the discount for low-grade iron ore is kind of overdone, and expect a mean reversion may be, which sort of signals that it's not, nor necessarily a secular shift in China towards higher quality pellets. Do you care to comment on that dynamic at all?

The first time I spoke about that probably, I think it was in March of 2015 in Perth, Australia when I anticipated that China would move toward higher grade iron contents in the feed and pellets. That was March of 2015. At that time, the only conversation that was going on was low-cost producer. Who is the lowest-cost producer in the world, the championship of stupidity that BHP and Rio Tinto and Vale are engaged. And they all 3 won that championship. They went back to Perth in March in 2016. I let them know that in that one year since I had explained how things really work in the iron ore business, they had already destroyed $100 billion combined, all 3. $100 billion in market cap on Vale, BHP and Rio Tinto. Just after that, coincidentally, this has so many coincidence, Sam Walsh was fired from Rio Tinto, Andrew Harding was fired from Rio Tinto; Jimmy Wilson was fired from BHP and Murilo Ferreira was fired from Vale. After that, Rio Tinto implemented the value-over-volume theory. The new CEO of Vale came to implement a shift towards higher-grade ore. And BHP continues to create driverless things, the driverless trucks, driverless train, driverless CEO suite. So they continue to be driverless everywhere. If China continues to tried to be a first world superpower, and first super powers don't pollute to produce steel. So long story short. The shift towards higher grade is there to stay. The shift towards pellets is there to stay. And BHP and Rio Tinto are on the path to become the next Fortescue. And Fortescue is already on the path to become the next Atlas. Do I need to be more clear?

No, I think that's pretty clear. I appreciate it, Lourenco.

Your next question comes from the line of Dan Knauff with Citi.

I just wanted to ask one more maybe on the broader iron ore market. Obviously, for a couple of quarters now, pellet premiums have been at very high levels. I was just curious kind of what your thoughts are in terms of what's kind of the sustainable level for pellet premiums? I know there is some limit to what regions are able to produce pellets due to water concern or iron ore, but I'd be curious to see if your thoughts on, if there is additional capacity that might come on? And kind of what you think the current premium price does -- do in terms of spurring that kind of investment?

Look, the biggest thing, Dan, that you need to look in terms of pellets and pellet premiums is not capacity. It's the [bins]. Remember, half of the steel produced in the world is produced in China, more than 800 million tons a year in a market that's a little more than 1.6 billion tons a year. So more than half of the steel produced in China is still -- the steel produced in the world is produced in China. Well, the rest of the world is comprised by big chunks like Japan, more than a 100 million tons, United States close to 100 million tons, and South Korea and Taiwan and Germany and Italy and the U.K. and Luxembourg. And these are places Belgium -- these are the places where pellets are favored. In our case, almost a 100%. Pretty much a 100% here in the U.S. and Canada. So the Chinese side of the pie, maybe a pizza, that half is pepperoni and the other half is pollution. So the pepperoni pizza is well-established. It's not going to change. And the pollution pizza will become pepperoni. Think about, as pollution becomes pepperoni, demand will increase so much and that's why the pellet premium in China was $18 per ton not too long ago, then went to $35, then went to $45, then went to $52, then went to $62.5 and that's where it is right now. That's China. So the pepperoni pizza is well-established pepperoni side of the pizza, haven't changed yet. Wait until the pollution pizza becomes pepperoni. That will be fun to watch. You get it?

Yes. Very helpful. Just one more to follow up. Just quick on APIO. I was wondering if you could maybe break out what portion of the cost in the quarter came from provisioning and severance cost versus the sale of the remaining inventory. And then maybe what portion was cash versus noncash?

Okay. Tim Flanagan will take that. Tim, please.

Yes. So for the quarter, again, we said majority of the cost that you saw come through the costs related to APIO, about $50 million of the $64 million were associated with Australia; $30 million of that loss was related to the sale of the inventory and the shipments we made during the second quarter. And then the other pieces would be contract termination of about $30 million, severance of about $10 million offset by the liquidation of the mobile fleet that we completed at the end of June, and we had a gain of about $15 million there. So that gets you to that roughly $50 million we saw come through during the quarter.

Your next question comes from the line of Nick Jarmoszuk with Stifel.

So one question for you. Obviously, the U.S. mills are benefiting from Section 232. I was hoping you can comment whether your Canadian customers are seeing any headwinds from 232? And whether longer-term you see any risk to downstream steel demand in the U.S. arising from the trade policies?

Nick, look, our Canadian customers are in Canada. And they are, of course, not extremely excited about the treatment that Canadians are getting from the current 232 consequences. But that's a fact of life at this point. For where Cleveland-Cliffs sits and from our standpoint, it's more or less like this. So far so good. They are buying. They are paying. They are suffering. They are crying. We're helping them with. But life doesn't change for me. We are just lending them a friendly shoulder for them to cry. If they go beyond that, if they no longer buy, the steel that they used to produce will be produced by my American clients. And I'll be happy to supply the same pellets to my American clients or new clients, and we will not be affected. So without elaborating too much what's going to happen or what's not going to happen, I'll tell you, no matter what happens the same pellets are being consumed today at the Canadian side of the Great Lakes can easily be consumed here at the American side of the Great Lakes, and we will be absolutely unaffected, no matter what the outcome we get from 232.

Okay. And then in terms of the downstream demand, are you seeing any risk there with the elevated steel prices?

Actually, downstream, it's actually exactly the opposite of your concern, because it's unquestionable at this point. I'm not telling, you like Trump, you don't like Trump, it doesn't matter. It's unquestionable that Donald Trump brought back the resurgency of American manufacturing. Let's take automotive. The car manufacturers that have been very vocal about against everything are running at a rapid pace. People don't talk about that. I don't see that in the headlines that it should be, the car manufacturers are producing at a record pace. They have never produced and sold as many cars that they're selling right now. And that's just one. You only need to drive by Toledo or any other Midwestern little town to see that there is hope out there. There are jobs out there. The restaurants are open. The dry cleaners are selling service. The cab drivers are working again. We are seeing American jobs being generated. Instead of generating jobs in China, in Taiwan, in Malaysia, in Thailand, we are generating jobs in Ohio, in Pennsylvania, in Indiana, even in Wisconsin despite of the spineless politicians from Wisconsin. All of them. So we are generating jobs in the Midwest thanks to tax reform, not Section 232, not anything else, other than pure-play book of tax reform. Longly overdue. Countries are no longer taking advantage of the United States in trade. Thanks to Wilbur Ross, Peter Navarro, these guys that have been defending United States out there, and we appreciate that. And I appreciate what President Trump did as far as supporting trade. And it's not a Republican thing. Here in Ohio, we have a Democrat, Sherrod Brown. His speech is exactly the same as Donald Trump, because he understands, he gets. So we are not at any risk of problems downstream. The logic will prevail at the end. We will continue to be geared towards more and more production in America. That's why I spent the last 4 years of my life out of retirement to bring Cleveland-Cliffs back to life as a supplier, as an enabler of steelmaking in United States, as a supporter of U.S. manufacturing. Because that's what I believe. I believe in middle-class, I believe in jobs. I believe in a strong economy, and I believe in doing things here in the U.S. And that's what's going on. So the risk of things not going well going forward are 0. With that, I will call it a day, because we are already past few minutes beyond the 11:00 mark. I will appreciate the support and the following from you guys, the research analysts during the last 4 years. I am here to stay. I'm going to be here for a long, long time. So better going along well than not going along well, because we are going to have to deal with each other for the foreseeable future. And I would like to particularly thank the investors that have been with me from the very first moment of our very difficult path, but very well plotted out of the woods that started on August 7, 2014. We have accomplished a lot. And we thank you all very much for the support. There is a lot more to come. There is a lot more wealth to be generated in this company. The upside is in the equity. And stay with me, because we're going to make a lot of money together. Have a great day. Bye now.

This concludes today's conference call. You may now disconnect.