Fortescue, founded five years ago, can deliver 55 million tons of iron ore a year to China and there is talk of boosting this to 200 million tons. Fortescue is already being tipped as the miner most likely to break the Rio Tinto-BHP Billiton stranglehold on exports from northwestern Australia’s iron-rich Pilbara region.
Investors have bought the success story, sending Fortescue’s stock up threefold in the last year. China now appears to be following suit – Baosteel and Sinosteel, an iron ore trader, have recently been touted as potential stakeholders.
“When Andrew Forrest [Fortescue CEO and Australia’s richest man] and I first discussed developing iron ore deposits in May 2003, we knew we could offer a major alternative source of supply for China,” said Graeme Rowley, Fortescue’s executive director for operations. “And right from the beginning we presented ourselves as being interested in Chinese investment.”
A matter of time
Although discussions have been held with a number of potential Chinese investors, Rowley says nothing concrete has happened yet. But it seems to be a case of when rather than if.
Chinese demand is generally credited with rejuvenating the global iron ore industry in recent years. China has large but low-quality ore reserves, so imports have more than doubled in five years. Australia, with vast stores of premium ore, which is at least 60% pure iron, and lower-grade magnetite and hematite deposits, tripled its exports to China in the same period.
It is only logical that China’s steel mills want to buy into the mines that sell them so much iron ore.
“Chinese companies are now looking to make investments in iron ore assets because they have realized the importance of having upstream supplies in order to sustain growth,” said Helen Lau, a steel analyst at Daiwa Securities in Shanghai.
Chinalco’s US$14.28 billion investment in Rio Tinto – a collaborative effort with US steel-maker Alcoa – is by far the largest Chinese investment in Australia’s materials sector. But there have also been a number of investments in so-called junior iron ore miners.
Financial data provider Thomson Reuters lists Midwest Corp, Cape Lambert Iron Ore, FerrAus, Fox Resources and Jupiter Mines as recipients of Chinese investment in the last 12 months. Midwest Corp has a fully operational mine with an annual production capacity of 1 million tons and several hundred million tons of magnetite and hematite reserves. The other miners, meanwhile, have yet to extract even low-quality ore.
If it wasn’t for the boom in the iron ore market – prices have soared in the last six years, rising 65% in 2008 alone – some of the assets controlled by these companies might have been left untouched.
“For a junior company such as Jupiter, today’s price makes it very financially rewarding,” said Greg Durack, the company’s CEO. Jupiter sold a 9.5% stake to a subsidiary of Haoning Group, a Chinese iron ore trader, for US$3.5 million in early May. Durack will use the money to develop a 2 million ton reserve of premium ore and to explore the Mount Mason area in southwestern Australia.
Andrew Caruso, managing director of Australasian Resources, has also received Chinese investment. Companies tied to Shougang, China’s fourth-largest steelmaker, spent US$53 million on a 12.8% stake in Australasian last March. Now Caruso wants Shougang to cover the US$2 billion cost of developing his company’s magnetite reserve in Pilbara. The reserve might produce 300 million tons of iron ore over 25 years – all of which could go to the Chinese steelmaker.
The take-off mechanism likely to be used in this deal has the customer paying upfront for future iron ore supplies so that the project can get started – common practice in Australia’s mining industry.
Australasia’s iron ore assets are just 30 kilometers away from a dedicated steel port at Cape Preston. But for many junior miners in Pilbara, moving iron ore to the coast is a challenge, as most of the railway lines are controlled by Rio Tinto or BHP Billiton. Fortescue’s solution was to build a 260 km railway, costing US$2.3 billion, to its own loading berths at Port Headland on the northwest coast. This measure is well beyond the means of most miners.
But Chinese investors, Caruso said, are increasingly open to footing the bill.
“When the Chinese look at the project, they examine the whole supply chain and in some cases, they are willing to invest in rail and port infrastructure,” he said. “There will be increasing interest in the Pilbara region.”
Digging for control
The contentious issue here is how much influence, and ultimately control, Chinese companies can expect to have over the operators they invest in.
Australia’s Foreign Investment Review Board must approve all direct investments by foreign governments or state-controlled agencies. For private sector deals, the approval process kicks in when a transaction passes the A$100 million (US$94.5 million) mark.
These regulations have not eased tensions between Chinese and Australian parties over potential or actual deals.
Reports in April that the Australian government had forced at least 10 Chinese companies to withdraw their applications to invest in local mining operations were quickly rebuffed. But earlier that month, the government stopped a Shougang subsidiary from buying 19.73% of Mount Gibson Iron. Shougang’s existing interest in Australasian, which owns 20.2% of Mount Gibson, was cause for discomfort in Canberra.
“Historically, some of our discussions [with potential investors] have fallen down over the control of the entity,” said Fortescue’s Rowley. “We have secured control at management level and are very careful about diluting it. We will never get to such a stage where an aggressive bid can cause concern.”
On the day Rowley made his remarks, Sinosteel raised its stake in Midwest Corp to around 40% in an attempt to thwart the company’s proposed merger with Murchison Metals, another local player. Sinosteel wants Midwest for itself and has launched several aggressive takeover bids for the company.
Jin Xiong, a senior associate with law firm Mallesons, said that as Chinese investors became more sophisticated, more hostile takeovers would emerge.
There is a potential downside for Chinese firms. They may have come to the party too late and shelled out too much for iron ore assets, only to pay the price when a down cycle hits. Australian miners counter that as long as lower-grade ores still command such high market prices, there is life in the party yet.
With their quality ores and relative proximity to China, operators in Pilbara are optimistic. Rio Tinto, for example, says its production in the region is set to hit 320 million tons a year in 2012.
“The extent of China’s role in the recent rapid growth of Australia’s iron ore industry cannot be overstated,” a Rio Tinto spokesperson said. “We expect that to continue.”