Analysis: winds of change blow coldly over Rinehart project

If Western Australia’s iron ore miners thought they had seen the worst of the price slump which sent shockwaves through their industry two months ago they had better think again because “the mother of all market disconnections” is pointing to a second wave of price falls.

What’s happening is that global steel production has fallen sharply, taking the steel price with it.

But, at the same time as the world’s steel mills are seeing future years of below-trend demand for their product the price of iron ore has been rising.

In the simplest possible terms this is an equation which does not compute for a very simple reason. Iron ore is used for only one purpose -- to make steel.

When will the penny drop is anybody’s guess, but mine is that the second wave of price falls will arrive before Christmas, triggering a fresh round of cost-cutting and project delays.

Deeply entrenched miners with the lowest costs, and that essentially means BHP Billiton and Rio Tinto, will ride out what looks like the arrival of the correction which has been forecast by cautious analysts for the past two years.

Higher-cost miners and those carrying excess debt, such as Fortescue Metals Group, will struggle unless they can get their costs down quickly.

Big new projects with multi-billion dollar price tags will also face additional hurdles, primarily from nervous bankers who will demand to see proof that the project can be built on time and on budget, that it can service its debts for a long period of low iron ore prices, and that its ownership structure is rock solid.

Most closely watched on all of points is Gina Rinehart’s proposed Roy Hill project which is fast approaching a period of critical decision-making just as the market turns against it.

Raising doubts about the outlook for the iron ore price might seem unusual after the recent recovery from around $US90 a tonne to $US114/t, a rebound which helped the share prices of miners rise, and Fortescue secure additional funding to undertake its essential cost-lowering expansion program.

But, what no-one has yet been able to explain is the disconnection between the iron ore price and the steel price, or explain how the iron ore price can stay above $US100/t if growth in global steel production has effectively stalled (which it has), and a wall of additional iron ore is hitting the market courtesy of new and expanded projects built in expectation of the price staying “stronger for longer”.

Two significant developments in the iron ore industry over the past 48 hours include a report published by the World Steel Association which has cut its global steel consumption forecast for the current year to 2.1 per cent, a significant fall on the 3.6 per cent growth forecast made in April, and a sharp fall on the 6.2 per cent expansion in steel demand enjoyed last year.

In other words, as the global economy slows, demand for steel slows – which leads to that rather obvious question about how can iron ore demand and price rise as its only market moves alarmingly close to stall speed.

The second development occurred in Sydney this morning when the chief executive of Gina Rinehart’s Roy Hill project, Barry Fitzgerald, skipped a speaking commitment at the Mines and Money conference.

His place was taken by general manager of external affairs, Darryl Hockey. Conference organisers told the audience that Mr Hockey's boss couldn’t attend the event because he was in negotiation with bankers who it was hoped would provide the debt financing component of the project.

What was not made clear by Mr Hockey was how much debt Roy Hill is seeking, despite an opening remark from a conference organiser that Mr Fitzgerald was no show because he was seeking $9 billion from the banks and other financiers.

Mr Hockey’s response to that number, the highest debt figure attached to Roy Hill so far, was that it should not be reported because it “might not be correct”.

The audience was left hanging as to what the real debt figure might be, but it was also left in no doubt from the tenor of the presentation that Roy Hill is facing the same head winds as all Australian resource developments; rising costs, higher taxes, falling commodity prices and the threat of union militancy.

Despite those problems, Mr Hockey said early work at Roy Hill was continuing, including work at the mine site, on the railway route, and at Port Hedland.

However, in terms of financing it seems that the timetable is being dragged out with finalisation of negotiations with banks not expected until the first half of next year, and a final commitment to the full-scale development of the project possibly delayed until mid-2013.

It would be unfair to say that Roy Hill is encountering serious problems, but it would be equally true to say that the ambitious project is being buffeted by a dangerous combination of high costs, a difficult funding environment, and lower commodity price.