BHP’s port move could take costs crown

It’s probably not a race that many iron ore executives thought they would be in but in an era of ever escalating costs, BHP Billiton could well be lunging for the line to claim the title for the country’s most expensive development project.

To date, the oil and gas world thought they had that crown firmly in their hands, held by the Chevron-led Gorgon project, which was committed to in 2008 at a projected cost of $43 billion.

Gorgon is a work in progress and there is plenty of talk that the final price might be a lot more than that as labour shortages, technical challenges and logistical problems blow out beyond expectations.

Nevertheless, BHP Billiton Iron Ore this week took a significant step towards challenging Gorgon’s current project cost by starting the public comment process for its environmental review of a proposed expansion of the company’s Pilbara operations, including an expensive wharf development 4km out to sea at Port Hedland.

With analysts putting the cost of adding each million tonnes of annual output – from mine to port – at $US200 million, the 240 million tonnes per annum expansion could start with a $US48 billion price tag. And, of course, it may not end at that number.

That is on top of BHP’s previous commitment to develop the inner harbour from 155mtpa capacity to 240mtpa at a projected cost of $US183 per tonne of additional annual output. All up, that is nearly $US15.6 billion.

Last year, BHP exported 133mt of iron ore through the port as it completed its Rapid Growth Project 4 to get its capacity to 155mtpa and was also well underway with RGP5 to reach 205mtpa during this calendar year.

The hesitation appeared to be RGP6, despite some preliminary work, but last month the group committed $US7.4 billion to reach 220mtpa, with a further $US1 billion planned for debottlenecking which, along with new blending arrangements, is expected to get BHP to 240mtpa from the inner harbour by around 2014.

The breakdown of that investment is $US3.4 billion for the development of Jimblebar mine and rail links, and the procurement of mining equipment and rolling stock that will deliver initial capacity of 35mtpa; $US2.3 billion for port infrastructure, including two additional berths and shiploaders; and $US1.7 billion for port-blending facilities and rail yards to enable ore blending, the expansion of resource life and to prepare for the future growth of the business beyond the inner harbour.

Last month, BHP president iron ore Ian Ashby said the development would provide for imminent further expansions – adding to the upfront cost.

“We have intentionally overbuilt the ore-handling facilities at Jimblebar and expect to incrementally grow mine production to ensure that our port and rail systems are operated at full capacity during this debottlenecking program,” Mr Ashby said.

By comparison, Rio Tinto’s planned expansion is relatively cheap, although of the big three Pilbara miners, Fortescue Metals Group claims the lowest expansion cost.

Last month, Rio Tinto iron ore and Australian CEO Sam Walsh said his company’s expansion cost was around $US130 per tonne of additional annual capacity.

Mr Walsh said his company was spending about $15 billion boosting its Cape Lambert facility by 103mtpa as well as 5mtpa at Dampier to take overall output to about 330mtpa.

The lower cost of Rio Tinto’s expansion is due to the relative ease of developing Cape Lambert, which currently has capacity to export 80mtpa.

This was recognised as the key driver to the now-abandoned merger of BHP and Rio Tinto’s iron ore operations to allow the joint development of that port rather than the expensive additions to Port Hedland, which requires development in a tidal-constrained inner harbour and well off the coast for the outer harbour.

Mr Walsh cites the close access to open water and significant onshore space required for iron ore operations, which makes Cape Lambert the readily expandable large-scale, blue-chip asset in the industry.

“It is the jewel in the crown of Rio Tinto’s business,” he said.

He made this point at a recent iron ore conference while challenging unnamed rivals on their ability to deliver on their forecasts – both in terms of timing and cost – in an environment that included a tight market for contractors and procurement.

“Things never work out as planned or claimed in some cases,” he said.

However, in February Andrew Forrest’s Fortescue stated in its first-half result for the six months to December 31 that it had approved expenditure of $US8.4 billion to expand capacity to 155mtpa from 55mtpa – all of which will be exported out of Port Hedland.

Close observers of Fortescue say its expansion options were lower cost because its operations had been designed from the start to operate at that volume.

While Fortescue still has to add a berth and ship-loading facilities, much of its existing infrastructure already has the capacity built in.

Furthermore, a lot of its costs were off balance sheet, such as mining machinery fleets, where the capital cost typically lies with the contractor.

“They don’t have to go to the market to raise money for the mining fleet,” said one observer.

However, Fortescue is not alone in that approach among the big Pilbara players and, with the tight market, even that upfront cost saving was being eroded as mining contractors sought assistance from their clients to raise the capital needed for major equipment purchases – especially given the changes to the debt markets since 2008’s global financial crisis.

One of the issues is not only increasing mining operations at a time when financial markets are tight, but that some of the key contract miners are also gearing up to work on the construction elements of various expansion projects, putting a strain on their balance sheets.

Major contract miners such as Downer EDI and Leighton Holdings (its subsidiary HWE does extensive mining contracting for BHP in the Pilbara) have expressed their concerns about the cost of doing business in this way.

Last month, Fortescue chief financial officer Stephen Pearce reportedly said the company would consider sharing equipment costs on forthcoming projects.