It’s best to steer clear of businesses that don’t have profit as their primary motive for existing.
CHINA Inc is not happy with the way Australia runs its resources sector, and it is starting to take action, as was seen last week in the bloody coup at Gindalbie Metals.
Dumping Gindalbie’s chief executive, Garret Dixon, was the first instalment of the price the company will pay for over-promising and under-delivering at its Karara iron ore project, inland from Geraldton.
More changes lie ahead, including the complete ‘chinafication’ of Gindalbie, either by replacing most of the senior staff with Chinese appointees, or by acquiring full (or increased) control of the company.
Whatever route is chosen, there is a common theme running through events at Gindalbie, and at other Chinese-controlled iron ore projects, especially those processing low-grade magnetite ore, where cost blow-outs and construction delays have proved embarrassing and expensive for China Inc.
Top of the list, but hidden from the view of most Australians, is the wholly owned Sino Iron project south-west of Karratha, where the cost blow-out is likely to top 70 per cent.
In other words, a project promised to cost around $US3.5 billion will end up costing around $US6 billion – not that China Inc will ever make a full confession about its mightily botched job.
Gindalbie appears to have been travelling the same cost road as Sino, with a project originally forecast to cost around $US1.6 billion now said to be facing a cost of $US2.7 billion – a 68 per cent increase.
Next cab off the cost blowout ranks will be Grange Resources’ Southdown project near Albany. Management there is currently ‘reviewing’ its cost base, with ‘review’ being a code word for increase, perhaps not by the full 60 to 70 per cent that has whacked Sino and Gindalbie, but painful nevertheless.
Clouding the cost increases at all three of Western Australia’s overly-ambitious magnetite projects are design changes and modest uplifts in output estimates, alterations that make it hard for outsiders to see the true extent of the damage done to Sino, Karara and Southdown.
But even a first-year accounting student knows that you cannot add 70 per cent to the capital cost of a business without significantly adding to the cost of the end product, which is the fate that awaits China’s grand experiment in attempting to process WA’s magnetite ore.
For non-followers of the iron ore business a basic introduction is required, and a few myths concocted by the public relations spin doctors blown away.
• Magnetite, no matter what the PR spinners say, is low-grade ore. To get it to a high-grade stage it must be processed, and that costs a lot. The end product contains more iron and fewer impurities than direct shipping ore, and does attract a high price, but it also costs a lot more to produce.
• Magnetite is used extensively around the world by steel mills, but it is generally where mines are close to the mill. It is not a product well suited to being transported over long distances with the best example being a switch a few years ago at OneSteel’s Whyalla blast furnace, which changed from haematite ore (suitable for direct shipping) to magnetite because it was closer to the mill.
• China Inc believed it could create a magnetite processing business in WA for its steel mills, blending the expensive processed material with direct shipping ore. It backed three starters in the magnetite race – Sino, Gindalbie and Grange. They all looked good a few years ago, when cost estimates were low and iron ore prices rising. They are all confronting the reality of rising costs and the prospect of falling iron ore prices by the time they start delivering.
Finally, the PR spin doctors working for China’s magnetite miners have never been able to explain why the global mining leaders, BHP Billiton, Rio Tinto, Vale, and Anglo American, have not signed up to the magnetite fan club.
The answer to that last point is that the big miners are driven by the pursuit of profit from their iron ore businesses. China is not. It is driven by the need to acquire iron ore to feed its steel industry and is not focused on making a profit at the iron ore stage of that process.
The WA government, contractors and other service suppliers can benefit from the China Inc approach, but investors should stay well clear of a business that has profit as a secondary motive.
Playing the game
ANOTHER example of how Australia is discovering the true motives of China towards the resources sector is the astonishing treatment of Mt Gibson Iron Ore by China Inc.
Back in 2008, a number of Mt Gibson’s Chinese customers reneged on contracts to take delivery of iron ore. Their excuse was the global financial crisis.
Since that scary time all but one of the disputes have been settled, with the Chinese coughing up the cash they owe.
Rizhao Steel Holdings is the one exception, and it is using every mechanism possible to avoid paying $US114 million awarded after a tortuous legal process that has gone all the way to international arbitration under a former chief justice of Australia, Murray Gleeson, and been ratified by Australian courts.
In theory, enforcement of such a decision is easy thanks to the New York Convention, a process under the auspices of the United Nations designed to settle international trade disputes, with legal decisions in one country recognised in others.
In Mt Gibson’s case the full weight of China Inc has been brought to bear, with the Australian company not even able to get a hearing day in a Chinese court to have the New York Convention invoked.
Meanwhile, in the background, Rizhao appears to have started a series of corporate manoeuvres which distance it from the $US114 million it owes.
Nasty stuff, but a glimpse of business Chinese style.
SHOOTING the messenger is always a stupid reaction to bad news, and last week we saw an entire industry indulge in a desperate attempt to pot the messenger.
The uranium industry, apparently incapable of recognising a game-changing event in the Fukushima nuclear disaster, tried to argue that it was a media ‘beat up’ – on the same day the US government suggested that its citizens leave Tokyo.
Credibility takes a long time to acquire, and a few seconds to destroy.
“A fool is his own informer.”