29/08/2006 - 22:00

Costs crunch warning for resources

29/08/2006 - 22:00

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On the road from Esperance to Albany there’s a factory rising from the low-lying, south-coast scrub, which will one day produce nickel but which is already acting as a red-flashing beacon, warning that all is not well with Western Australia’s resources boom.

BHP Billiton’s Ravensthorpe nickel refinery is a cost blow-out phenomena. It is acutely embarrassing to the management of a company that promised it had learned its lesson about not wasting shareholders funds on badly designed, or poorly implemented mining projects, and a pointer to what lies ahead for all prospective project developers.

The 1990s delivered more than enough unpleasant surprises for BHP in the form of the Beenup titanium minerals project (didn’t work), Hartley Platinum (killed too many employees), Magma Copper (a high-priced dud), and the Port Hedland hot-briquetted iron (killed and maimed staff, and also failed to work as advertised).

Ravensthorpe, BHP promised, would be different. So far, it’s not; it’s just more of the same – though not totally BHP’s fault. The blame, and here lies the big worry for WA’s resources boom, is that a lot of what’s going wrong at Ravensthorpe is part of an industry-wide infection of dramatic cost inflation, and skills shortage.

So far, the best that BHP can tell is that the cost of building Ravensthorpe’s has blown out by around 50 per cent. What was supposed to cost $1.5 billion is now said to be costing around $2.3 billion.

Sky-high prices for nickel will absorb the blow out. But that’s at today’s nickel price.

What if – and this is the issue keeping resource company managers awake at night – the resources boom is at a peak and next year we start to see a modest correction in metal and fuel prices. Analysts are not tipping a crash, but they are becoming more consistent in the view that prices are close to a peak, supply is rising to meet demand, and global economic growth is being stymied by the twin forces of oil prices and interest rates.

It’s the pincer effect of rising costs and falling prices that has the potential to destroy a number of highly-promoted projects – including the biggest of them all, the $11 billion Gorgon liquefied natural gas development – and lay waste to at least half of the 40 major resource projects listed by the WA government.

The word reaching Briefcase is that senior staff at the Chevron-led Gorgon project are becoming deeply concerned about the cost outlook for their project, as well as the delicate subject of how to handle the flatback turtle, which has reared its ugly head as a potential environmental show-stopper, on Barrow Island at least.

This is an awfully simple equation, but what if a 50 per cent cost blow hit Gorgon, like it has hit Ravensthorpe. Suddenly, an $11 billion project becomes a $16.5 billion project, with no guarantee that the game stops there.

Off the Russian coast there is an even worse example of cost inflation at work. ExxonMobil and Shell thought they could build the Sakhalin No.1 LNG project at a cost of $US10 billion. The latest cost estimate is $US20 billion – a 100 per cent blow out which, if applied to Gorgon, would take its cost to $22 billion; that really would be a show stopper.

The problem for Briefcase, and all other outsiders, is that Chevron is not talking about costs right now. It’s focused on the turtle.

But when pressed to say whether there is a firm development timetable, Chevron spokesmen parrot a line that goes something like: “Gorgon is big and complex, and all we’re doing right now is working through the engineering and design phase to finalise costs and other matters so a decision can be made as soon as possible.”

The English translation to this American-style gobbledegook is (a) we’ve got design issues, (b) there’s a turtle on the beach, and (c) we don’t really know how much it will cost.

•••

Gorgon, of course, is not alone.

As a way of filling in time, Briefcase went back to the Goldman Sachs JBWere ‘best guess’ commodity forecasts sheet mentioned last week – and cross-referenced that with the latest ‘golly gosh, gee-whiz’ resource project list from the WA government – that 40-item agenda with a price tag approaching $68 billion.

What happens, your idle scribbler wondered, when you apply a 50 per cent cost blow out (the Ravensthorpe quotient) to a project such as Alcoa’s long-delayed Wagerup stage three alumina refinery expansion?

The official cost estimate for Wagerup is $1.5 billion, but that’s ancient history. A true figure today is almost certainly closer to $2 billion. With the Ravensthorpe quotient added, hey presto, its $3 billion, and that’s enough to have the chaps at Alcoa head office in Pittsburgh shivering in their Florsheims.

To take the game of costs plus commodity prices a step further, work the Goldman alumina price forecast into the equation. From around $US361 a tonne today, Goldman expects the alumina price to fall to $US269 in 2008, a 25 per cent drop over the next two years, before rising again towards the end of the decade.

In Pittsburgh, the chaps have stopped shivering. They’ve just fainted.

Pick a price and pick a cost is a game that can be played by everyone. Even Gorgon, which is a certainty for a cost blow out, is looking at a lower LNG price, according to Goldman. This year’s $US251/t is tipped to decline to $US212/t by 2010.

In the iron ore game, the big one, of course, is Fortescue Metals with its $3 billion Chichester Range project. FMG’s costings are probably the most up-to-date, but so were BHP’s at Ravensthorpe when it started construction. Whack 50 per cent on FMG and you get a truly staggering $4.5 billion.

It’ll never happen, will be the cry from FMG. But remember, that’s what BHP said at Ravensthorpe, HBI, Beenup, Hartley and Magma.

What becomes even more interesting with FMG is to factor in a cost inflation effect with Goldman’s iron ore price forecast which, for lump ore, is for a decline from $US93.75/t today to $US62.72/t by 2009 – a 33 per cent fall.

Interesting, isn’t it, this game of costs versus price?

•••

 “If one tells the truth, one is sure, sooner or later, to be found out.” Oscar Wilde

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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