17/08/2009 - 12:30

FMG plans expansion with $6bn from China

17/08/2009 - 12:30

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Fortescue Metals Group says a proposed $US6 billion funding agreement with Chinese banks will give it optimum flexibility to expand its Pilbara iron ore operations to meet demand from Chinese customers.

Fortescue Metals Group says a proposed $US6 billion funding agreement with Chinese banks will give it optimum flexibility to expand its Pilbara iron ore operations to meet demand from Chinese customers.

Fortescue today revealed it had struck a landmark six month pricing and supply deal with China's biggest steel maker, Baosteel and the Chinese Iron & Steel Association (CISA) that will see it deliver 20 million tonnes of ore to Chinese customers by the end of the year at a 35 per cent discount to last year's contract price.

Crucially, this is three per cent less than the 'benchmark' price agreed between Japanese buyers and Rio Tinto and BHP Billiton.

The agreement is conditional on Chinese lenders finalising an agreement to provide up to $US6 billion in new debt funding to Fortescue on mutually acceptable terms by the end of September.

Speaking to reporters about the supply and funding agreements today, Fortescue chief executive Andrew Forrest ruled out using the Chinese funds to retire and replace the company's existing multi-billion dollar debt pile owed to US bondholders, although some of its fleet and equipment leases may be repaid.

Instead, the funds would primarily be used to expand the company's Pilbara iron ore operations to meet the needs of its Chinese customers.

Fortescue was simply "making sure we have absolute flexibility on an un-capital constrained basis as to how we expand this company."

"Our expansion strategy has been very keenly influenced by the availability of capital," Mr Forrest said.

"Now we may choose to repay some of our Australian leases when this capital comes through, but the bulk - if not all of the capital at this stage - will be used to most optimally expand our assets. We are comfortable with our capital structure with (respect to) the US bonds and don't intend interrupting them at all."

Mr Forrest declined to give any firm details on the nature of the proposed funding deal, but said it would not require the issue of new equity and that it would involve low-cost long-term funding arrangements with Chinese banks.

Mr Forrest said Fortescue had been working on a major funding facility with China for 12 months, and it would enable Fortescue to better optimise its expansion schedule.

FMG is currently exporting ore at an annual rate of 32 million tonnes, and had previously indicated an initial aim of increasing its capacity to 95 million tones per annum over the next two years at an estimated cost of $3 billion to $4 billion.

Mr Forrest said the focus of the funding initiative would be on expansion of its existing operations at Cloudbreak and Christmas Creek in the Chichester Range, rather than greenfields development of its untapped resources in the Western Pilbara, such as the Solomon deposit.

Mr Forrest said Fortescue's ground breaking pricing agreement with Baosteel on behalf of CISA members not only broke the impasse between Chinese buyers and major producers, but would also help counter the damaging uncertainty, volatility and risk which had characterized the iron ore market over the last 12 months.

"The price achieved is a very small discount to what is already on the table ... and we are comfortable with the fairness and equity of that price level," he said.

"This deal gives China the ability now to go on and achieve their own iron ore price index and bring in the kind of discipline that you see in the steel industry in Korea and Japan where there is a benchmark price ... and there is not a spot price which some producers get and benchmark price that other producers get."

Similarly, it gave Fortescue the confidence in volumes and revenues needed to grow its business.

The price deal also entitles FMG to a priority role as a price negotiator should CISA again engage in annual price talks with iron ore suppliers next year.

The future of such talks is highly uncertain, given the failure of CISA or the major producers to agree on prices months after Japanese and Korean producers agreed to a 33 per cent reduction for this financial year.

BHP, in particular, is pushing for a more fluid and transparent market-linked pricing index that reflects prevailing conditions throughout the course of the year.

Mr Forrest said the negotiating priority granted to Fortescue was indicative of the Chinese steel industry's high regard for the company as a fair-minded large scale supplier to the sector.

He said that negotiating pricing on a six monthly basis also "looks like the proper timeframe".

Although CISA has said it considers the Fortescue agreement to be an important step toward achieving a single benchmark price for all iron ore sold into China, a spokesman for Rio Tinto rejected any suggestion it would have a flow on effect to its own ongoing price negotiations with CISA.

"We do not see this pricing agreement as relevant to our pricing for fiscal 2009. Rio Tinto conducts its own negotiations with its customers worldwide," he said.

"Whether and how other producers reach their own agreements is up to them."

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