Forrest faces financial test as China slows

ANDREW Forrest is not alone in facing a testing time after a marital split which has slashed his fortune and raised doubts about the future of Fortescue Metals Group.

Uncertainties are being experienced everywhere as an economic sea change starts to blow. Retreating inflation and the prospect of lower interest rates next year are two of the positive potential changes.

Slow growth verging on stagnation is one of the negative potential changes with “stagflation” (stagnation plus inflation) the worst possible outcome.

The most obvious event so far in the shift under way is what appears to be a significant slowdown in the Chinese economy, an event with widespread implications, especially for iron ore miners such as FMG and the broader Australian economy.

Forecasts of a big fall in the iron ore price are not new having been made repeatedly over the past few years without eventuating, but this time it could be different because China has decelerated, which means steel production cuts will follow along with reduced demand for iron ore.

Goldman Sachs, an investment bank with close connections to the commodity sector, is factoring in a fall in the iron ore price from its recent $US111 a tonne to $US90/t by the end of the year and then down to a long-term price of $US82/t.

The Western Australian government is even gloomier, with its iron ore forecast for this year of $US74/t, falling to $US66/t, a number which, if right, will have a severe effect on the profits of all iron ore miners, especially higher-cost operations such as FMG.

Easy to dismiss as best guesses, the reason iron ore forecasts need to be taken seriously this time is that the global economy, especially Europe, is edging towards recession caused by central banks reeling in the excess cash they created during the COVID 19 crisis.

The effect of a falling iron ore price will be magnified over the next 12 months by inflation-linked cost increases which, in the case of FMG, are likely to see its cash cost rise from last year’s $US15.90/t to $US20.70/t next year with the full cost roughly double the cash cost.

It’s the effect of falling prices and rising costs which explains the Goldman Sachs sell tip on FMG and its share price forecast of $15, down 34 per cent on recent sales at $22.88.

Handsome profits are likely to continue flowing at FMG but if costs keep rising and the iron ore price does fall then belt tightening across the company, and the wider Forrest empire, will be required.

Questions will also be asked about how future profits, whether up or down, will be distributed in what could be the biggest test of Forrest’s management of the company he founded with his estranged wife, Nicola, who has emerged as a key player in the future of the business.

Investors have, so far, dismissed concern about FMG’s future profitability and generous stream of dividends, which have enabled Mr Forrest to pursue his dream of creating a world-class renewable energy business out of Fortescue Future Industries.

His vision remains intact today but a crimp in the cash flow from iron ore could derail one of the business world’s most ambitious transformations, with the FMG ownership split adding to the challenge of creating a new type of energy business.

Energy reckoning

Energy policy will remain a test for governments around the world, including Australia where there’s a rush to force coal and gas out of a mix that will be increasingly supplied by renewables such as wind turbines and solar farms. 

But like the Forrest family and its FMG challenge, there are monetary hurdles to clear before a plan can become reality.

For Australia, the price of meeting green energy targets is said to be $1.5 trillion, money that needs to be found over the next seven years or risk missing self-imposed carbon dioxide emissions targets.

Finding that amount of cash, which has been compared with the cost of rebuilding Europe after World War II will not be easy. It might even be impossible.

The test, as it is for both sides of the Forrest family, is to first raise the money and then decide how to allocate the cash.

Andrew and Nicola Forrest can rely, up to a point, on iron ore cash to meet their energy plans.

The Australian and WA governments will share in the iron ore cash and perhaps seek more through tax and royalty increases.

But the major source of finance for government energy plans are taxpayers who will be forced to join the energy changeover, whether they like it or not.

For governments, like the Forrest family, a reckoning is coming which will see environmental ideology bump headfirst into economic reality.

To borrow a famous comment from an American movie, the combination of a Chinese economic slowdown, falling iron ore profits and rising energy costs will produce Australia’s own “show me the money” moment.

China changes

OUTSIDERS have a limited grasp of the economic problems facing China but a slump in exports and a growth rate of 3 per cent, or less, is starting to produce changes at the top, with some of the Chinese shift caused by Australia.

Earlier this month Chinese President Xi Jinping called for greater economic opening and increased trade as the country’s post-pandemic recovery faltered.

President Xi said he wanted increased foreign cooperation, a seemingly contradictory comment given a hardening approach to international companies and consultancies operating in China.

What appears to have happened is that the Chinese government has been shocked by the way western governments and their leading companies have been turning their backs on China, concerned they could be the target of the treatment dished out to Australia when it was hit by trade embargoes.

But the real lesson learned by China in its trade spat with Australia is that it was the loser because Australia was able to redirect exports, effectively bypassing China, which probably believed it was indispensable to Australia.

Other countries will have learned from Australia’s experience.

Project in balance

A FINAL test for the new financial year is likely to be the fate of the once heavily promoted Winu copper discovery in the Pilbara.

Development of Winu, 350 kilometres south-east of Port Hedland, was expected to start this year but has been mothballed by its owner, Rio Tinto, because there are better copper projects overseas and a deal is yet to be struck with the first nation owners of the land.

WA’s new Aboriginal Cultural Heritage Act coupled with the proposed Voice referendum will probably not be encouraging Rio Tinto to rush future investment in Winu given its world-class copper development opportunities in North and South America.