21/05/2015 - 13:46

Forrest shoots, and scores, an own goal

21/05/2015 - 13:46


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It should be clear by now to Andrew Forrest that his campaign for a political inquiry into the iron ore industry has done the company he runs, Fortescue Metals Group, more harm than good – and might even have stirred up trouble for another local billionaire, Gina Rinehart.

Forrest shoots, and scores, an own goal
Fortescue Metals Group chairman Andrew Forrest.

It should be clear by now to Andrew Forrest that his campaign for a political inquiry into the iron ore industry has done the company he runs, Fortescue Metals Group, more harm than good – and might even have stirred up trouble for another local billionaire, Gina Rinehart.

Rather than attract support, Mr Forrest’s claims about BHP Billiton and Rio Tinto deliberately flooding the iron ore market in order to crush smaller producers has triggered criticism.

The sooner he stops playing the political card, the better for everyone.

Unfortunately what Mr Forrest has done is ask questions that he would prefer not be asked, such as whether Fortescue is under more pressure than meets the eye, and whether his ‘our iron ore’ drive is designed to divert attention rather than raise awareness.

To mix a couple of metaphors, it seems someone protesting too much has released a genie from its bottle.

Two weeks ago I reported a damning analysis of the iron ore market by a London-based research team working for Deutsche Bank. The central theme of its work was that steel mills, the only customers for iron ore, were demanding higher quality ore while applying heavier discounts to sub-standard material.

Fortescue’s ore is regarded as inferior to that produced by BHP Billiton, Rio Tinto and the big Brazilian mine, Vale, with a snapshot of profit margins showing that the biggest and best miners have been earning close to $US30 per tonne, even in a depressed market, while Fortescue has been earning around $US12.30/t.

Two fresh developments in this seemingly never-ending iron ore saga with its business, political and international angles have occurred in the past few days.

Firstly, China has entered the game by providing financial assistance to Vale so it can develop a big new, high-grade, iron ore mine with the ungainly name of S11D, as well as expand its fleet of mega-sized iron ore carriers to help cut the cost of freight on a per-tonne basis.

Vale’s ChinaMax ships can carry 400,000t, roughly double the tonnage carried by most vessels plying the Pilbara to China route.

Whether Brazil can get its transport costs down to a level that matches the natural advantage of Western Australia’s mines, which are much closer to China, seems unlikely; but the bigger ships certainly make Brazil more competitive, as does China’s cheap finance.

The second development that ought to have everyone in the iron ore industry taking notice is a provocative analysis of the market published last week by the investment bank Credit Suisse, which asked a question some people had hoped would never be asked: ‘How can the new iron ore be accommodated?’

The problem, which is the one dogging Mr Forrest, is that with Brazil adding 90 million tonnes from S11D, and with Mrs Rinehart adding 55mt from her Roy Hill mine – plus other recent developments such as Anglo Americans Minas Rio mine in Brazil – an already over-supplied market is about to be flooded by a tsunami of material.

The Credit Suisse view is all that iron ore producers are under pressure because of the supply flood and sluggish demand growth in China. Even a recent fall in port stockpiles is dismissed as a temporary adjustment.

“We take a long-range view to determine how all the new iron ore supply can be accommodated (including Roy Hill and S11D) and believe that there is sufficient room for the major producers, but only if all seaborne supply from smaller producers gives way,” Credit Suisse said.

Interestingly, the bank does not regard Fortescue as one of the marginal producers likely to be forced out of the market, which is what ‘gives way’ means.

That dubious title goes to Anglo American, which operates high cost mines in South Africa (via its Kumba subsidiary) and from Minas Rio. Anglo’s cash-flow breakeven price is believed to be $US44/t versus $US35/t for Fortescue and $US40 for Vale, while Rio Tinto and BHP Billiton are below $US30/t.

But, and this really is the biggest of buts, what happens if China’s steel production goes into a steep decline – a development some people are predicting.

If that happens then all bets are off and only a handful of major, low-cost, producers can survive; even Mrs Rinehart could have a big problem with her almost-complete Roy Hill mine.

“While Roy Hill construction will undoubtedly be completed, we believe there is a question over whether Roy Hill will operate for a sustained period,” Credit Suisse said.

“We estimate the iron ore breakeven price for Roy Hill may be $US40/t when it is operating at the full 55mt rate.

“But in the two years prior to that, the breakeven price is likely to be much higher, perhaps $US50/t to $US55/t due to high fixed costs and general inefficiencies of employees learning how to operate a large mine and beneficiation plant most effectively.

“If iron ore prices subside to $US45/t and then recover to $US50/t as we expect, we believe that Roy Hill would burn cash in 2016 and perhaps 2017, as it ramps up.

“We wonder who would be prepared to fund the working capital during this period, as Roy Hill has no other operations to supply cash in the period.”

How much of that extremely negative commentary is a reflection of market events, and how much has been stirred up Mr Forrest playing the political card is another unknown; but it does seem that a sleeping dog has been stirred and his bite could be a lot worse than his growl.


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