Verrender: Twiggy “disaster” unfolding

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From Ian Verrender at the ABC:

After months of seemingly erratic behaviour, Rinehart’s neighbour, Andrew Forrest, finally has begun to unveil snippets of his end game strategy.

If he pulls it off, it is a strategy that could see him emerge from the iron ore wars with a vast personal fortune and with his legacy as one of the world’s great entrepreneurs intact.

It now appears that his end game could involve selling a large portion, or perhaps even control, of his hugely indebted Fortescue Metals Group to the Chinese government.

Should that occur, it would be a disaster for Australia.

It would be a disaster for the simple reason that Fortescue, by the sheer weight of its production volumes, could be used by China as a means to permanently depress the price of iron ore and denude the nation of export revenue.

China is the largest single buyer of iron ore, accounting for 70 per cent of seaborne trade. Naturally, it has a vested interest in keeping a lid on prices. Ensuring Fortescue’s survival, and flooding the market with supply, would fit that strategy.

It is a decision that Joe Hockey ultimately will have to decide, just as his predecessor Wayne Swan was forced to confront China’s pounce on Rio Tinto in 2009.

Just like Swan, Hockey will be forced to balance the diplomatic and commercial consequences of any decision. Rejecting a Chinese government-led incursion into our biggest export earning industry would infuriate Beijing.

It could also lead to a corporate collapse, the loss of thousands of jobs and billions of investment dollars.

Given both Hockey and Tony Abbott’s willingness to support Forrest’s bizarre call for an inquiry into iron ore, it would appear they could be persuaded to take the easy path and rubber stamp a Chinese incursion.

Swan was saved the headache by a convenient offer from BHP to “merge” its Pilbara iron ore operations with Rio Tinto; an offer Rio deemed too good to refuse even though global competition regulators would never have allowed it. Which they didn’t.

It is a strategy Hockey would do well to consider.

Until recently, Fortescue was viewed as a “swing” producer. As a higher cost operation, with lower grade ore, it was always presumed that should export prices fall, it would be the first major casualty. If it did fail, tragic as that would be for employees and investors, the removal of so much supply would help boost prices and hence salvage national income.

The company’s vulnerability was first exposed in late 2012 when prices suddenly dropped below $US100 a tonne. Crisis was averted when export prices recovered. But the near death experience jolted Forrest into action and the company embarked on a singeing cost cutting regime.

So far that’s worked, even as prices have dropped to the low $US50s. But the prospect of a major lift in supply from Brazil, continued expansion from Rio Tinto and BHP and the emergence of Rinehart’s new mine could tip the balance back to Fortescue’s breaking point.

Diminutive in stature he may be, but Forrest has more front than a double-decker bus, as his recent campaign demonstrates.

First up, he called for a cartel, an alliance of Australian producers to restrict supply and boost prices. If it wasn’t illegal, it could work for a short period – until Brazil’s massive new mine came on stream.

It was an argument that also ignored Fortescue’s role in the oversupply of iron ore. In the past four years, it has been responsible for the biggest increase in iron ore supply.

Then, Forrest switched tactics. He accused BHP and Rio Tinto of rigging the market, forcing prices lower (as opposed to his earlier call to rig the market and force prices higher).

He employed emotion and bandied about pejorative terms. No longer were BHP and Rio competitors, they became “multinationals”. They had “announced” deliberate “over-supply strategies”.

The multinational tag could just as easily be applied to Fortescue. A Chinese government controlled entity, Hunan Valin, owns about 15 per cent and, apart from Forrest’s controlling stake, foreign investors loom large on the register.

For all his bluster, the charade about an iron ore inquiry now is exposed for what it truly is – an attempt to muddy the waters about increased Chinese ownership either of Fortescue mines or the company.

Never once has Forrest accused China of subsidising its own domestic iron ore production or criticised its wildly uneconomic venture with Clive Palmer. Nor is he outraged by China’s sudden cozying up to Brazil to ensure a huge lift in output.

Yep.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.