When Gina dropped an anvil on Andrew

cartoon_anvil

The coming iron ore glut got some bad news today. From the Gina’s Chanticleer:

At a time when the resources sector is beset with an endless flow of bad news, it is impressive that Gina Rinehart’s Hancock Prospecting is powering ahead towards completing $7 billion in funding for the Roy Hill iron ore mine.

Rinehart is within reach of starting to export about 55 million tonnes of iron ore every year for 25 years. At today’s prices, that would generate annual revenue of about $6.5 billion a year while employing 2000 people.

Confidence among bankers about the mine moving to financial close was bolstered by a visit from representatives of about 20 commercial banks to the mine site, 1300 kilometres north-east of Perth, in May.

The bankers would have been reassured by the fact that about $1.3 billion has been spent on infrastructure and groundwork associated with the project.

These funds have been invested in staff accommodation, a new airport that takes 737 aircraft, initial work on a 350-kilometre rail line, dredging at Port Hedland and construction of a $50 million headquarters near Perth International Airport.

Commercial bankers like the Roy Hill project for three reasons. First, it is a high quality deposit that has iron ore off-take agreements with shareholders in the mine and other parties.

Second, it is happening at a time when the cost explosion bubble in West Australia has burst. Costs remain high in the mining sector but Hancock is coming to the market for about 3500 construction workers when the workers are available locally.

…A third reason why commercial bankers are comfortable about putting aside precious Basel III capital for Roy Hill is that they are riding in on the coat tails of some of the world’s biggest export credit agencies.

Export credit agencies from South Korea, Japan and the United States are in discussions with the Roy Hill mine in relation to about $4 billion in funding.

These agencies only put their sovereign stamp of approval on projects after they have done extensive due diligence. It is believed the extent of their due diligence is causing some delays but that does not worry the commercial bankers.

Lol, yeh, yeh. The truth is, export credit agencies are government lenders of last resort. They get involved in projects for two reasons only. The first is that by definition the private sector sees the project as too risky and refuses funding. The second is to offer backdoor financing to its own sovereign companies’ export projects. In the case of Korea, it will benefit from cheaper ore and Samsung is building the mine. The US gets the benefit of shipping some more GE locomotives. Japan gets the benefit of cheaper ore.

That doesn’t mean Gina isn’t playing it smart. But it does mean that the private sector has little interest in funding the project on its merits.

In the end, though, cost of production is what matters. The inability to attract private sector funding shows that the cost per tonne is not super cheap, as it would have to be in the current environment. But it surely does mean that it’s significantly cheaper than the high cost marginal producer in the emerging cheaper ore future (ie Fortescue and notwithstanding Chinese producers), which does nothing for the prospects of Andrew Forrest.

Rio’s Pilbara 360 project quandary also deepens. It’s spent $10 billion on readying infrastructure for another super cheap 70 million tonnes of ore that could be brought to market more quickly than Roy Hill. Does it just give away that market share or go hammer and tongs and dump the price even further? Just about every broker has a buy rating on it but I would read that as a function of the distortions presented by fund management relative returns if I were you. The truth is it will either not proceed and see its net present value fall as well as watch others drive down the price, or proceed and get itself into an iron ore price war that drives down the price even further.

There is more news today that it will choose the former. Under the ludicrous headline of “Iron shortage looms with Rio tipped to delay plans” The Australian reports:

“The decision to add 70 million tonnes a year of mine capacity appears to be taking longer than previously outlined by the company, suggesting Rio may be pursuing a go-slow option,” JPMorgan analyst Lyndon Fagan said in the report.

“On this basis, medium-term physical markets may be tighter than most investors anticipate; our revised Rio projections would result in global iron ore moving into deficit in 2016.”

This is just one analyst’s view. But even if it happens, in the short term, there is still 200 million tonnes of capacity coming on line in the next year, as China slows. And in the long term, well, Roy Hill takes care of that.

I think it reasonable to conclude that if Roy Hill goes ahead, nobody but Gina and her clients will benefit. Australia will see more investment for a short while but greater rationalisation over time forced by lower ore prices. The other ore companies will all see lower profits.

Such is the reality of state capitalism.

David Llewellyn-Smith
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Comments

  1. Thanks HnH, this looks like investment that is too late in the day. Also as more and more supply arrives surely we will be looking at global oversupply soon?

    They can’t build forever can they these emerging markets vis-a-vis Pettis.

    I see a collapse in the offing.

    But hey I just watch markets and am a mere subscriber to MB.

    Thank you for the article.

    TM.

  2. “But it does mean that the private sector has little interest in funding the project on its merits.”

    Perhaps, it means that, as a result of policy decisions meaning we over-consume and run CAD’s, Aus doesn’t HAVE the savings to finance such projects?

    Perhaps it means that with what limited funds that might be available any large scale iron ore project is regarded as too risky given the time frames required before the monstrous investment generates any return?

    Perhaps we ought look at why we are not prepared to invest in our own country..either in manufacturing or mining. Perhaps we ought look at our policy of pouring all our funds into housing and infrastructure for immigration around cities?

    Perhaps lots of questions we should ask ourselves rather than continue with the great celebration of the possible difficulties that some of those who have invested in these very long term, expensive and difficult projects may face?

    Perhaps we ought question why we sit around cities in our arm chairs evjoying our Pinot Gris thinking how much smarter we are than these ‘stupid’ people who actually get up and produce something that helps to allow us to live in our self-entitled luxury?

    That said I do appreciate your sharing your knowledge. I just think your slant is wrong.

    • Dude, what on earth are you talking about? If Gina wants to pursue this good luck to her.

      I’m not going to gild the lilly on what it means, though. If you want Gina’s in-house media you know where to go.

      Your CAD obsession is ruining your comments.

  3. Hey, if Gina wants to soak up some of the soon-to-be-out-of-work mine infrastructure/digging guys & girls, even if it is on the back of a multi-billion dollar speculation on the price of ore holding up, then more power to her.

    I agree with flawse – even if she has made a turkey of herself on many fronts (her family being the first to come to mind) doesn’t mean we should beat up on everything she does (not saying that your write-up does that, just that the natural response when it comes to anything Gina is a “serves her right” attitude)

  4. Crocodile Chuck

    Ahh, the AFR is now the Mining Gazette

    “The bankers would have been reassured by the fact that about $1.3 billion has been spent on infrastructure and groundwork associated with the project”

    1) Sunk costs are irrelevant for future lending/investment decisions.

    “These agencies only put their sovereign stamp of approval on projects after they have done extensive due diligence. It is believed the extent of their due diligence is causing some delays but that does not worry the commercial bankers”

    2) So, the implication is that the credit teams of the institutional bankers of nab and Westpac can’t perform their own due diligence?

    3) Last, what about Vale and its Carajas project?

    http://blogs.wsj.com/moneybeat/2013/07/01/brazils-vale-outlook-for-iron-ore-hasnt-changed-2/

  5. Totally agree flawse. Here are 2 more perhaps:
    Perhaps we ought to be asking how countries like Norway, Saudi, Russia, Kuwait & China utilise their resources to generate positive Current Account Surplus rather than Deficit.
    Perhaps we ought to get someone to explain how a Commonwealth resource be that iron ore, coal or gas gets exchanged/gifted for a minimal lease payment + royalty.
    From my understanding and as explained by one mining CEO on ABC Lateline a couple of years ago now, the government “releases” minerals/gas to miners. No wonder that miners like the Reinhart and non-business tax paying Fortescue Minerals Group are trying to empty the till as quickly as possible before some government comes along and takes ownership of its own assets.
    Better to use savings in Super Funds to inflate land prices than manage our own resources?
    What a soft target we are.

    • You should certainly be asking how your example countries run big surpluses. The answer: the massive government taxes and industry ownership you seem to hate.

  6. Roy Hill
    Oh ye of little faith. Consider the funding mix as a form foreign aid as it seems when it comes to our resource sector others see the value of investing more clearly than we!

    Vale
    Oh ye of a lot of faith…

  7. Please show me where the 400-500 mtpy will come from once the cost of iron ore goes to 90-100 and squeezes the top percentile cost producers?

    • It won’t come. I never said it would. What will happen is the same thing that’s occurring in thermal coal and increasingly coking coal. The price will keep marching down cost curve, much further and for much longer than most think possible.

      Eventually the big low cost producers will buy up their bankrupted small competitors and consolidation will stabilsie the price around $80 long term.

      • If I/O goes to 80, production will be flat to down the next 3-5 yrs due to all the high cost production coming off line… And you think it stabilizes at 80?

        If it goes to 80 it won’t stay there long… I/O will easily be back into the 150-200 range over the next 3-7 years. Even if the big 3 buy up all the cheap high cost iron ore they won’t put it online until prices are significantly higher.

        Bottom line: iron ore is heading higher. My msg has been consistent… Why try to catch the last 10-25% downside and. Possibly miss 250-500% upside. Not a smart bet.

        Vale is a steal right now

      • The price is soon heading back to the range that was made possible by the biggest steel bubble in history?

      • Estimating the LOW point for any cyclical by Fundamental analysis is a pointless exercise because the market has a life of its own especially on the down side. Greed drives the market higher and fear guides it lower.

        As an industry insider/manager, even when you absolutely know that a market is about to turn and recover, it does not mean you can convince your bankers/investors to supply the capital needed to take advantage of the irrational under-pricing of available assets. You want to buy but you cant, the competitor wants to sell but they cant, so instead they dump product at a loss just to keep the venture alive and maintain some value (i.e. not realize their losses). Which means they drive the price even lower …ahhh

        Everyone involved hates the illogical of the lows but to be honest it is a bad managers that buys out competitors too early, we call it capitalism and this is simply the way the cyclicals game is played!

  8. Where do you see anything “bubbly”? China had the largest expansion the world has ever seen last decade and they are not done. In the next decade India will follow their footsteps.

    China is still 10-12 years away from leaking in steel consumption.