reality, page-25

Hi Mozart,

I noticed your run in with the UMC devotees on their thread today and was half way on the way to get involved and then realised why bother. However, I will address your question as it seems a bit more productive. I’ve included some quick thoughts on the iron ore industry and the rail access regime from an economist’s perspective that don’t seem to be getting enough attention at the moment IMO.

The duopoly (BHP/RIO) has become an oligopoly with the addition of FMG. An oligopoly is characterised by dominant producers that control pricing, product differentiation (via ore products/contaminants/one stop shop offerings (ie coal and ore), there are thousands of small producers (that follow the pricing lead) and there are huge barriers to entry to the industry (infrastructure/plant cost etc). The barriers to entry are part of the reason why dominant producers stay dominant (wont share infrastructure), Fe grade is another.

You can be rest assured that the majors will push for a limit on the tonnage they have to offer a junior as canvassed in the access regime. It’s another barrier to entry. The draft access regime also requires the access seeker to front up with the capex to remove the bottlenecks which the provider will most likely gold plate (ie over engineer). Infrastructure providers, that are not also producers, do not typically have such requirements unless there is stranded asset risk. This effectively is a further barrier to entry by the majors. Juniors would prefer an on-going access charge to an upfront capital cost. If you have to come up with the debottlenecking capital cost, the logical extension is to consider whether you are better off combining that capital with others to build your own infrastructure.

In this regard, consider the NWIOA submission on the Hamersley Rail Declaration to the NCC. The Alliance said the resulting NPV of the capital outflows to cover the constructing and operating a dedicated railway is $2.8 billion (with a capacity of Xmtpa). The NPV of the cash outflow to cover annual access cost was given as $1.78 billion (ie transporting max 25mtpa using existing RIO infrastructure).” That’s a $1b difference in NPV. That $1b additional expenditure provides rail certainty and an offsetting revenue stream from the spare capacity in the new rail line that can be on sold (ie Xmtpa less 25mtpa). Alternatively, the $1b gap narrows for a company like BRM if the ownership of the rail line is shared with several other juniors. A first best solution is to get access (both for the company and from the country’s perspective as it is more efficient and raises productivity). However, first best often takes time and often requires the credible threat of second best solutions that I have suggested. We unfortunately live in a second best world in which self interested politicians actively seem to promote third best solutions.

The NWIOA is a step in the right direction. Alliances, mergers, acquisitions are the best means by which juniors can tackle the majors. Consolidation will be driven not only by infrastructure costs, but also by the need to lower costs as the price cycle unwinds unfavorably. The NWIOA port ambitions are just the start. It doesn’t matter whether the Alliance (perhaps in conjunction with a specialist rail company) builds a rail line or not. It’s the threat that is required to keep the majors honest. Its will be a major strategic mistake for BHP/RIO to be difficult negotiators such that another rail provider emerges. This would reduce the barriers to entry (that they can currently control through their infrastructure ownership), get more competitors product to market and thus undermine their global pricing power.

Consider for example how BRM may build a 30km spur to FMG and UMC may also contemplate a 110km spur to FMG. That’s around 150km of rail line, supplemented by an unknown amount of additional debottlenecking rail line expenditure required by the majors (by comparison both companies are around 300km from port aren’t they?). All of its upfront capital outlay and BRM and UMC will then compete for available capacity on FMG’s line.

Alternatively, high grade low contaminant UMC ore would blend quite well with BRM ore (assuming a detrital upgrade). Seems like an alliance worthy of consideration. Westcott has previously tried to alert UMC devotees to the potential to share the spur line expenditure (I can get the post number if you want). It’s a logical extension for the two to stop competing and to join forces in their need to get their resources to port and not just the FMG line. It doesn’t matter whether this example is plausible or not. My point is that HC is full of grade purists and my company is better than yours junky’s that miss the business side of infrastructure access/development and the strategic issues associated with it. Infrastructure requires scale, scale and more scale. Obviously the ideal is to have both scale and grade, whereas most will have to tradeoff between the two. Watch for market consolidation amongst juniors and for BHP/RIO to eventually sell down their rail assets (as per FMG) as their barrier to entry advantage is reduced by new infrastructure providers or by regulatory oversight. My pick is that the fourth major in Australia will come from a merger of three or four entities in which the CEO’s/boards/shareholders can control their ego’s and apply some foresight. A merged entity will have the scale and financial resources to perhaps combine with a specialist rail provider to build/operate the required rail and port infrastructure (dont look for Babcock & Brown Infastructure to get involved though!!!). China would undoubtedly throw some money into the pot as they have every incentive to see greater competition on the infrastructure front. Their current strategy of securing supply via mine ownership is less effective IMO.

These comments arent pertaining to the startup case for BRM and perhaps also for the 10mtpa case. I just struggle to see how access for 25 or 30mtpa can conceivably be aquired by BRM in the current environment. I hope I'm wrong, but that would require a first best outcome.

There are numerous other problems with the draft access regime as I read thru it. As a first draft, it’s not bad but needs to be more prescriptive in my mind and often allowed for an unjustified transfer of risk from providers to seekers. I just hope that seekers obtain some quality economic consultancy advice, preferably from states such as Queensland which have far more advanced and mature access regimes (around 10 years old). See - my states better than yours!!! I would also push for national regulator control rather than the state based regulator.